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Summary DIVY is Reality Shares’ primary ETF offering. DIVY is an interesting ETF that is based on dividend growth. DIVY, however, isn’t about income. If you love dividends, wouldn’t an exchange traded fund, or ETF, that ties itself to the growth of dividends be an ideal investment? The answer depends on what you want from your investments. This isn’t about income To get this out of the way up front, the Reality Shares DIVS ETF (NYSEARCA: DIVY ) isn’t looking to produce income for investors. So, if you like dividends for the income they provide, this ETF is not for you. However, if you like the fact that broader market dividends have a history of increasing over time and buy dividend stocks because you expect them to increase in value (capital appreciation) as their dividends increase, then, well, you might be interested… maybe. A little confused? You should be. DIVY is a very complicated ETF. For example, according to the sponsor, DIVY uses, “An investment strategy seeking to deliver the dividend growth of Large Cap Securities independent of stock price.” So, looking at this from a big-picture perspective, DIVY’s value is intended to increase by the amount that dividends grow. It is all about capital appreciation. But DIVY’s value won’t change based on the stock price movements of dividend paying stocks. Or at least that’s the goal, anyway. Why would you want that? Because dividends have historically grown in most years (though not every year). For example , the S&P 500 Index has seen dividends grow in 40 of the last 43 years. We all know painfully well that stocks have a habit of going up and down in often violent fashion. So dividend growth, while slow and steady, is really not well correlated with stock price movements. That offers diversification and, potentially, safety in broad stock market downdrafts. OK, that’s interesting. But remember, this is about capital appreciation, not dividends. So if you want income, you won’t find it here. An “option” to watch The thing is, DIVY can’t just buy dividend growth. It has to use an options strategy to mimic dividend growth: The Fund may purchase a series of listed index option contracts that, when combined together, are designed to eliminate the effect of changes in the trading prices of the Large Cap Securities and the effect of interest rate changes on the prices of the option contracts. As a result, the value of the Fund’s option portfolio is designed to change based primarily on changes in the expected dividend values reflected in the option prices. These option combinations are designed to reflect expected dividend values and eliminate the Fund’s exposure to changes in the trading prices of the Large Cap Securities. There’s a lot of math involved in figuring out how to turn that mouthful into actual investments. And, to be sure, it’s an impressive feat that DIVY even exists. But all that math leads to an expense ratio of around 0.85%, so in ETF land this is a pricy product. And then there’s the not-so-small fact that this is a relatively new product that hasn’t lived through a market downturn. The idea sounds really great, but that doesn’t mean it will stand the tests of a bear market. After all, DIVY is an ETF that trades based on supply and demand. True, it should trade fairly close to its net asset value, or NAV, because of the ETF structure, but it might not, too. Why do I say that? Because ETFs trade close to their net asset values because of the arbitrage available to large traders who take make payment in kind redemptions. For an S&P 500 Index that means getting all the stocks in the index. So, if an S&P 500 Index ETF is trading below its NAV a large investor will simply redeem via payment in kind and sell the securities it receives at a profit. But DIVY is a complex collection of options contracts. If it trades below its NAV, who’s going to want to own all those options contracts? In reality, it’s more likely that redemptions will be paid in cash , but DIVY has fees in place to discourage frequent creation and redemption activities. And what if everyone rushes to redeem at once? This process hasn’t been stress tested by a bear market and the fund’s complexity could mean it implodes at exactly the time when you are expecting it to hold steady. Wait for the next downturn At the end of the day, DIVY is an interesting concept that hasn’t proven itself. I’d suggest waiting and watching, for now. The idea sounds great, but then so did the idea of portfolio insurance, bonds backed by mortgages, and any number of other investment ideas that blew up in the face of adversity (tulip bulbs anyone?). If DIVY does what it’s supposed to, it could be a good addition to a diversified portfolio. If it doesn’t, you’ll be glad you waited before jumping aboard a complicated new product. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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