ETF Income Strategies for Defensive Investors

We feel that because the way the strategy is structured, it's able to potentially thrive regardless of the direction of interest rates because of the two screens that it implements.

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Today we are pleased to have with us Chandler Nichols, vice president of ETF product at Advisor Asset Management.

Chandler, it's great to see you again.

Great to be back.

The Fed seems unsure where interest rates will go.

How is the AM SLC lowduration income ETF ticker Loi managing the current uncertainty about inflation and rates? a great question and uh you know just to set the stage and give a quick primer on the strategy.

Loi is it's an actively managed ETF.

It's subadvised by SLC fixed income who's an affiliate company of ours here at AAM.

Uh they have a vast amount of experience in managing different types of fixed income portfolios with with well over 140 billion in assets under management.

Um and the value that this particular strategy of theirs uh and what it's providing in this what we call a stagflation light environment um is its fundamental bond picking strategy.

So regarding interest rates just to answer that part of the question Loi actually seeks to stay duration neutral to its benchmark.

Um so typically its duration tends to hover anywhere from one and a half to two years.

So definitely on the lower end of the duration spectrum.

Um the primary value ad from that strategy typically comes from that security selection process and the ability for the portfolio managers to stay unconstrained from a sector standpoint where they can invest in other security uh other security types outside of just your typical corporate credit sectors.

So think asset back securities, commercial mortgage back securities, collateralized loan obligations or also known as CLOS's.

Uh so right now these sectors are a bulk of the portfolio and where the managers have been taking profits where necessary and then redeploying that capital uh into higher quality uh securities within those particular sectors.

So um that's how we feel that the strategy is really able to navigate um both of those sides of the current environment.

What specific sectors or credit qualities is the fund currently rotating between and why?

Yeah, definitely it's a good good uh good question to get a little deeper into. um you know the set the stage load eyes portfolio.

It's largely an investment grade portfolio.

So for example, right now most of its exposure can be found anywhere from uh from single A rated to tripleB rated debt.

So on the lower end of the investment grade spectrum and from a sector standpoint in particular, it's largest overweights are found within primarily that CNBS and ABS sector.

Um now most of the positive spread opportunities are where the PMs feel that um that where they can potentially find more value ad opportunities in order to outperform uh other corporate credit like um counterparts uh in the marketplace.

Now of these two subsectors ABS has typically encompassed the bulk of the strategy sector exposure um for for the vast majority of its inception.

CNBS is a is a it's actually a newer overweight where they're seeking to find uh loans backed by higher quality properties that are demonstrating a level of positive relative valuations to other securitized segments.

Um you know going into this year uh credit spreads were already pretty tight across multiple uh types of fixed income sectors to begin with.

Now that spreads have widened a bit uh post uh pre-liberation day as they called it. um there's a lot more opportunity in some of these more deep value sectors uh in the marketplace.

What investors does the AAM SLC low duration income ETF ticker Loi especially appeal to?

Yeah, so we feel there's two types of investors this appeals to.

Um, one is that cash plus investor uh who's willing to take on a level of credit risk and a level uh and an uptick in duration risk in order to potentially increase uh both their income potential but to also increase the inflation beating characteristics of their fixed income portfolio as well.

So I mean it's important to remember while cash and money markets and money market alternatives they are safer instruments and they feel safer but their ability to drive uh inflation beating returns in the long run uh is definitely on the lower end of the spectrum.

So we feel loadi could potentially be a good complement for those types of investors looking to increase their income potential.

Um the second type of investor is the core fixed income investor. that value ad from that bottoms up fundamental uh bond picking strategy uh could potentially be a nice fit here for an investor who's one seeking to lower duration to be a little more defensive on that front but also looking for sector diversification uh as well.

I mean for example the uh the Bloomberg aggregate bond index it's basic basically one of the most well-known uh bond indexes out in the marketplace typically has minimal exposure uh to securitize sectors as do other broad benchmarks out there.

So, so overall we feel load can be a good complement to those types of strategies to increase sector diversification.

So, um to investors overall we feel load can be uh you know a nice potential choice for the AAM lowduration preferred and income securities ETF PLD is also a lowduration fixed income fund.

How does the current interest rate environment affect it?

Yeah, I mean to to set the stage on what PFLD is to be uh is to begin with uh you know we just went through LOI.

LOI is an actively managed ETF but PLD is actually an index based strategy.

So um we feel that because the way the strategy is structured it's able to potentially thrive regardless of the direction of interest rates because of the two screens that it implements.

So it starts off with a broader universe of the US preferred stock landscape and incorporates a duration screen where upon its monthly rebalance PLD will seek to remove any preferred stocks with a duration above uh that of 5 years or more.

Um but on the flip side it'll also remove preferreds that are trading uh greater than 5% uh to the face value uh of the preferred uh as well.

So basically in that higher interest rate environment or rising interest rate environment um preferred duration stream could potentially help uh navigate a time of higher interest rate volatility and uh potentially lower the volat volatility of the strategy uh in comparison to other like longer duration counterparts.

Um but that call screen as I mentioned earlier is what I like to call it um is uh potentially could thrive in a lowering interest rate environment.

So um you know to take a step back preferred stocks overall are typically issued with embedded call options to give the issuer the right the right to call that back.

So PLD if they it had a by able by being able to navigate through those types of risks PLD could potentially uh mitigate uh its exposure to those types of securities in order to lower the level of reinvestment risk that could occur in the portfolio.

So two twopronged uh approach while low durations in the name it's a we view PFLD as a pretty evergreen strategy regardless of the direction of rates.

How do LOI and PFLD complement each other in a fixed income allocation and what are the key tradeoffs between corporate bonds and securities versus preferred securities for income generation?

Yeah.

So to to start with the latter question first when comparing you know uh the overall capital stack you know you very high level you have your corporate bonds uh on the higher end prefer then preferred shareholders will get paid uh after bond holders and then common equity holder dividends are paid thereafter.

So because preferred sit in the middle of that they're typically known as hybrid securities and they tend to have characteristics of each both bonds and equities.

So when complementing uh them together, the investor um should be aware of that PFLD is viewed as the quote unquote higher volatile investment relative to LOI because it's investing in a basket of preferred stocks.

Now the trade-off there is that PFD would also be expected to have a higher level of income potential and also a potential a higher level of uh inflation beating return potential as well.

So um that's the trade-off in terms of preferred um and how we view those strategies in a portfolio.

And you know just to also um you know uh answer the question in full in terms of the PFLD benefits versus LOI is the potential tax efficiencies of preferred stocks.

So preferred stocks in general uh tend to have the ability to have their dividends treated as uh as qualified dividends.

So an investor is not just looking for higher income but higher after tax income could be another way to see these two together in a in a potential portfolio mix.

What investors does the AAM low duration preferred and income securities ETF PFLD specifically target?

Yeah, typically typically two types here again.

So one is the fixed if the fixed income investors seeking to really increase their after tax income potential.

Let's say the most common um swap story we hear about in the preferred space typically happens within the near below investment grade or the below investment grade market that high yield bond space.

We've seen investors either complement uh the two together or fully replace their high yield bond exposure with preferred in order to potentially, you know, keep risk in a similar range to what they've been accustomed to on the high yield bond side, but while increasing the income potential and increasing the tax efficiencies as well.

So being able to achieve a higher level of tax efficient income is a a general story with preferred stocks and how uh they could potentially be a benefit relative to bonds who are typically taxed at uh at higher ordinary income tax rates.

Um but for the second investor type that we feel PFLD could be a fit for is actually the defensive equity investor too.

So um taking a step back, preferreds are typically issued the largest issuers of preferred tend to be large financial institutions.

So think like your largest banks.

So an investor that either currently has exposure to this segment of the market or uh is seeking to increase their banking sector exposure, maybe they want to play that in a more defensive manner.

Instead of going to the common equity side of the space, they can look to the preferred side of the space.

So that's where we also feel PLD could be um an enticing option as well.

Uh so yeah, again, two two different types of investors, but we feel PLD can be a good fit for for both of those.

Thank you, Chandler, for your timely insights.

Thanks for having me.

Please visit aamlive.com.

I'm Britney Mason with ETF Guide.

Thanks for watching.

We'll see you next time.