Everyone loves a monthly dividend paying
ETF, which is why so many dividend investors gravitate towards funds that
use covered call strategies. Funds like QYLD, XYLD, RYLD, JEPI, NUSI and more use covered calls to generate monthly
dividends that pay up to 12% annually. And while that kind of yield may sound appealing,
there are usually some trade-offs investors make because of the strategies these ETFs use. Most
notably, investors will be trading off growth potential in favor of collecting that monthly
income, which typically means that you’ll earn lower returns than the total market as
measured by something like the S&P 500. However, the DIVO ETF from
Amplify ETFs is a different story. This is the Amplify CWP
Enhanced Dividend Income ETF, which I’ll be referring to as DIVO in this video.
It pays a monthly dividend of about 5% annually, and at first glance, it checks a lot of the
boxes I want to see from a dividend income ETF. So in this video, we’re taking a deep
dive into the DIVO ETF and its strategy to determine whether it deserves a spot in a
dividend investing or passive income portfolio. As usual, we’ll start with a basic
overview of the fund’s strategy before taking a closer look
at their stock portfolio. Then, we have to discuss the stand-out feature of
this fund, which is their covered call strategy. This is very different from what we
see with other covered call ETFs, so we’ll cover how it separates
DIVO as a dividend income strategy. Afterwards, we’ll take a look
at the distributions and what this means for taxes on your monthly dividends. Finally, we’ll wrap up with my personal
thoughts on this fund and how you can get some free cash to invest in DIVO or
any other stocks, so let’s get started. The first thing I want to highlight about DIVO is
that while the fund is offered by Amplify ETFs, the strategy itself is managed by Capital Wealth
Planning, which is an investment advisory firm that mostly serves institutions. CWP has teamed
up with Amplify ETFs to bring this fund to the market, so if you want to dig deeper into
the management team, be sure to check there. But, the strategy laid out by the
DIVO ETF is fairly straightforward. They aim to provide monthly income with
the potential for capital appreciation. To do this, the managers at CWP select a
portfolio of large-cap dividend paying stocks with a history of dividend growth. In addition
to this dividend stock portfolio, they’ll sell covered calls on individual holdings. We’ll cover
this in-depth in a few minutes, but this is unique because they’re strategically selling covered
calls on individual stocks as opposed to an index or the entire portfolio, which is something
we don’t see often with covered call ETFs. Ideally, this combination of dividend growers and
covered calls should fulfill that goal of income and capital appreciation to provide competitive
total returns with lower levels of risk. In terms of the income sources, they expect to
produce 2-3% of the annual yield from dividend income. This shouldn’t be much of a surprise, as
that’s a pretty reasonable yield for a large-cap dividend growth portfolio. Additionally, they
expect to get an extra 2-4% of their annual yield from writing covered calls and
collecting the option premiums. Finally, DIVO comes with a .55% expense ratio,
which is pretty on par with other covered call strategies, and I think pretty justified
considering it’s an actively managed fund. So with that, let’s take a closer look at
DIVO’s approach to their stock holdings. As we said, they focus on large-cap dividend
stocks with a history of dividend growth, which is going to be pretty exclusive to stocks
in the S&P 500 index. Out of the potential stocks, the managers at CWP select just 20 to 25 holdings
for the portfolio. We don’t have a whole lot of additional details on how they’ll select these
stocks, except for that they screen them for some basic qualities like the company’s track
record, earnings, cash flow and return on equity. But, we do know that they try to keep these
holdings diversified across sectors similarly to the balance of the S&P 500 index. This is going
to be a key part of the strategy that helps them track the performance of the S&P 500 without
holding the entire index. However, the managers may over- or underweight holdings depending on the
market environment. According to the CWP website, they do this to participate in defensive
and cyclical trends in a given environment. So as far as the stock selection methodology
goes, this is a pretty standard outline for a large-cap dividend fund. Ultimately, it’s all
up to the managers at Capital Wealth Planning, which can either work for or against you
depending on whether they make the right choices. But let's take a look at the current portfolio,
with the latest update published on June 30th, 2021. Starting with the sector allocation, we
can see that the DIVO portfolio does match the S&P 500 sector allocation pretty closely.
The biggest difference that stands out to me is that the S&P is a little heavier in
information technology. My guess here is that these are lower dividend companies that
by some metrics are considered overvalued, and therefore have a reduced weight in
the DIVO portfolio. But, DIVO still has exposure to heavyweight tech with Microsoft and
Apple both holding top positions in the fund. And in the operating year of 2020, this strategy
appears to have worked exactly as expected. They collected about two-fifths of their
investment income from dividends this year, which is right in line with
the income goals they outline. I don’t think there’s much else worth
mentioning with the stock portfolio, except for one more caveat of active management
that I want to highlight. According to their annual report, their portfolio turnover rate
for last year was 86%, and even higher in the years prior. This means that the management
is trading in and out of holdings quite often, which again could be good if they’re making
the right calls, but that’s not a guarantee. Most often, high portfolio turnover comes at a
cost to the investor because it means more costs are being incurred by the fund, reflected
in management fees, and distributions may be taxed higher. I just get a little concerned
when I see that much trading within a portfolio, but if you find active trading to be an advantage,
then maybe you’ll see this as a positive. Now we have to discuss the covered call strategy,
which produces most of the DIVO dividend. Again, the unique feature of this fund is that
it actually sells covered calls on individual stocks in its portfolio, rather than on an
entire index. This is completely different from just about every other covered
call ETF I’ve reviewed on my channel, because they all sell covered calls on
either the S&P 500 or the Nasdaq 100. If you’re unfamiliar with covered calls, it’s
an options strategy that allows you to earn cash when you own the underlying shares, but
you give up growth potential in the process. You’re essentially selling someone else the
right to buy your shares if the price goes up. If the price does go up, you have to sell your
shares at a fixed price, but if it doesn’t, then you keep your shares and the cash you were
paid for the covered call contract. I’ve covered this plenty in other videos, so be sure to check
any of those out if you need more information. The main benefit of DIVO selling covered calls
on individual holdings is that they can be more strategic with how they generate income. Most
covered call ETFs sell covered calls on the entire portfolio, which gives up growth potential for
the entire portfolio. Plus, when sold on an index, there aren’t really any chances to
capitalize on opportunities in the market. DIVO, however, is able to both
preserve the growth of its portfolio and maximize its covered call income
using an individual stock approach. According to CWP, they’ll monitor their stocks
for strength or an increase in implied volatility. When a stock price increases, or its volatility
increases, the cash premium earned from a covered call will also increase. So DIVO management sells
covered calls when these opportunities arise, enabling them to earn the highest possible
cash premium with their options strategy. As outlined on the CWP website, they sell
short-term covered calls on approximately 30 to 60% of the portfolio. These short-term calls
ensure consistent cash flow, which can help with the monthly dividend distributions. And again,
selling calls on only a portion of the portfolio ensures that the rest of the portfolio
has the potential for continued growth. So overall, this “tactical” covered call
strategy is a clever way for the fund to generate substantial income, but also
allow its assets to continue growing, which is something missed far
too often with covered call ETFs. I also really like that you can actually see
the covered calls sold by DIVO, whereas most index-based covered call strategies
can be difficult to find details on. If you visit the amplify ETFs website, you can
check their current list of holdings, which includes their covered call positions. This page
shows the options’ expiration dates, strike prices and how many contracts they hold, so you always
know exactly how the fund is using covered calls. Interesting note here, this screenshot shows
that the covered call contracts have been written against a little under 20% of the portfolio. This
is short of that 30 to 60% estimate outlined by CWP, which may just be an effect of the
current market environment. In any case, it’s great to know that we can always check back
and see updates on their covered call positions. Hopefully you now understand why DIVO’s approach
to covered calls can offer some benefits, but you might be wondering how it actually
compares to other covered call strategies, some of which still offer higher yields. However, this comparison requires looking at
more than the dividend yield, because as we said, DIVO offers more growth than is traditionally
found in covered call strategies. We need to look at total returns to figure out how this fund
has performed and might perform in the future. DIVO hit the markets in December of
2016, which gives us a little less than 5 years to look back on. But, the performance
during this time hasn’t been too bad at all. Since inception, DIVO has delivered average
annualized returns of about 14 and a half percent. Keep in mind about 5% of this is
made up of the annual dividend, while the rest will be of returns through
appreciation of the stock portfolio. At the bottom, we have a revealing comparison
to the CBOE S&P 500 buy-write index. These are the returns you would’ve received if you bought
into the S&P 500 index and sold a covered call on 100% of that investment, which again, is what
most covered call ETFs do. However, this strategy produced less than a 7% annualized return since
2016, which is less than half of DIVO’s return. So clearly, DIVO is successful in delivering
monthly dividend income from covered calls, but is also successful in delivering growth on
top of that income for higher total returns. The other comparison to the
S&P 500 total return index, which measures the annual returns from
dividends and growth in the S&P 500, shows a slight underperformance by DIVO. It is
expected that covered call strategies miss out on some of the growth of the market, but it is
cool to see that DIVO has stayed pretty close. We can dig even farther back than 2016 thanks
to capital wealth planning, as they have been tracking this strategy since 2013. The numbers
look a little worse in these earlier years, but it is good to know that the strategy still
consistently beats the S&P 500 buy-write index. Even compared to the QYLD ETF, which writes more profitable covered calls on the
more volatile Nasdaq 100 index, DIVO looks pretty good. QYLD has historically
produced about 9% annualized total returns, which is better than an S&P 500 buy-write strategy,
but worse than the tactical strategy of DIVO. So while DIVO may produce slightly lower
dividends than these pure covered call strategies, it definitely produces higher total returns,
which is an important consideration for any investor who wants both growth
and income from an investment. The last thing to discuss is
taxes on your DIVO dividends so you can get a full picture of what
to expect from this dividend income. The first thing I check for with
income funds is return of capital, because it means that you have to take a much
closer and more critical look at the dividend income. Return of capital means that the money
distributed technically comes from your initial investment. It’s not immediately taxable, but
it reduces your cost basis in your investment, so you’ll owe greater taxes when
you sell your shares. Sometimes, this is a red flag that the fund can’t afford
distributions. Return of capital is definitely a complicated subject but I did a whole video
to break it down if you need to learn more. So first I checked the 2021
dividend distributions, which have been approximately 71%
return of capital for the year. I looked back at the annual report, and
found that in 2020, approximately 60% of dividends were a return of capital. However,
they used absolutely no return of capital in 2019. A general rule of thumb is that
return of capital isn’t a bad thing if the fund is able to continue
growing its NAV. As we can clearly see, DIVO has had no issue growing since its
inception, which is very reassuring. My guess is that DIVO realized some substantial
losses during the early months of 2020 as the pandemic crushed the markets. Since they
collected plenty of dividends and covered call income in 2020 and 2019, they were able
to continue paying dividends as expected, but were able to call them a return of capital
thanks to the losses they experienced. This is a sneaky accounting tactic I covered in my
return of capital video, and it actually comes as a benefit to investors, because they’re
able to delay taxation on their dividends. But they won’t be able to do this forever, so
I looked back to the taxes on 2019 dividends to figure out what investors can expect
in the future. I apologize for this really ugly screenshot, but this is all Amplify
ETFs has on the site. In 2019, DIVO paid out roughly 14¢ per share each month, about 8¢
of which was considered a qualified dividend. This means a little over half the dividend will
receive the qualified dividend tax treatment at the long-term capital gains tax rate. The rest,
which is made up of profits from covered calls, is considered income, and therefore taxed as
such under the short-term capital gains rate. Also shown is a distribution of capital
gains, which could be a mix of the two depending on the fund’s activity - we just
don’t have enough information to know for sure. But overall, this really isn’t too much of a
surprise. The current use of return of capital isn’t showing me any red flags, but those tax
advantages won’t last forever. Over the long-term, investors can probably expect the qualified
dividend rate on about half their dividends, and income taxation on the other half, as a very
rough estimate. This is because most of their income comes from covered calls, which is almost
always taxed at the short-term capital gains rate. So if I didn’t bore you to death with taxes and you’re still interested in hearing my
thoughts on DIVO, I like what I see. After reviewing a handful of covered call ETFs, I’ve been consistently disappointed
in how little growth they can achieve. The tactical covered call strategy of DIVO is
something I have yet to see any other ETF do, and it clearly works well to achieve a combination
of monthly income and capital appreciation. However, keep in mind that this is
my perspective as a growth investor who wants the highest total returns.
If you are simply looking for a high yield investment that can pay all of its
returns in the form of a monthly dividend, you might not care that other covered
call strategies fail to deliver growth. The only thing that makes me a little uneasy
is the small portfolio of holdings and the high turnover rates, both of which can be
dangerous in the hands of poor management. But, DIVO seems to be doing fine so far, so it’s
by no means a dealbreaker for me just yet. I’ve been learning a lot about different covered
call strategies lately, mostly from my research into these covered call ETFs, and I’m really
starting to think that the covered call ETF is just a convenience. As DIVO proves, selling
covered calls yourself on individual holdings can be more profitable and may produce higher
total returns and growth in your portfolio. Investors can definitely get easy access
to the strategy with ETFs, but you can save on expenses and get much more flexibility by
learning and executing the strategy yourself. But whether you like DIVO or want to stick
with some of the traditional covered call ETFs, I would highly encourage you to check out the M1
Finance platform. It has automatic rebalancing and dividend reinvesting, which are really
powerful tools for the passive dividend investor. I’ve personally been using the platform for
months and find it to be the perfect brokerage for long-term investors of any experience
level. Plus, they currently give you $50 for free when you open and fund an account, which
you can do by using the link in the description. So check that out if you’re interested, drop me a comment if you have any questions or
feedback, and I’ll see you in the next video.
