Margaret Farquharson is a senior director with the Nationwide Funds Group and leads its exchange traded fund business, where she has oversight for all aspects of the business including product development, product management, marketing, distribution, and operations.
I interviewed Marge on February 28.
What was the demand that you and your team saw that led to the development of Nationwide's newest ETF, the Risk-Managed Income ETF (NUSI)?
What we've seen since the 1980s has been a steady decline in real interest rates and Treasury yields. It's become exceedingly more difficult for investors to generate reliable streams of income from traditional bond investing. Consequently, investors have sought out alternative investment strategies for generating that supplementary income that's needed to address their retirement and other cash-dependent needs in this low-rate world.
In developing NUSI, Nationwide’s aim was to provide a more thoughtful alternative to some of the more popular income-oriented strategies in the marketplace – strategies like REITs, MLPs, fixed-rate preferred stocks, high-yields and emerging-market debt. Accordingly, Nationwide sought to offer a strategy that targets a higher level of income, while mitigating some of the risks that are traditionally associated with some of those aforementioned investments. This strategy also aligns with Nationwide's overarching value proposition. If you look at our 93-year history, we've cultivated a reputation as a protection company with an unwavering commitment to helping America prepare for and live in retirement.
We wanted to provide a meaningful addition to Nationwide's already differentiated lineup of solutions that seek to deliver better investor outcomes, while managing the short- and long-term risks inherent to retirement planning. In this case, we had a targeted focus on income generation given the low-rate environment in which we are currently operating.
Secondarily, the launch of this strategy, in partnership with recognized derivative asset manager, Harvest Volatility Management, affirms Nationwide's commitment to broadening access to institutional-quality investment solutions that address the unique and entrenched needs of investors while adhering to an investment philosophy that emphasizes long-term value creation, efficient implementation, and the reliance on a diverse body of academic research and strong empirical and economic intuition.
Tell me more about NUSI, including how the strategy’s underlying investment process aids in achieving its stated investment objectives.
NUSI is a solution that seeks to simultaneously harness the income-generating potential of a dynamic protective collar and the enhanced downside protection benefit of active risk management. What you get is a product that seeks to generate high income, while providing a measure of downside protection and upside participation potential. It does that in a few ways.
First, we purchase, in full replication, the constituents of the Nasdaq-100. Secondly, we deploy a rules-based options-collar strategy that is geared towards providing a constant, fully financed portfolio hedge. To break that down a little further, an at-the-money Nasdaq-100 index call option is sold with the intent to generate a premium. We then use a portion of the premium received to purchase a Nasdaq-100 index put option. That provides downside protection, because it fully hedges the portfolio and seeks to protect against potential losses in the underlying equity portfolio. Next, we distribute a monthly income derived from a combination of options premium and equity dividends. Essentially, a managed distribution is paid to investors each month using a portion of the net credit that's generated by that collar. The remaining premium is then reinvested in the fund’s underlying stocks to allow for equity participation.
With this investment approach, investors get a consistent income stream with that monthly managed income distribution, in addition to a measure of constant downside protection and the opportunity to participate in the upside potential of the underlying equity portfolio.
So you're selling a call, using some of the proceeds to buy a put, some of the proceeds to reinvest in the equity portfolio and the remainder is being distributed to the investors. What are the potential benefits for investors in NUSI?
This strategy was fundamentally designed with income generation in mind. But what makes NUSI truly distinctive is that it offers a number of additional benefits that may further aid in addressing the yield enhancement and volatility reduction needs of investors. With this particular strategy, we seek to provide similar or higher income than traditional income-focused investment – some of those solutions that we talked about earlier including REITs, MLPs and high-yield bonds – but with less volatility than traditional equity-based income solutions.
Investors may benefit from a systematic payment of a monthly distribution with the reinvestment of a portion of the options premium, allowing for market participation. Further, the Fund seeks to provide a reasonable measure of capital appreciation, alongside the added benefit of downside risk mitigation in a volatile market environment. Investors may also derive enhanced diversification from this solution, relative to existing income-focused portfolio allocations, stemming from the fact that the fund exhibits less sensitivity to credit and duration risk, interest rate changes, and commodity risk. Finally, NUSI seeks to offer enhanced tax efficiency, attributable to the use of highly liquid index options, which are subject to a lower 60/40 tax rate.
Where does NUSI fit in an investor's portfolio and how have you seen it typically used?
NUSI offers income generation in concert with the added benefits of volatility reduction and downside risk mitigation. It is a robust selection for investors who are seeking to enhance and diversify a core-income-focused portfolio allocation.
One of the central use cases for this product is as a compliment to a traditional 60-40 allocation. The fund may essentially enhance the yield generated by the fixed income allocation, while also reducing the volatility derived from the equity allocation. This product can additionally be used as a bond alternative that may provide investors with greater flexibility across different markets environments.
The fund employs a thoughtful approach to navigating uncertainties around interest rate moves and bond price reductions in a yield-starved environment. Accordingly, the product may also be used in a portfolio as a volatility dampener that augments existing investment processes, whereby it can be employed as a less volatile tool for maintaining equity exposure, given that the strategy offers a fully financed constant hedge, which seeks to provide that measure of downside protection that we talked about. Further, NUSI can be used as a tool that may aid in supplementing current income in the midst of this low-yield environment or conversely, in a rising-rate market with the potential decline in the value and liquidity of fixed income portfolios.
How might NUSI specifically improve investor outcomes relative to other income generating strategies?
The high income potential of some of the more popular income-oriented solutions that we have discussed has been a major draw among investors. However, there is a caveat whereby the enhanced yield profiles of those investments are often accompanied by a unique set of risks and challenges that may not necessarily be commensurate with the value add stemming from enhanced income.
NUSI seeks to generate a high level of income while mitigating some of the risks that are traditionally associated with those other income-generating strategies. For example, NUSI seeks to exhibit materially less interest-rate sensitivity, relative to REITs and high-dividend equities. Additionally, NUSI seeks to offer the capital appreciation and upside potential benefits that are traditionally overlooked by MLPs and fixed-rate preferred securities. Finally, NUSI limits idiosyncratic risk and seeks to eliminate investor exposure to the credit and cross-border risks characteristic of high yield and emerging market debt investing.
I'm going to switch gears a little. We're going to publish this article on International Women's Day, which is March 8th. What advice would you offer to young women who want to pursue a career in investments and finance and aspire to a leadership role such as you have?
I love the idea of this piece and I give serious props to Advisor Perspectives for showcasing the important role of women in our industry. This is very exciting.
If I were to share some advice with younger women who are interested in pursuing a career in investments and finance, the first thing I would say is to be a forever student. Never think that you know everything. There are tremendous resources and absolutely amazing figures in our industry who are willing to share their expertise and their experience in this space. Our industry is dynamic. It's constantly changing. To be successful long term, it's absolutely imperative on younger professionals to develop relationships with those individuals who can pass along their experience and their expertise and of course, to study the industry and get to know the space very well.
Secondly, persistence is absolutely key. We've had a crazy week in the markets and sometimes working in this industry can be a real grind. Having that thick skin and being willing to work hard is absolutely imperative to long-term success in this space.
Finally, understand and appreciate the importance of relationships. At the end of the day, this is a relationship business – how we serve investors, our partners, and our colleagues is everything. I encourage young professionals who are looking to pursue a career in this space to cultivate strong relationships. A big part of that comes back to empathy and demonstrating a steadfast commitment to learning about the experiences of the individuals with whom we work on a day to day basis.
Thank you for that advice. I look forward to sharing it with our readers. Coming back to the original question that we posed in this interview, if there's one piece of advice that you would offer to advisors who are considering the array of strategies that can generate income and offer downside protection and are looking for an analytical framework to evaluate those choices, what would that be?
Protection and income generation go hand in hand and serve as the foundations for well-constructed portfolios that succeed in building substantial and reliable streams of income. With that in mind, the piece of advice I'd share is to look under the hood when assessing different income-oriented strategies, particularly from a risk perspective. Do a deep dive into the sensitivity to risk that comes with those investments. Evaluate how those strategies would perform in different market environments in order to ascertain whether that enhanced-yield profile is in fact commensurate with the level of risk that you'd be taking on with different investments.
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Margaret Farquharson is a senior director with the Nationwide Funds Group and leads its exchange traded fund business, where she has oversight for all aspects of the business including product development, product management, marketing, distribution, and operations.