Portfolio construction

The rise and benefits of derivative income ETFs

February 14, 2025 - 4 min read

Vice President, ETF Capital Markets and Product – Natixis Investment Managers – US Distribution

In the ever-evolving landscape of finance, options-based strategies, including derivative income exchange-traded funds (ETFs), have emerged as a compelling choice for investors seeking to enhance income generation.

These innovative financial instruments combine the benefits of traditional ETFs with the sophistication of derivatives, offering a unique blend of income, market participation, and risk management. By employing options strategies, such as covered calls, derivative income ETFs aim to generate a steady income stream while providing exposure to underlying assets. This makes them particularly attractive in uncertain economic environments when traditional income sources may falter.

The evolution of ETFs and proliferation of options-based strategies

ETFs have come a long way since their inception in the early 1990s. Initially, they were designed to provide investors with a low-cost, diversified way to gain exposure to broad market indices.

Over time, ETFs have expanded to cover specific sectors, regions, commodities, and even alternative asset classes. The introduction of options-based ETFs represents the latest chapter in this evolution, offering sophisticated tools for portfolio management. The popularity of options-based ETFs has surged in recent years, driven by several key factors.

First, the low-interest-rate environment has led investors to seek alternative and more robust sources of income. Options-based ETFs have become an attractive choice as cash flow is primarily driven by option volatility premiums and equity dividends, not interest rates.

Second, the increased volatility in the markets has heightened the need for effective risk management tools. Options-based ETFs offer sophisticated strategies to navigate uncertain conditions, making them appealing to both retail and institutional investors. Furthermore, advancements in technology and new regulatory guidelines have allowed for a more streamlined path for fund managers to launch and implement options strategies in the ETF wrapper.

This has led to the launch of new options-based ETFs, catering to a wide range of investment needs and preferences. Options-based ETFs can come in several varieties, including defined outcome, leveraged/inverse, and derivative income.

Specifically, within the Morningstar Derivative Income category, the ETF asset growth trajectory has exploded in recent years. As recent as 2018, there were only 10 of these ETFs listed in the US with about $1B in total assets under management (AUM). Since then, there have been over 100 new ETFs brought to market, and AUM has surged to around $100B.

Growth of derivative income ETFs

Source: ISS SimFund, US-Listed ETFs within the Morningstar Derivative Income category. Data as of 11/30/2024.

How do clients use derivative income ETFs within a portfolio?

Derivative income ETFs use derivatives, such as index-based options, to generate income for investors. By employing strategies such as covered call writing, derivative income ETFs can collect premiums from selling options, which are then distributed to investors on a consistent basis. This approach not only enhances the yield of the ETF but also provides a steady income stream, making it particularly appealing to income-seeking investors.

Beyond providing this attractive yield, derivative income ETFs also act to manage risk. By carefully selecting and balancing options strategies, these ETFs can create a unique risk-reward profile that aims to capitalize on market conditions while cushioning against potential downsides. This level of sophistication offers investors a powerful tool for portfolio diversification and income enhancement.

The flexibility of derivative income ETFs, especially those that are actively managed, allows them to adapt to various market environments. Whether the market is bullish, bearish, or sideways, these ETFs can adjust their options strategies to optimize returns and mitigate risks. This adaptability is a key advantage, providing investors with a dynamic approach to income generation in an ever-changing financial landscape.

Investors, both retail and institutional, are particularly excited about the ability of these ETFs to provide enhanced yield, offer a diversified income stream and improve the risk profile of a portfolio.

For conservative investors, they offer enhanced yield opportunities, while balanced portfolio holders appreciate the diversification of income sources outside traditional corporate and government bonds.

More aggressive investors may use derivative income ETFs to supplement growth and manage equity volatility. This balanced approach helps to ensure that these ETFs can meet various portfolio objectives, potentially making them a valuable addition to any investment strategy.

A compelling opportunity for income-focused investors

In an increasingly crowded ETF marketplace, several derivative income ETFs have garnered attention for their innovative approaches, strong risk-adjusted performance, and robust income streams.

One notable example is the Natixis Gateway Quality Income ETF (GQI). This ETF employs a covered call overlay strategy on typically 50% of the equity portfolio to generate consistent monthly income. For the underlying equity portfolio, GQI also takes a unique approach by investing in stable, high-quality U.S. companies with strong fundamentals. Some competitor ETFs simply provide passive exposure to the S&P 500^®. In summary, the GQI ETF provides investors quality equity exposure with a lower risk profile vs. the S&P 500^® Index and a consistent monthly income stream.

“We have had a lot of support from our clients on the launch of GQI,” says Portfolio Manager Daniel Ashcraft, CFA^® of Gateway Investment Advisers. “I think it has been very successful in achieving its objective by offering investors a compelling level of yield vs. other asset classes.” Since inception, GQI has yielded in the range 6–10%, with an average of roughly 8.2%*.

As financial markets continue to evolve, derivative income ETFs are poised to play an increasingly significant role in helping investors achieve their financial goals and navigate the complexities of modern investing. By understanding the unique features and potential benefits of derivative income ETFs, investors can make informed decisions and take advantage of the opportunities presented by these cutting-edge financial instruments.

* As measured by the 30-day SEC yield from the Fund’s inception date of 12/13/23 to 12/31/24. The average for the 30-day unsubsidized SEC yield over this period is 8.0%.

All investing involves risk, including the risk of loss. Investment risk exists with equity, fixed income, money market, and alternative investments. There is no assurance that any investment will meet its performance objectives or that losses will be avoided. Investors should fully understand the risks associated with any investment prior to investing.

The views and opinions expressed may change based on market and other conditions. This material is provided for informational purposes only and should not be construed as investment advice. There can be no assurance that developments will transpire as forecasted. Actual results may vary.

This material does not constitute legal or tax advice. Investors should consult with their legal or tax advisors.

The S&P 500^® Index is a widely recognized measure of US stock market performance. It is an unmanaged index of 500 common stocks chosen for market size, liquidity, and industry group representation, among other factors; it also measures the performance of the large-cap segment of the US equities market. It is not possible to invest directly in an index.

Exchange-traded funds (ETFs) trade like stocks, are subject to investment risk, and will fluctuate in market value. Unlike mutual funds, ETF shares are bought and sold at market price, which may be higher or lower than the ETF’s net asset value. Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. Active ETFs: Unlike typical exchange-traded funds, there are no indexes that an active ETF attempts to track or replicate. Thus, the ability of an active ETF to achieve its objectives will depend on the effectiveness of the portfolio manager. Transactions in shares of ETFs will result in brokerage commissions, which will reduce returns. Equity-Linked Notes Risk: Investments in Equity-Linked Notes (ELNs) are subject to liquidity risk, which means there may not be an active market for ELNS which would prevent them from being sold at a fair price. Since ELNs are in note form, they are subject to certain debt securities risks, such as credit or counterparty risk. Should the prices of the underlying instruments move in an unexpected manner, the Fund may not achieve the anticipated benefits of an investment in an ELN, and may realize losses, which could be significant and could include the Fund's entire principal investment. Options Risk: Options may be used for hedging purposes, but also entail risks related to liquidity, market conditions and credit that may increase volatility. The value of the fund’s positions in options may fluctuate in response to changes in the value of the underlying asset. Selling call options may limit returns in a rising market. Equity Securities Risk: Equity securities are volatile and can decline significantly in response to broad market and economic conditions.

Before investing, consider the fund's investment objectives, risks, charges, and expenses. You may obtain a prospectus or a summary prospectus containing this and other information. Read it carefully.

ALPS Distributors, Inc. is the distributor of the Natixis ETFs. Natixis Distribution, LLC is a marketing agent. ALPS Distributors, Inc. is not affiliated with Natixis Distribution, LLC.

CFA^® and Chartered Financial Analyst^® are registered trademarks owned by the CFA Institute.

NIM-02062025-3ndvn4if

NTX000872