HYBI ETF: A Tax-Smart, Lower-Cost Alternative to High-Yield Bonds

In an era where traditional high-yield bond funds face mounting criticism over high fees, opaque tax treatment, and vulnerability to rising rates, the NEOS Enhanced Income Credit Select ETF (HYBI) emerges as a compelling alternative. By blending a quantitative model with a tax-efficient options overlay, HYBI seeks to undercut the cost and complexity of conventional approaches while delivering enhanced income. Here's how it stacks up.

The Strategy: Quantitative Precision Meets Tax Efficiency

HYBI's core advantage lies in its dual-pronged approach:
1. Dynamic Bond Allocation: A proprietary quantitative model shifts exposure between high-yield and investment-grade bonds (or Treasuries) based on short-, intermediate-, and long-term trend analysis. Factors like credit spreads, Federal Reserve policy, and interest rate outlooks guide allocations. This systematic rebalancing aims to reduce risk during unfavorable market conditions.
2. Options Overlay: HYBI sells SPX put options in a spread configuration (5–8% out-of-the-money), generating premium income. These contracts qualify as Section 1256 instruments, ensuring gains are taxed at a favorable 60/40 split (60% long-term, 40% short-term capital gains), regardless of holding period. This contrasts sharply with traditional high-yield bonds, which pay interest taxed at ordinary income rates (up to 37% for top earners).

The combination of bond income and options premiums fuels HYBI's 8.74% distribution rate (as of October 2024), distributed monthly. This dual revenue stream offers stability while reducing reliance on volatile bond prices.

Cost Efficiency: Challenging the High-Fee Status Quo

Traditional high-yield bond funds often carry expense ratios exceeding 0.5%, with some actively managed options charging closer to 1%. HYBI's net expense ratio, capped at 0.68% through 2025, is competitive in this context. While higher than passive ETFs like the iShares High Yield ETF (HYLB, 0.15%), HYBI's active management and tax-smart design justify its fee structure for investors prioritizing risk mitigation and after-tax returns.

Performance: Outperformance in Stress, Challenges in Calm

HYBI's quantitative model has proven its mettle during volatile periods. For example, in 2022—a year when the Bloomberg U.S. Corporate High Yield Index fell 11%—HYBI's predecessor fund (WSTCM Credit Select) declined just 2.3%, thanks to its options overlay and reduced bond duration. However, in calmer markets, HYBI has lagged benchmarks. As of September 2024, its one-year return of 10.61% trailed the High Yield Index's 15.74%, though its volatility-adjusted returns remain superior.

Risks and Considerations

HYBI is not without flaws:
- Sector Concentration: Over 94% of its bond portfolio is allocated to financial sector ETFs (USHY, HYLB, SPHY), exposing it to sector-specific risks like regulatory shifts or geopolitical conflicts (e.g., Israel-Iran tensions).
- Interest Rate Sensitivity: With an average bond duration of 4 years, rising rates could depress prices.
- Tax-Loss Harvesting Limits: While HYBI employs this strategy, its high turnover (>100%) may generate short-term gains offsetting the Section 1256 benefits.

Investment Takeaway: A Niche, But Strategic, Play

HYBI is best suited for aggressive income seekers in high tax brackets who can tolerate volatility. Its 8.74% distribution rate and tax-smart design make it a viable complement to core bond holdings, particularly in portfolios already exposed to high-yield credit.

Recommendation:
- Buy: For investors with a 5+ year horizon, willing to accept sector concentration and volatility for tax efficiency and income.
- Avoid: For those needing liquidity, risk-averse portfolios, or low-turnover strategies.

In a landscape where traditional high-yield funds charge excessive fees and deliver poor after-tax outcomes, HYBI offers a fresh alternative. While no panacea, its blend of quantitative rigor and tax optimization positions it as a standout in the evolving ETF universe.

Disclaimer: Past performance does not guarantee future results. Consult a tax professional before making investment decisions.