A Dividend Income Strategy That Actually Works! (DIVO ETF) - YouTube

Everyone loves a monthly dividend paying  ETF, which is why so many dividend investors  

gravitate towards funds that  use covered call strategies.

Funds like QYLD, XYLD, RYLD, JEPI, NUSI and more  

use covered calls to generate monthly  dividends that pay up to 12% annually.

And while that kind of yield may sound appealing,  there are usually some trade-offs investors make  

because of the strategies these ETFs use. Most  notably, investors will be trading off growth  

potential in favor of collecting that monthly  income, which typically means that you’ll earn  

lower returns than the total market as  measured by something like the S&P 500.

However, the DIVO ETF from  Amplify ETFs is a different story.  

This is the Amplify CWP  Enhanced Dividend Income ETF,  

which I’ll be referring to as DIVO in this video.  It pays a monthly dividend of about 5% annually,  

and at first glance, it checks a lot of the  boxes I want to see from a dividend income ETF.

So in this video, we’re taking a deep  dive into the DIVO ETF and its strategy  

to determine whether it deserves a spot in a  dividend investing or passive income portfolio.

As usual, we’ll start with a basic  overview of the fund’s strategy  

before taking a closer look  at their stock portfolio.

Then, we have to discuss the stand-out feature of  this fund, which is their covered call strategy.  

This is very different from what we  see with other covered call ETFs,  

so we’ll cover how it separates  DIVO as a dividend income strategy.

Afterwards, we’ll take a look  at the distributions and what  

this means for taxes on your monthly dividends.

Finally, we’ll wrap up with my personal  thoughts on this fund and how you can  

get some free cash to invest in DIVO or  any other stocks, so let’s get started.

The first thing I want to highlight about DIVO is  that while the fund is offered by Amplify ETFs,  

the strategy itself is managed by Capital Wealth  Planning, which is an investment advisory firm  

that mostly serves institutions. CWP has teamed  up with Amplify ETFs to bring this fund to the  

market, so if you want to dig deeper into  the management team, be sure to check there.

But, the strategy laid out by the  DIVO ETF is fairly straightforward.  

They aim to provide monthly income with  the potential for capital appreciation.  

To do this, the managers at CWP select a  portfolio of large-cap dividend paying stocks  

with a history of dividend growth. In addition  to this dividend stock portfolio, they’ll sell  

covered calls on individual holdings. We’ll cover  this in-depth in a few minutes, but this is unique  

because they’re strategically selling covered  calls on individual stocks as opposed to an index  

or the entire portfolio, which is something  we don’t see often with covered call ETFs.

Ideally, this combination of dividend growers and  covered calls should fulfill that goal of income  

and capital appreciation to provide competitive  total returns with lower levels of risk.  

In terms of the income sources, they expect to  produce 2-3% of the annual yield from dividend  

income. This shouldn’t be much of a surprise, as  that’s a pretty reasonable yield for a large-cap  

dividend growth portfolio. Additionally, they  expect to get an extra 2-4% of their annual yield  

from writing covered calls and  collecting the option premiums.

Finally, DIVO comes with a .55% expense ratio,  which is pretty on par with other covered call  

strategies, and I think pretty justified  considering it’s an actively managed fund.

So with that, let’s take a closer look at  DIVO’s approach to their stock holdings.  

As we said, they focus on large-cap dividend  stocks with a history of dividend growth,  

which is going to be pretty exclusive to stocks  in the S&P 500 index. Out of the potential stocks,  

the managers at CWP select just 20 to 25 holdings  for the portfolio. We don’t have a whole lot of  

additional details on how they’ll select these  stocks, except for that they screen them for  

some basic qualities like the company’s track  record, earnings, cash flow and return on equity.

But, we do know that they try to keep these  holdings diversified across sectors similarly  

to the balance of the S&P 500 index. This is going  to be a key part of the strategy that helps them  

track the performance of the S&P 500 without  holding the entire index. However, the managers  

may over- or underweight holdings depending on the  market environment. According to the CWP website,  

they do this to participate in defensive  and cyclical trends in a given environment.

So as far as the stock selection methodology  goes, this is a pretty standard outline for a  

large-cap dividend fund. Ultimately, it’s all  up to the managers at Capital Wealth Planning,  

which can either work for or against you  depending on whether they make the right choices.

But let's take a look at the current portfolio,  with the latest update published on June 30th,  

2021. Starting with the sector allocation, we  can see that the DIVO portfolio does match the  

S&P 500 sector allocation pretty closely.  The biggest difference that stands out to  

me is that the S&P is a little heavier in  information technology. My guess here is  

that these are lower dividend companies that  by some metrics are considered overvalued,  

and therefore have a reduced weight in  the DIVO portfolio. But, DIVO still has  

exposure to heavyweight tech with Microsoft and  Apple both holding top positions in the fund.

And in the operating year of 2020, this strategy  appears to have worked exactly as expected.  

They collected about two-fifths of their  investment income from dividends this year,  

which is right in line with  the income goals they outline.

I don’t think there’s much else worth  mentioning with the stock portfolio,  

except for one more caveat of active management  that I want to highlight. According to their  

annual report, their portfolio turnover rate  for last year was 86%, and even higher in the  

years prior. This means that the management  is trading in and out of holdings quite often,  

which again could be good if they’re making  the right calls, but that’s not a guarantee.  

Most often, high portfolio turnover comes at a  cost to the investor because it means more costs  

are being incurred by the fund, reflected  in management fees, and distributions may  

be taxed higher. I just get a little concerned  when I see that much trading within a portfolio,  

but if you find active trading to be an advantage,  then maybe you’ll see this as a positive.

Now we have to discuss the covered call strategy,  which produces most of the DIVO dividend.  

Again, the unique feature of this fund is that  it actually sells covered calls on individual  

stocks in its portfolio, rather than on an  entire index. This is completely different  

from just about every other covered  call ETF I’ve reviewed on my channel,  

because they all sell covered calls on  either the S&P 500 or the Nasdaq 100.

If you’re unfamiliar with covered calls, it’s  an options strategy that allows you to earn  

cash when you own the underlying shares, but  you give up growth potential in the process.  

You’re essentially selling someone else the  right to buy your shares if the price goes up.  

If the price does go up, you have to sell your  shares at a fixed price, but if it doesn’t,  

then you keep your shares and the cash you were  paid for the covered call contract. I’ve covered  

this plenty in other videos, so be sure to check  any of those out if you need more information.

The main benefit of DIVO selling covered calls  on individual holdings is that they can be more  

strategic with how they generate income. Most  covered call ETFs sell covered calls on the entire  

portfolio, which gives up growth potential for  the entire portfolio. Plus, when sold on an index,  

there aren’t really any chances to  capitalize on opportunities in the market.

DIVO, however, is able to both  preserve the growth of its portfolio  

and maximize its covered call income  using an individual stock approach.  

According to CWP, they’ll monitor their stocks  for strength or an increase in implied volatility.  

When a stock price increases, or its volatility  increases, the cash premium earned from a covered  

call will also increase. So DIVO management sells  covered calls when these opportunities arise,  

enabling them to earn the highest possible  cash premium with their options strategy.

As outlined on the CWP website, they sell  short-term covered calls on approximately  

30 to 60% of the portfolio. These short-term calls  ensure consistent cash flow, which can help with  

the monthly dividend distributions. And again,  selling calls on only a portion of the portfolio  

ensures that the rest of the portfolio  has the potential for continued growth.

So overall, this “tactical” covered call  strategy is a clever way for the fund to  

generate substantial income, but also  allow its assets to continue growing,  

which is something missed far  too often with covered call ETFs.

I also really like that you can actually see  the covered calls sold by DIVO, whereas most  

index-based covered call strategies  can be difficult to find details on.  

If you visit the amplify ETFs website, you can  check their current list of holdings, which  

includes their covered call positions. This page  shows the options’ expiration dates, strike prices  

and how many contracts they hold, so you always  know exactly how the fund is using covered calls.  

Interesting note here, this screenshot shows  that the covered call contracts have been written  

against a little under 20% of the portfolio. This  is short of that 30 to 60% estimate outlined by  

CWP, which may just be an effect of the  current market environment. In any case,  

it’s great to know that we can always check back  and see updates on their covered call positions.

Hopefully you now understand why DIVO’s approach  to covered calls can offer some benefits,  

but you might be wondering how it actually  compares to other covered call strategies,  

some of which still offer higher yields.

However, this comparison requires looking at  more than the dividend yield, because as we said,  

DIVO offers more growth than is traditionally  found in covered call strategies. We need to  

look at total returns to figure out how this fund  has performed and might perform in the future.

DIVO hit the markets in December of  2016, which gives us a little less than  

5 years to look back on. But, the performance  during this time hasn’t been too bad at all.

Since inception, DIVO has delivered average  annualized returns of about 14 and a half percent.  

Keep in mind about 5% of this is  made up of the annual dividend,  

while the rest will be of returns through  appreciation of the stock portfolio.

At the bottom, we have a revealing comparison  to the CBOE S&P 500 buy-write index. These are  

the returns you would’ve received if you bought  into the S&P 500 index and sold a covered call  

on 100% of that investment, which again, is what  most covered call ETFs do. However, this strategy  

produced less than a 7% annualized return since  2016, which is less than half of DIVO’s return.  

So clearly, DIVO is successful in delivering  monthly dividend income from covered calls,  

but is also successful in delivering growth on  top of that income for higher total returns.

The other comparison to the  S&P 500 total return index,  

which measures the annual returns from  dividends and growth in the S&P 500,  

shows a slight underperformance by DIVO. It is  expected that covered call strategies miss out  

on some of the growth of the market, but it is  cool to see that DIVO has stayed pretty close.

We can dig even farther back than 2016 thanks  to capital wealth planning, as they have been  

tracking this strategy since 2013. The numbers  look a little worse in these earlier years,  

but it is good to know that the strategy still  consistently beats the S&P 500 buy-write index.

Even compared to the QYLD ETF, which writes more  

profitable covered calls on the  more volatile Nasdaq 100 index,  

DIVO looks pretty good. QYLD has historically  produced about 9% annualized total returns, which  

is better than an S&P 500 buy-write strategy,  but worse than the tactical strategy of DIVO.

So while DIVO may produce slightly lower  dividends than these pure covered call strategies,  

it definitely produces higher total returns,  which is an important consideration for any  

investor who wants both growth  and income from an investment.

The last thing to discuss is  taxes on your DIVO dividends  

so you can get a full picture of what  to expect from this dividend income.

The first thing I check for with  income funds is return of capital,  

because it means that you have to take a much  closer and more critical look at the dividend  

income. Return of capital means that the money  distributed technically comes from your initial  

investment. It’s not immediately taxable, but  it reduces your cost basis in your investment,  

so you’ll owe greater taxes when  you sell your shares. Sometimes,  

this is a red flag that the fund can’t afford  distributions. Return of capital is definitely  

a complicated subject but I did a whole video  to break it down if you need to learn more.

So first I checked the 2021  dividend distributions,  

which have been approximately 71%  return of capital for the year.  

I looked back at the annual report, and  found that in 2020, approximately 60%  

of dividends were a return of capital. However,  they used absolutely no return of capital in 2019.

A general rule of thumb is that  return of capital isn’t a bad thing  

if the fund is able to continue  growing its NAV. As we can clearly see,  

DIVO has had no issue growing since its  inception, which is very reassuring.

My guess is that DIVO realized some substantial  losses during the early months of 2020 as the  

pandemic crushed the markets. Since they  collected plenty of dividends and covered  

call income in 2020 and 2019, they were able  to continue paying dividends as expected,  

but were able to call them a return of capital  thanks to the losses they experienced. This  

is a sneaky accounting tactic I covered in my  return of capital video, and it actually comes  

as a benefit to investors, because they’re  able to delay taxation on their dividends.

But they won’t be able to do this forever, so  I looked back to the taxes on 2019 dividends  

to figure out what investors can expect  in the future. I apologize for this really  

ugly screenshot, but this is all Amplify  ETFs has on the site. In 2019, DIVO paid  

out roughly 14¢ per share each month, about 8¢  of which was considered a qualified dividend.  

This means a little over half the dividend will  receive the qualified dividend tax treatment  

at the long-term capital gains tax rate. The rest,  which is made up of profits from covered calls,  

is considered income, and therefore taxed as  such under the short-term capital gains rate.  

Also shown is a distribution of capital  gains, which could be a mix of the two  

depending on the fund’s activity - we just  don’t have enough information to know for sure.

But overall, this really isn’t too much of a  surprise. The current use of return of capital  

isn’t showing me any red flags, but those tax  advantages won’t last forever. Over the long-term,  

investors can probably expect the qualified  dividend rate on about half their dividends,  

and income taxation on the other half, as a very  rough estimate. This is because most of their  

income comes from covered calls, which is almost  always taxed at the short-term capital gains rate.

So if I didn’t bore you to death with taxes and  

you’re still interested in hearing my  thoughts on DIVO, I like what I see.

After reviewing a handful of covered call ETFs,  

I’ve been consistently disappointed  in how little growth they can achieve.  

The tactical covered call strategy of DIVO is  something I have yet to see any other ETF do,  

and it clearly works well to achieve a combination  of monthly income and capital appreciation.

However, keep in mind that this is  my perspective as a growth investor  

who wants the highest total returns.  If you are simply looking for a high  

yield investment that can pay all of its  returns in the form of a monthly dividend,  

you might not care that other covered  call strategies fail to deliver growth.

The only thing that makes me a little uneasy  is the small portfolio of holdings and the  

high turnover rates, both of which can be  dangerous in the hands of poor management. But,  

DIVO seems to be doing fine so far, so it’s  by no means a dealbreaker for me just yet.

I’ve been learning a lot about different covered  call strategies lately, mostly from my research  

into these covered call ETFs, and I’m really  starting to think that the covered call ETF  

is just a convenience. As DIVO proves, selling  covered calls yourself on individual holdings  

can be more profitable and may produce higher  total returns and growth in your portfolio.  

Investors can definitely get easy access  to the strategy with ETFs, but you can save  

on expenses and get much more flexibility by  learning and executing the strategy yourself.

But whether you like DIVO or want to stick  with some of the traditional covered call ETFs,  

I would highly encourage you to check out the M1  Finance platform. It has automatic rebalancing  

and dividend reinvesting, which are really  powerful tools for the passive dividend investor.  

I’ve personally been using the platform for  months and find it to be the perfect brokerage  

for long-term investors of any experience  level. Plus, they currently give you $50  

for free when you open and fund an account, which  you can do by using the link in the description.

So check that out if you’re interested,  

drop me a comment if you have any questions or  feedback, and I’ll see you in the next video.