Income investors have multiple ways to make money. They can buy dividend stocks or bonds. Closed-end funds often generate attractive income. And then there are exchange-traded funds (ETFs).
Many ETFs might not look all that exciting to income investors. There's one, though, that will almost certainly cause them to do a double-take. The iShares High Yield Corporate Bond Buy-Write Strategy ETF (HYGW 0.27%) currently pays a jaw-dropping yield of more than 16%. But should you buy it now?
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What the ETF does
BlackRock launched the iShares High Yield Corporate Bond BuyWrite Strategy ETF in August 2022. The fund's name reveals quite a bit about the approach it takes to make investors money.
First, the ETF owns shares of another Blackrock fund -- the iShares iBoxx $High Yield Corporate Bond ETF (HYG 0.31%), which provides exposure to a wide range of high-yield bonds (sometimes referred to as junk bonds) issued by U.S. corporations.
However, it doesn't just own shares of HYG. It also actively writes (sells) covered call options on those shares every month. These options give other investors the right to purchase the ETF's shares of HYG at a specified price before a specified expiration date.
The iShares High Yield Corporate Bond Buy-Write Strategy ETF then returns most of the income it generates each month to its own shareholders. Its option-adjusted yield, which is calculated by dividing the annualized most recent distribution by the fund's most recent net asset value, can fluctuate, but currently stands at 16.7%.
Downsides to consider
Income investors might already be salivating at the thought of that juicy yield. However, there are several downsides to consider before buying shares of the iShares High Yield Corporate Bond Buy-Write Strategy ETF.
For one thing, investing in the ETF comes with a hefty cost. The current net expense ratio for it is 0.69%. This percentage reflects Blackrock Fund Advisors' contractual agreement to waive some of its management fees through Feb. 29, 2028. Without this waiver, the expense ratio would be 1.19%.
There's also an opportunity cost to keep in mind. The ETF has delivered a total return of around 6.9% so far this year. However, the S&P 500 has provided a total return of more than 20%.
HYGW Total Return Level data by YCharts.
Although this ETF does own shares of HYG, which itself owns bonds, investing in it isn't the same as investing directly in bonds. You can hold bonds until their maturity, and if you do that, you can count on receiving the specified yield (unless the issuer defaults). The BuyWrite Strategy ETF's yield can and will change over time.
Is it a buy?
The iShares High Yield Corporate Bond BuyWrite Strategy ETF is most likely to outperform high-yield corporate bonds during periods when interest rates are rising. That has been the case throughout 2022 and the first half of this year. It's possible that a few more rate hikes could be on the way, but I suspect we're near the end of the cycle.
The Federal Reserve aggressively increased interest rates starting at the beginning of last year to fight inflation. Now, though, inflation has been moderating. Some economists with Wall Street firms believe that the Fed is done raising the federal funds rate, even if it hasn't explicitly said so yet.
Morningstar predicts that steep interest rate cuts are on the way in 2024. If the financial services firm is right, bond prices should rise significantly. Writing covered calls isn't as great of a strategy in such an environment. Blackrock specifically warns about this risk in its prospectus for the BuyWrite Strategy ETF.
I think that investing in the iShares High Yield Corporate Bond BuyWrite Strategy ETF right now wouldn't be a bad move for income investors. However, don't bet the farm on this super-high-yield ETF. My hunch is that its yield will fall in the not-too-distant future.