In the ever-evolving landscape of fixed income investing, investors are constantly seeking strategies that can deliver both yield and stability. The recent launch of the NEOS Enhanced Income Credit Select ETF (HYBI) has caught the attention of savvy investors, offering a unique approach to enhancing their portfolios. This innovative fund, born from the conversion of a successful mutual fund, promises to provide notable yields and reduced volatility, making it a compelling option for those seeking to diversify their fixed income allocations.

Navigating the Turbulent Bond Market with Precision

Weathering the Storm: HYBI's Resilience in 2022

The bond market faced significant challenges in 2022, with both stocks and bonds experiencing declines. However, the WSTCM Credit Select Risk-Managed Fund, the predecessor to HYBI, demonstrated remarkable resilience, declining only 2.3% while the Bloomberg High Yield Index fell more than 11%. This performance highlights the fund's ability to navigate turbulent market conditions, making it an attractive option for investors seeking stability in their fixed income allocations.

A Quantitative Approach to Bond Investing

At the heart of HYBI's strategy is a quantitative, rules-based approach that sets it apart from traditional bond investing. The fund's managers, Garrett Paolella and his team at NEOS Investments, have developed a model that considers various indicators, such as price trends within high-yield bonds, credit spreads, and relative strength compared to the benchmark. This data-driven approach allows the fund to dynamically adjust its risk exposure, investing in high-yield, investment-grade bonds, and short-term Treasuries as market conditions dictate.

Diversifying Risk through a "Fund of Funds" Structure

HYBI's unique structure as a "fund of funds" further enhances its risk management capabilities. By investing in high-yield corporate bond ETFs, the fund reduces potential liquidity risk compared to direct investment in individual bonds. This diversification across underlying assets helps to mitigate the impact of any single bond or issuer, providing investors with a more resilient fixed income allocation.

Enhancing Yield with an Options Overlay

In addition to its bond exposures, HYBI employs an options overlay strategy to boost potential yields for investors. The fund utilizes put spreads on the S&P 500 Index, selling out-of-the-money puts and using the premium earned to buy puts at a slightly lower strike price. This strategy, known as a "ladder," helps to narrow the spread risk and maintain a consistent level of volatility that matches the fixed income portion of the portfolio.

Tax-Efficient Income Generation

The options overlay employed by HYBI offers a unique tax advantage. As Section 1256 Contracts under IRS rules, the options held by the fund are treated as if they were sold at fair market value on the last market day of the year. This allows for favorable tax treatment, with any capital gains or losses taxed as 60% long-term and 40% short-term, regardless of the holding period. Additionally, the fund's managers actively engage in tax-loss harvesting opportunities throughout the year, further enhancing the tax efficiency of the overall portfolio.

Consistent Income and Reduced Volatility

Despite the potential for fluctuations in bond yields and prices, Paolella does not anticipate sharp swings in income for HYBI investors. The fund's average duration of over four years as of the end of October helps to provide a level of stability, ensuring a more consistent stream of income for investors. Furthermore, the combination of the fund's quantitative approach, diversified bond exposures, and options overlay strategy aims to deliver a lower-volatility fixed income solution, making it an appealing choice for investors seeking to enhance their portfolios.

A Compelling Opportunity for Fixed Income Investors

The NEOS Enhanced Income Credit Select ETF (HYBI) offers a unique and compelling proposition for fixed income investors. By blending a quantitative, rules-based approach to bond investing with an options overlay strategy, the fund aims to deliver notable yields, reduced volatility, and tax-efficient income generation. As investors navigate the challenges of the current bond market, HYBI presents a compelling opportunity to diversify and strengthen their fixed income allocations, potentially enhancing their overall portfolio performance.