Two Interesting High Income ETFs Investors Are Totally Ignoring

I think there's a strong case for looking beyond the quote-unquote big-box ETF providers when it comes to income investing. Nothing against the industry giants though.

Firms such as JPMorgan Asset Management, BlackRock iShares, Global X ETFs, and NEOS Investments have done a tremendous job expanding the income ETF universe over the last several years. Investors today have access to more yield-focused products than ever before.

The downside is that when an idea becomes popular, the market tends to get crowded. Covered call ETFs are probably the best example. Every major issuer now offers some variation of the strategy. There is certainly nothing wrong with that, but it does mean investors can end up overlooking smaller and more specialized products that take a different approach to generating income.

That is where some of the boutique ETF issuers become interesting. Many of these firms partner with white-label ETF platforms to bring niche investment strategies to market without having to build an entire ETF infrastructure business from scratch. The result is a growing ecosystem of ETF entrepreneurs experimenting with ideas that often fall outside the mainstream.

Not all of those ideas are good, of course. But every now and then, you come across a strategy that is genuinely different from the dozens of covered call funds competing for investor attention.

Today, we're going to look at two such examples. Both are relatively small funds with less than $100 million in assets under management. Both seek to deliver above-average income through less conventional approaches. And both come with trade-offs that investors should understand before allocating capital, particularly when it comes to liquidity, complexity, and fees.

Peerless Options Wheel Income ETF (WEEL)

The Peerless Options Wheel Income ETF (WEEL) is probably the closest thing Canada currently has to r/thetagang in ETF form. For readers unfamiliar with the term, r/thetagang is a popular online community built around one simple idea: consistently selling options rather than buying them.

The name comes from theta, one of the option Greeks that measures time decay. Every day an option moves closer to expiration, some of its value erodes. Option buyers lose that value, while option sellers collect it. ThetaGang investors aim to systematically harvest that decay as income.

WEEL takes that concept and packages it into an ETF. The fund employs a two-stage process combining cash-secured put writing and covered call writing. The objective is to generate equity-like returns that are primarily driven by income while reducing overall portfolio volatility.

The first stage involves selling cash-secured put options. These options are generally written out of the money, meaning the strike price sits below the current market price of the underlying security. That creates a buffer against modest declines while allowing the ETF to collect option premiums upfront.

The strategy primarily targets highly liquid sector ETFs with active options markets, although individual securities may also be used when appropriate. Importantly, these options are typically written with relatively short times to expiration. Shorter-dated contracts allow the ETF to harvest time decay more efficiently while limiting the amount of time the position is exposed to adverse market moves.

If the underlying security remains above the strike price, the option expires worthless and the ETF simply keeps the premium. If the market falls below the strike price, however, the ETF may be assigned and required to purchase the underlying position. That is where the second phase of the wheel begins.

Once shares are acquired, WEEL transitions into a covered call strategy, selling call options against those holdings to generate additional income. The goal is to continue collecting option premiums while potentially having the shares called away at a profit, at which point the cycle can begin again.

One interesting aspect of the wheel strategy is that equity exposure naturally increases as markets decline. During a prolonged bear market, a larger percentage of put positions are likely to be assigned, causing the fund to accumulate more underlying holdings at progressively lower prices.

That can work against the strategy during strong momentum-driven selloffs, but it also means the ETF is systematically purchasing assets at more attractive valuations.

For that reason, WEEL is probably best viewed as a middle ground between traditional equity investing and pure income strategies. It is unlikely to outperform a fully invested stock portfolio during a powerful bull market, but it may hold up reasonably well in sideways or range-bound environments where option premiums can contribute meaningfully to total returns.

Many individual investors attempt to run the wheel strategy themselves. The challenge is that it requires constant monitoring, position management, trade execution, and tax reporting. WEEL effectively automates that process on investors' behalf.

The trade-off, unfortunately, is cost. The ETF currently carries a 0.99% expense ratio, which is undeniably expensive relative to traditional index ETFs. Investors are paying for active options management, but the fee remains substantial, nonetheless. The income profile, however, is likely to attract yield-focused investors. WEEL currently offers a 12.08% distribution rate alongside monthly payouts.

Liquidity is another area worth monitoring. While not excessively illiquid, the ETF's 30-day median bid-ask spread currently sits at 0.34%, meaning investors may incur meaningful transaction costs when entering or exiting positions. For long-term holders that may not be a major issue, but frequent trading could quickly erode returns.

Brookmont Catastrophic Bond ETF (ILS)

ILS is a truly unique offering in the U.S. ETF industry. At roughly $77 million in assets under management, it is not in imminent danger of closure, but it has largely flown beneath the radar of most investors. That is a shame because it provides exposure to one of the more sophisticated and genuinely exotic segments of the fixed-income market.

As its name suggests, ILS focuses on catastrophe bonds. These are specialized insurance-linked securities that allow insurance and reinsurance companies to transfer risk to capital markets. Rather than keeping all the risk of a major natural disaster on their own balance sheets, insurers can issue catastrophe bonds to investors who are willing to assume some of that exposure in exchange for higher yields.

The underlying risks can include hurricanes, earthquakes, wildfires, floods, and more. In effect, investors are taking the opposite side of the insurance contract. They collect attractive premiums as compensation for assuming the possibility that a covered disaster occurs.

If the specified catastrophe never happens, investors generally receive their interest payments and principal back at maturity. If a triggering event does occur, however, some or all of the principal may be used to cover insurance claims, resulting in losses for bondholders.

That risk profile is precisely what Brookmont argues makes the asset class attractive. Catastrophe bonds are largely driven by weather patterns, seismic activity, and actuarial probabilities rather than economic growth, corporate earnings, or central bank policy.

Natural disasters can certainly occur during recessions or bear markets, but the underlying drivers are fundamentally different. As a result, catastrophe bonds have historically exhibited relatively low correlations with traditional stocks and bonds.

Another attractive feature is that most catastrophe bonds carry floating-rate structures. The coupon payments typically reset based on prevailing short-term interest rates plus a risk premium. That characteristic can provide some protection during rising-rate environments such as 2022, when many traditional fixed-income sectors suffered substantial losses as bond prices declined.

Yield is naturally a major selling point. While ILS differs from most income-focused ETFs by paying quarterly rather than monthly distributions, the income potential remains substantial. The fund currently offers a 12-month trailing yield of 8.14%, placing it in the same general range as senior loans

That elevated yield makes sense given the risks involved. According to Brookmont, the portfolio carries an equivalent average credit rating of approximately B+, firmly within non-investment-grade territory. Investors are being compensated for assuming catastrophe risk in much the same way high-yield bond investors are compensated for assuming greater credit risk.

There are drawbacks, however. The biggest is liquidity. ETF liquidity ultimately depends on the liquidity of the underlying securities, and catastrophe bonds are not particularly liquid instruments. That reality has translated into a relatively wide 30-day median bid-ask spread of 0.1507%, making the ETF more expensive to trade than many traditional bond funds.

The illiquidity has also contributed to a second issue. The ETF's creation and redemption mechanism has not always kept market prices tightly aligned with net asset value. Since inception, ILS's market-price return has been approximately 7.63%, while its net asset value return has been closer to 7.90%.

One possible solution would have been to use a synthetic structure. Rather than physically holding catastrophe bonds, Brookmont could theoretically have gained exposure through a total return swap referencing a catastrophe bond index. That might have improved liquidity and tracking efficiency. Still, credit should be given where it is due. Brookmont chose physical replication over synthetic exposure, which I appreciate as it eliminates counterparty risk.

The final drawback is cost. ILS carries a hefty 1.58% expense ratio. That is undeniably expensive and will create a meaningful drag on long-term returns. Even so, investors should keep the alternative in perspective. Catastrophe bonds are notoriously difficult for individual investors to access directly.

The institutional market tends to be opaque, transaction costs can be significant, and building a diversified portfolio independently would be impractical for most investors. While the fee is high, ILS may still represent the most accessible way for retail investors to gain exposure to this niche asset class.