With the Fed continuing to increase interest rates, many investors continue to look for safety and park their cash on the sidelines to protect their wealth and earn income. Some investors have looked to increase their equity income holdings in high yielding ETFs such as JEPI to benefit from market volatility. Other investors have desired a lower risk option. As a result, there have been a slew of new alternative cash investment products that seek to produce high income yield with low risk. In this article, we will be evaluating NEOS’ Enhanced Income Cash Alternative ETF (CSHI) as an alternative option compared to conventional cash options.
Disclaimer: Please note that our analysis and commentary below are opinions and not financial advice.
Investment Priorities for Cash
Investors hold cash for different reasons, but the reasons are extremely important to understand. The common answer is to protect their wealth while putting money to work so that they can take advantage of high interest rates. According to CNBC’s recent Millionaires Survey, ~34% are hoarding more cash and approximately 24% of their portfolio is in cash because they expect interest rates to remain higher for longer.
If you were to rank protection and income yield based on importance, which objective would you rank as more important? The purpose of holding cash influences your interpretation of the risk tolerance of different investment opportunities, including CSHI. For emergency funds, you would likely have a very low risk tolerance and would be wiser to keep it in a high yield online savings account. For downside protection against market volatility similar to other fixed income assets, then your risk appetite may be slightly higher. This purpose behind why you are holding cash directly influences your perception of CSHI’s risk reward benefit.
Overview of CSHI
In August 2022, NEOS Investments created CSHI ETF which is a new actively managed Enhanced Income Cash Alternative ETF run by three portfolio managers:
- Garrett Paolella (Managing Director/Co-Founder) with 15 years of options-based experience
- Troy Cates (Managing Director/Co-Founder) with 20 years of options-based experience
- Ryan Houlton (Head of Trading) with 23 years of experience
After speaking with family offices, private equity, VC and financial advisors, they believed there was a market opportunity for an income product that provided an extra annual yield of 1-1.5% above US T-Bills with relatively low risk.
As a result, they created CSHI which seeks to generate monthly income via a portfolio of 1 to 3-month US T-bills and utilizes a long/short put option strategy on the SPX index for enhanced income. The Fund’s option strategy seeks a positive return in rising and flat equity markets and may generate a positive return in equity markets that are modestly declining, assuming the net premium collected from the options sold and purchased exceeds the net cost to close the positions. The fund is very new with less than 1 year on the market and currently only has ~$120M assets under management. Additional details from the fund’s fact sheet and prospectus include:
- Short-term US T-bills with < 90-day maturities and buys & sells out of the money SPX put options
- Annual distribution yield of 6.39%
- Monthly income distributions
- Expense ratio of 0.38%
- At least 80% of assets in US short-term T-Bills, forwards, options, and future contracts
- 18 total positions with 9 positions in US T-Bills and the remaining in SPX put options (as of Jun 9th)
- SPX index options classified as section 1256 contracts (60% long-term, 40% short-term)
Currently, the Fund pays $0.27 per share monthly and has increased its distribution since inception as shown in the chart below:
The fund generates the enhanced income by collecting the premiums from the out of the money put options on the S&P 500. The fund sells 8-11% out of the money puts on a weekly basis with 2-week durations. Essentially, they are betting that the S&P 500 will climb higher in the future and will unlikely drop more than 8-11% within the span of two weeks.
However, the Fund could lose money on their short put options if the S&P 500 drops significantly below the strike price. The Fund would have to pay the buyer the difference in value between the S&P 500 market price and strike price, resulting in a loss for the Fund. For the Fund’s long put options, the Fund could lose money limited to the amount of premium if the S&P 500 price is above the strike price at the expiration date.
The portfolio manager manages these risks by buying and selling put options weekly with 2-week durations and 8-11% out of the money spreads. In the fund’s short history, the only time we’ve seen the S&P 500 drop by 10% was between August and September of 2022. During this time, CSHI price dipped moderately by -0.2% per share ($50.02 to $49.92) but the distribution grew from $0.16 to $0.19 per share. While this data point is positive, it is hard to feel comfortable from this one data point alone.
The question for investors is: what are the odds of experiencing future black swan events that will cause the S&P 500 to drop beyond 10%? Several analysts predict scenarios that the S&P 500 could experience a potential correction of 10-20%. However, no one can predict the future and future black swan events can impact CSHI’s total return.
Comparing CSHI to HY Savings and Money Market Funds
To compare CSHI vs. other mainstream high-yield cash alternatives (e.g., High Yield Savings / CDs, Money Market funds), we will evaluate CSHI through the following criteria:
- Liquidity
- Risk and Post-Tax Income
- Fees & Expenses
- Protection (FDIC / SIPC guarantee)
Liquidity
Liquidity is extremely important especially if you are looking to park your short-term cash. You want access to your money without any withdrawal restrictions. Traditional high yield bank products such as High Yield Savings Accounts and CDs put restrictions on withdrawals which include amount of withdrawals, frequency of withdrawals as well as other restrictions. Since CSHI is a public ETF, you can buy and sell your positions with no withdrawal restrictions. However, because the Fund is new and has limited trading volume, when investors try to exit their position, there may be risk of selling at a slight loss.
Risk and Post-Tax Income
Given that CHSI is so new, there is not sufficient historical performance data to help quantify the risk. CSHI is likely more risky than pure T-bills, but less risky than stocks. While CSHI’s stock price has fluctuated monthly as seen below, the differences have been minor. The price volatility has likely been a result of its income distribution given the dates of the steep declines aligns with the fund’s payout dates. Even when reviewing the spread between the 52-week low and high, the difference is only ~3.5%.
As discussed earlier, the Fund could potentially lose money under the following scenarios:
- Short Puts: When the S&P 500 experiences a steep drop either below the put option strike price for its short put positions, the Fund would have to come up with the difference in value
- Long Puts: If the S&P 500 price is above the strike price at the expiration date for its long-put options with the loss limited to the amount of premium.
If either of these cases were to occur, then the investors’ return could be impacted. Alternatively, money market funds and the 3-month T Bill provide nearly no risk of loss of principal and they pay you 5%+ yield.
Below, we analyzed the incremental post-tax income from CSHI for two types of cash investors. The first scenario considers an investor with a cash allocation of 10% from a $10K portfolio. The second scenario considers an investor with a cash allocation of 10% for a $10M portfolio. We applied the following:
- Assume short-term capital gains / ordinary income tax rates for both Federal and NYS for simplicity (in reality, it may be a blend of short and long-term capital gains rates based on section 1265 contracts)
- Assume tax rates for married couples filing jointly
- Assume net investment income tax (NIIT) of 3.8%
- Assumes monthly distribution of $0.27 / share continues for all 12 months
- Assumes income before expenses and excludes any losses in principal and distribution
In this example below, due to taxes, the post-tax yield is more favorable for Investor A vs. B and the income yield could be ~5.2% and ~5.0% respectively.
The estimates above are illustrative. Please consult with your CPA on your specific tax estimates.
Fees & Expenses
Since CSHI is a managed ETF, CSHI charges a 0.38% expense ratio which is relatively lower compared to other managed ETF funds with the average being ~0.6%. However, other traditional high yield savings and CDs do not have these expenses. Additionally, Vanguard’s average expense ratio for its money market funds is ~0.13% which is significantly lower than 0.38%.
Another way of thinking about this is assuming that you are receiving 1 to 1.5% more income over the risk-free rate, the incremental expense ratio of 0.25% suggests the ROI being 4-5X. As a result, the incremental fees should not be a consideration when considering the upside.
Protection
Unlike conventional high yield savings accounts or CDs or other cash accounts offered by digital advisors (e.g., WealthFront, M1 Finance), CSHI does not have FDIC or SIPC protection. SIPC is only protection for brokerage accounts, but does NOT protect against the decline in value of your securities. Therefore, you do not have FDIC or SIPC insurance protection for CSHI compared to other cash accounts.
Conclusion
Overall, this product is slightly riskier than parking your cash in T-Bills or other money market funds because of its options-based income strategy. From our analysis, we believe that while this fund may be attractive to certain cash investors, it is not attractive for us.
Our key takeaways include:
1) If you are looking to earn extra yield on a small amount of cash, the extra 1.4% annual yield is insignificant
2) If you are a wealthy investor with $1M in cash, your priority for holding cash is likely protection. You only want to earn yield on this cash that is risk-free. The trade-off of the incremental 1-1.5% during a volatile market may not be worth the risk.
Even though CSHI is relatively lower-risk compared to other assets like equities, we would rather stick to keeping cash in our money market funds without worrying about the possibly of the next black swan event.