Targeting Distribution Rates to Manage Cash Flow Needs

 

 

 

Nasdaq HANDLS™ (High-Distribution AND Liquid Solutions) Indexes were created to address the needs of high-net-worth investors who require predictable distributions to manage monthly spending needs. HANDLS represent a new indexing category called Target Distribution Indexes. Nasdaq HANDLS Indexes seek to employ well-diversified, multi-asset portfolios to deliver total returns over time sufficient to support a stated, target distribution rate while taking advantage of the low expenses and tax efficiency of exchange-traded funds (ETFs).

Nasdaq HANDLS Indexes employ well-diversified, multi-asset portfolios of low-cost ETFs, relying upon diversification to reduce the level of idiosyncratic risk posed by individual securities. By reducing or eliminating such security-specific risk, diversified portfolios can produce higher risk-adjusted returns than undiversified portfolios. The use of low-cost ETFs ensures that the benefits of diversification are not subsumed by the cost of obtaining exposure to different asset categories and investments. The target return/distribution can be enhanced by increasing the exposure to the optimized portfolio using limited amounts of leverage. For example, the Nasdaq 7HANDL Index was specifically developed with the goal to support, from total return, a 7% distribution rate by incorporating 23% structural leverage, while the Nasdaq 5HANDL Index was designed to support a 5% annual distribution without any leverage.

The second key component of the Nasdaq HANDLS indexing solution—a target distribution rate that seeks to systematically monetize the expected total return of a portfolio over time—responds to the needs of investors who require regular and predictable monthly distributions. The Nasdaq HANDLS™ indexing solution amortizes its distribution over 12 monthly payments, which eliminates the need for regular piecemeal sales of investments to generate cash flow and potentially trigger the recognition of capital gains. The solution offers the potential to earn a total return that fully supports a consistent, high distribution over time using a low-volatility strategy that is approximately 70% fixed income. Of course, there can be no guarantee that a given Nasdaq HANDLS™ index will earn a sufficient total return to support its target distribution rate, but the potential for capital appreciation exists.

An extra benefit is that a significant portion of a distribution received from a fund benchmarked to a Nasdaq HANDLS Index may be classified as return of capital. Investors frequently require regular cash flows to address funding a lifestyle. Holding all else equal, the investor may be indifferent to the source of cash flow, which could come from current income, capital gains or even return of capital. However, all else isn’t equal as each is taxed differently, or in the case of return of capital, isn’t taxed at all. This being the case, investors seeking high distributions may wish to incorporate return of capital as part of a distribution plan, particularly if a client’s applicable estate-tax situation allows for a step-up of cost basis upon estate dissolution. Furthermore, if underlying investments, such as ETFs, allow for potential capital growth to accrue while seeking to minimize the realization of capital gains, these unrealized gains can offset part or all of the returned capital in a fund’s net asset value.

The teachings of modern portfolio theory can be effectively deployed to help manage the cash-flow needs of high-net-worth investors. Research suggests that investors may enhance risk-adjusted returns by modestly employing leverage to increase exposure to a well-diversified, balanced portfolio while minimizing the idiosyncratic risk posed by concentrated investments in high-yielding asset classes. Combining these principles with a high target distribution provides an additional potential benefit to investors -- minimizing the need to maintain an excessive amount of cash reserves, an asset class virtually guaranteed to not keep pace with a high required drawdown and the effects of inflation. By building well-diversified, balanced portfolios of low-cost ETFs and enhancing potential returns, investors seeking high monthly cash flow can minimize idiosyncratic risk posed by concentrated investments and earn higher risk-adjusted returns.

 

HANDLS™ Indexes have been licensed to Strategy Shares as the benchmark indexes for the Strategy Shares Nasdaq 7HANDL Index ETF (HNDL) and the forthcoming Strategy Shares Nasdaq 5HANDL Index ETF (FIVR, anticipated to launch on the Nasdaq exchange December, 2018). For more information please visit Strategy Shares

 

For more information on the Nasdaq 7HANDL Index, please see Managing for Drawdown, First Target Distribution ETF Seeks to Help Investors in Retirement.

 

 

 

HANDLS™ and HANDL™ are trademarks of Bryant Avenue Ventures LLC.

 

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