In this month’s funds overview, we revisit the exciting world of gold and especially gold trackers which provide a regular income via options writing strategies. We also look at a very adventurous way of generating a big regular income, all through a well-established and successful investment trust. We also quickly glance at a new exchange-traded fund that aims to challenge Fundsmith and Blue Whale with a concentrated portfolio of quality equities.
Gold
Gold as an asset class still looks very bullish, with the latest milestone here in the UK – it hit £2,000 per Troy ounce. In sterling terms, gold has risen by 23% since the start of this year. According to Royal Mint data in September, buying has outweighed selling by a ratio of 2 to 1 among investors, suggesting many believe the yellow metal could rally further this year and beyond. Ross Norman from the widely read Metals Daily website reckons that the heavy Chinese buying from earlier this year has resulted in a new wave of Chinese speculators buying into exchange and OTC forwards, futures and options.
According to Ross, there are some counter-trends, namely Indian demand, which “has waned after the sugar rush from the duty cut rally and domestic prices, as in Shanghai, now trade at a large discount to the loco London or international price. Traditional physical buyers are just not buying in. Middle Eastern gold buyers are going for lighter and lower caratage gold jewellery, while Chinese and Hong Kong jewellery groups report a significant decline in trade, etc etc. The market has lost its connection to its base. In the US and Europe, it is worse. Physical dealers in Germany – often second only to China in size on gold coins and bars – the physical trade has been worryingly thin. Only the UK stands out as an exception where the poor old inhabitants have been frightened to near death by threats of massive tax increases by its new government, prompting a flight to safety. But the UK is a small market. But there has been a second phase to the Chinese speculators – and that is the US speculators… they have joined the party late with futures longs now at a near 4-year high. For sure the institutional buyer has also re-emerged and the net ETF position has turned net positive probably driven by momentum plays as much as anything else (gold does well when it gets headlines – another self-reinforcing story). “
I’m still bullish on the gold price, it’s only because I think it’s a reasonable hedge against both geopolitical risk and fiscal incontinence driving ever-higher budget deficits, which in turn could produce a future fiscal crisis. Whatever the underlying driver, it’s worth revisiting a novel product I mentioned earlier this summer: the Leverage Shares Gold Income ETF, ticker GLDI.
This product tracks the gold spot price but then writes options on top, which generate income from selling those call options. When I first wrote about this exchange-traded product (ETP), that income from call option writing was running at 9.7% per annum, but that’s now declined to the current 6.7% level. In technical terms, it is an investment in a physical gold ETC from SPDR, which is then used to write upside call options to generate an income, though that yield will vary depending on the volatility (or lack of) of the gold price. It’s part of a broader product suite that uses covered call options writing for individual shares. Overall, I would argue that this covered call strategy is a tad risky for individual stocks like Nvidia or Tesla but more interesting for less volatile assets like gold.
The product launched this summer on July 22nd at $10 a share and is currently priced at $10.87 for the mid-price. One feature of this product is that the upside from the Gold Income share is capped by all that call options writing, done weekly. In simple language, that means that although you’ll capture the broad upward trend (or downward trend if the market is weak), you won’t capture all the upside, as the call option owners will benefit to some degree. But, here’s an important point: because the call writing is done every week, and the price of gold is not that volatile, you should – in theory – still capture most of the upside (or downside). Has that worked in reality?
The chart below shows the Gold Income share in black and the gold price since July 22nd in Green. As you can see, the shares are running parallel with the gold price but lagging. Since July 22nd, when I first wrote about this innovative product, the gold price has risen 11.3%, whereas the Income Shares have increased by 8.7% in value. However, the income shares will also accumulate an income consisting of 4 cents paid through to the 31st of July, another month through to the end of August and then the income for all of September. Suppose we assume a minimum of 7% monthly income from the shares. In that case, that should amount to another slug of income amounting to roughly 16 cents (that may change and is variable), bringing the total return to a level that is not far off that of the spot gold price itself.
Of course, it’s early days for this product, but the first few weeks have shown that investors are capturing most, if not all, of the upside and generating an income from exposure to gold. That makes it a potentially useful product for those who think – like I do – that gold is a long-term upward trend. Of course, you’ll make much more money if you invest in something like the Golden Prospect Precious Metals fund, which invests in gold mining equities. Over the same period since July 22nd, this fund has risen by 16 %, outpacing both physical gold prices and the Income shares.
One final note: Leverage Shares has just launched a version of these Income shares for the S&P 500. You can see the new product HERE. The principle is exactly the same—you invest in the SPDR S&P 500 ETF Trust, but every day, your options are sold to generate income. There’s no stated likely yield as of writing, but I imagine it should be fairly chunky. Watch this space to see how much income this product – the S&P500 Options (0DTE) ETP – will generate!
Adventurous Income idea – Fair Oaks
You might be under the impression that the world has gone tech crazy, that only US equities are powering ahead, and that nearly every other market is in the doldrums with little new issuance. Here in the UK, for instance, we’ve seen very few IPOs, and we’ve not had an investment trust IPO for over two years and counting. However, some markets are booming, especially in the US – many are based around the bond and CLO markets and focused on refinancing of corporate debt.
In fact, there are record volumes of CLO issuance, especially for refinancing activities for deals issued in 2021. For those who can’t remember, CLOs are one of those slightly controversial financial structures that got bad press after the Great Financial Crisis. In effect, a bunch of (mortgage) loans back in the mid-2000s were bundled and then split up into tranches, with super safe AA-rated secured at the top and very definitely not super safe equity tranches at the bottom. What could go wrong? You might ask? As it turned out, everything, as those super safe AAAs beloved by German banks fell over, and vast losses were made.
The CLO structure doesn’t have to be toxic, though, and when issued by the right kinds of corporates, it can actually be very popular and even, hold your horses, a good investment idea. If you don’t find that idea too ridiculous, there is one more argument. Those risky, subordinated equity portions of CLOs can be a good investment if you have a smart manager who can see through the loan structures, work out what works and then avoid the duds. That’s the premise behind a very successful UK investment trust called Fair Oaks Income. Its listed investment fund has been hugely popular with professional and institutional investors but could be a handy source of income, generous income for adventurous private investor types.
CLO equity has been benefiting from all the refinancing activity in recent months as it lowers the cost of debt for CLOs that have repaid a portion of their cheapest debt, improving the arbitrage opportunity for active fund managers like Fair Oaks to focus on. In total, the fund has 10% in cash plus 17 CLO equity positions and 11 CLO mezzanine investments, with exposure to 1,356 loan issuers and 18 CLO managers. It pays out its profits as dividends, which are well covered by cash earnings, and the fund’s track record in recent years is excellent – the manager has been especially smart at avoiding those US corporate issuers in deadbeat sectors such as retail and energy. Unlike most other CLO funds, its shares trade on a tiny discount of just over 2%.
I wouldn’t want anyone to think this is all low risk. It isn’t. It invests in complicated, financially engineered corporate loan structures that can and do go wrong. The key, obvious risk is default, not just on the loans at the more senior level but also on the equity at the bottom of the structure. As you can imagine, most of the borrowers are not triple AA-grade investment-grade corporates—if they were, they’d issue dirt-cheap investment-grade corporate bonds. Looking at the fund and its portfolio, the vast majority of its end borrowers seem to be B-rated, i.e. not junk but not safe.
The CLOs are all American and in America, CLOs are absolutely mainstream and used by many corporates. Also, the recent level of defaults has been low – according to fund analysts at Numis, the CLO equity investments in this fund have been running at an annualised default rate of 0.36% since inception. Crucially, many of the CLOs are over-collateralised, which means that according to Numis analysts, again, you’d need over 11% a cumulative default rate, assuming 70% recoveries, to generate a loss on the investments. Is that possible? Yes, in a crisis, but it’s not remotely normal, especially in a world where central banks are lowering interest rates. I’d also emphasise that if you think the US is about to slide into a recession, you absolutely would NOT want to invest in any corporate CLOs.
So, to repeat, this is only for the truly adventurous; it is risky, and it requires a proper understanding of how these CLOs work, but Fair Oaks is a genuinely interesting income fund generating double-digit, sustainable, cash-backed earnings and it is ideally positioned to benefit from a new world of slightly lower interest rates and a massive wave of corporate refinancing (assuming a recession doesn’t arrive first).
Fund Facts
Price $0.54
Latest NAV $0.55
Quarterly dividends : 2cents , 8 cents pa
Market Cap $219m
Discount 2.9%
Yield 14.8%
Ticker FAIR
Website: www.fairoaksincomefund.com
A quality compounding ETF
I’ll finish with another riff on an idea I’ve talked about – funds that systematically build portfolios full of quality companies on a growth trajectory whose shares are attractively priced. Last month, I mentioned the Nutshell Growth fund, which I think might be an attractive alternative to the FundSmith and Blue Whale products – Nutshell is a systematic strategy designed to buy quality stocks via a unit trust structure. This month, I want to mention another even newer idea, this time in the shape of an exchange-traded fund or ETF. It’s called the Lloyd Growth Equity UCITS ETF (GEP), and it aims to expose investors to companies of outstanding quality and superior growth profiles.
According to the funds’ managers, “Companies must have a long history of good financial performance and a strong balance sheet. They must maintain a high operating margin, consistently exhibit positive operating earnings, generate large free cash flow, and show robust returns on invested capital. The quality of the companies, the sustainability of their earnings power, and their development potential is also assessed through the analysis of 4 critical factors that Lloyd Capital defines as the 4 “M”s – Moat, Management, Market and Macro.”. It’s very similar to an actively managed unit trust, but it’s been structured as an exchange-traded fund which tracks the Solactive Lloyd Growth Equity Index CNTR (SGEPNTRC), which in turn targets companies with strong financial fundamentals and superior growth.
In practical terms, you end up with a concentrated portfolio of just 27 stocks – see the top holdings table below – with a strong bias towards technology and growth stocks (which are largely American). The fund is 63% exposed to technology stocks. One key selling point is that its cheap compared to many competitor funds in terms of fees, with a total expense ratio of just 0.85%. The ETF’s ticker is GEP.L. It’s very early days for this fund as it was only launched this summer, but the underlying index was up 22.4% over the last year, though it did register a big loss at the three-year mark. These concentrated portfolios of high quality growth stocks can be an interesting investment idea in bullish markets, driven by positive momentum. But concentrated portfolios require careful nurturing, and this fund still has to build up a longer-term track record.
Top holdings in the Lloyd Growth Equity ETF
| Name | Weight |
| MICROSOFT CORP COMMON | 7.91% |
| SERVICENOW INC COMMON | 6.94% |
| ASML HOLDING NV COMMON | 6.57% |
| THERMO FISHER SCIENTIFIC | 6.07% |
| SALESFORCE.COM INC. | 4.90% |
| ASHTEAD GROUP PLC COMMON | 4.80% |
| ADOBE INC COMMON STOCK | 4.48% |
| APPLE INC COMMON STOCK | 4.40% |
| APPLIED MATERIALS INC | 4.37% |
| AMAZON.COM INC COMMON | 4.23% |
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David Stevenson
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