LQDW: An Innovative Approach But Unclear In The Near Term

The only way to get rid of temptation is to yield to it… I can resist everything but temptation. – Oscar Wilde.

There’s been a slew of new exchange-traded funds, or ETFs, recently that are taking popular investing themes, overlaying an options strategy, and enhancing yield. I’m a fan of the innovation I’m seeing with these types of products, but not all ETFs are created equal even with juiced-up yield. The iShares Investment Grade Corporate Bond Buywrite Strategy ETF (BATS:LQDW) is one that has gotten some good buzz, but I’m just not a big fan of relative to just allocating to LQD directly.

The BuyWrite Strategy: A Brief Overview

A buy-write strategy is a method used in investment where an investor buys a financial instrument and writes (sells) call options on that same instrument. This strategy can effectively generate additional income while potentially reducing the overall volatility of the portfolio. This approach is often employed in periods of low volatility when the markets are expected to trade in a narrow range.

Launched by BlackRock Inc. under the iShares fund family in August 2022, LQDW is one of the first ETFs to apply a buy-write strategy to the bond market. The fund essentially holds a core position in the long-only iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD), while also selling one-month call options on the same ETF. The fund aims to write call options up to the full value of the underlying exposure, thus creating a 100% coverage.

The income generated from the premium received for selling the options adds to the regular cash flow of the fund, which is then used for portfolio management and regular income distribution. While the upside potential of the fund is capped due to the selling of call options, the downside risk is partially mitigated by the premium received, thereby reducing the overall volatility.

Performance of LQDW ETF

Total return results have been a mixed bag. If we look at the price ratio of LQDW relative to LQD (total return), we see that that fund has actually underperformed. In fairness to the approach, it happened to launch in one of the greatest bond market dislocations of all time. Still, this does emphasize the point that yield alone doesn’t make for a stronger return profile. If/when a credit event happens, I’ll be particularly curious to see how the strategy behaves.

LQDW ETF: A High-Yield Component In A Diversified Portfolio

The LQDW ETF can serve as an excellent high-yield component in a diversified portfolio. With a strategy focused on reducing volatility and generating a higher yield, the fund can provide a steady income stream for investors, making it a reliable choice for income-focused investors.

The fund’s monthly distribution, yielding more than 19% over the last 12 months, is particularly attractive for investors seeking regular income. However, it’s important to note that a portion of this distribution is classified as a return of capital (ROC), which lowers the original cost basis of the investment and defers the tax liability until the final sale of the fund.

Conclusion: An Innovative Approach With Potential Benefits

The iShares Investment Grade Corporate Bond BuyWrite Strategy ETF offers a unique approach in the investment landscape. By applying a buy-write strategy to the bond market, the fund presents a compelling proposition for investors seeking to reduce volatility and enhance yield in their portfolios.

While the fund’s strategy may not appeal to all investors, particularly those bullish on bonds, it does provide a novel option for those seeking innovative investment strategies. However, despite its innovative approach, some investors like myself may prefer traditional methods. Regardless, iShares Investment Grade Corporate Bond Buywrite Strategy ETF is worth keeping in your toolkit.

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