I’m Breaking Up With SVOL
Introduction
I was quick to espouse the merits of alternative strategies when I first started writing on Seeking Alpha, back in late 2023. I employ them in my own investment strategies, and have long pushed their use in portfolios as a great way to diversify sources of return, add in uncorrelated assets, and potentially generating alpha over a portfolio of just stocks and bonds.
So it makes perfect sense that I published buy ratings on the Simplify Volatility Premium ETF (NYSEARCA:SVOL) shortly after I began writing on this platform back in 2023; this strategy rose quickly to become the king of alternative strategies. That's also why it may be a surprise to folks to see a sell rating on the fund now from me, and to hear that I am exiting my SVOL position entirely.
In short (no pun intended), the fund goes 0.2-0.3x short the volatility index, or VIX, and otherwise holds a basket of yield-producing instruments to try to hit a distribution rate of 15%.
I've covered SVOL extensively, and this will be my 10th article in the last two years, so please check out those articles for context, but note that the strategy has changed insidiously over time, so details in those past articles are not necessarily relevant to today's SVOL.
In fact, the strategy changes so often, that among those articles, none of them have had the same holdings snapshot when they were written. The holdings change dramatically month to month, even week to week, and so keeping up with SVOL has proven a challenge.
Since the fund's inception, investors have returned over 25%, but you may notice something very concerning with this chart: the volatility of the fund went ballistic this year, and it definitively snapped its streak of keeping up with the S&P 500. At least it's still outcompeting bonds, but the chart isn't so pretty, and the fund has given up all of its 2024 gains.
Of course, there are going to be "I told you so" comments about this one; the fund that shorts the VIX had a blow up when the VIX spiked this year in early April, hitting over 50, which is a level rarely seen, happening only 37 times since 1990.
Performance, however, isn't the primary reason I've decided to exit my SVOL position. Rather, I feel that the fund has changed its character far from the original fund I recommended, and it has done so in insidious ways that initially blinded me to the shift.
The results of this shift speak for themselves, the fund has a very different risk:reward profile now than it used to. Part of that is just what being short the VIX does to a fund during a VIX spike, but even before April, we can see significant elevation in SVOL's volatility in late 2024 and early 2025, when the shift began to happen.
SVOL Holdings Change
It was around that time that we started to see the weird performance, in October 2024, when I called out SVOL for its holdings changing dramatically, and including the "kitchen sink" of yield ideas, down to being long and short equities indices like the S&P 500 to try to juice out a little extra yield.
After publishing that article, Simplify's IR team reached out to me on Seeking Alpha to clarify the position, and let me see into the black box just a bit. This was troubling looking back on it, but I felt assuaged at the time, and I wrote a follow-up that essentially said all is well, they explained that SVOL isn't taking equities positions as a part of its strategy.
Fast-forward to today, and it's become very clear that the strategy is lacking in its return, and the managers are scrambling to find assets to assist in making up the losses caused by being short the VIX as its primary strategy.
To that end, we have more than just bonds in the fund now, and they're not just pair trades that I'm misinterpreting this time.
Immediately, we see a few red flags akin to those I saw before, but getting worse and more frequent:
LITL, a small-cap ETF with an options overlay
NXTI, an ETF that tracks "intangible assets"
SBAR, a "barrier" hedged equity fund
XV, a target distribution fund
SPUC, US equities fund with long call options
These are "held down" by a large short position on the S&P 500, shown by the "ESM5 IND" positions, but this means that the managers are betting on the individual assets outperforming in their factor tilt or whatever gimmick the fund uses. That just isn't the strategy I expect to see when I invest in a fund that is short the VIX.
Sure, the short VIX trade components are in the fund, you can see both the short VIX positions in the "UXN5 IND" positions and its call options on the VIX to use as a hedge in case of a VIX spike.
There is also a 10% allocation to QIS that is of note, which is massive for this fund, and is likely better off being held in bond funds. I am an advocate for the kind of asset allocation that QIS delivers investors, but incorporating QIS should be done on the portfolio level and not as a sub-holding in a fund that has little to do with hedge fund quant investing.
What do all of these funds have in common? Other than being not VIX related.
They are all Simplify ETFs, and many of them are those with tiny amounts of assets under management. Because of SVOL's AUM success, I have long suspected that Simplify uses the fund to bolster many of its smaller projects, some of which fail to generate much of their own assets.
I initially had this qualm with SVOL's inclusion of AGGH as a core holding; at one point, 86% of AGGH's AUM was from SVOL's investment. That has changed, thankfully, but I was okay with the incestuous relationship SVOL tends to have with its own funds because owning bond funds makes sense for SVOL. It's a basket of bonds, risk managed, that goes short the VIX. That's the marketing, at least.
For me, enough is enough with these extra inclusions and deviations from the stated strategy. It has become very troubling for me to justify SVOL's inclusion in my portfolio due to it being used in this way, to help prop up some of these other funds from Simplify.
If I want a 10% allocation to QIS, I can buy QIS. If I want exposure to small caps or "intangibles," I can buy LITL and NXTI. However, Simplify using SVOL like an incubator for these funds, since it can cannibalize some of SVOL's NAV.
I do not find this very encouraging from their end.
SVOL Dividends & Yield
What SVOL does still have going for it, if you disagree with me about the holdings being too far a deviation from stated strategy, is that it still pays a huge distribution rate.
The one-year low is above 15%, SVOL's target, and the current rate (because of the suppressed price) is nearly 20%.
The dividends themselves have come down over time, but that was expected, as management has been forthright about the dividend amount being tied to the short-term interest rate. Although, the last few dividends bucked that trend. My theory is that the changes to the holdings has enabled this.
I wasn't expecting such large distributions, like back up to the $0.30 mark, especially since rates haven't moved on the short end this year, but here we are. Part of it is due to the April VIX spike, where the managers were likely able to take advantage of the VIX going over 50 to re-adjust their short positions, which are now likely worthless (a good thing for options sellers) due to the VIX being back around 20.
Regarding the tax status of the dividends, something many investors are concerned about, SVOL distributes a mix of return-of-capital ("RoC"), a function of how futures and options proceeds are classified by the IRS, and net investment or "ordinary" income ("NII").
There is a distinction to be made here because RoC counts against your cost-basis, deferring taxes until you sell the fund, which then is classified as long-term capital gains. NII counts toward your ordinary income level, which is subject to income taxes in the year that you received the distribution.
SVOL is mostly RoC, which is favorable for taxable accounts; it's last three 19a-1 forms, estimates before the year-end IRS-ready form, show mixes that favor RoC.
Conclusion
Ultimately, I can't bring myself to justify the inclusion of the Simplify Volatility Premium ETF (SVOL) in my portfolio anymore, and believe it now deserves a sell rating, after a long run of impressing me and distributing heavy dividends. However, there are cracks in the portfolio, and they are primarily created by strategy drift. SVOL has a hand in boosting the AUM of Simplify's other funds, even if they don't necessarily fit SVOL's strategy.
While I have been assuaged in the past about the fund's shortcomings, the last few months have shown that SVOL's early run by not be repeatable. After three years, I'm out. SVOL is no longer going to have a place in my personal or model portfolios.
There's just too much going on under the hood that isn't related to the core objective, and the risk it adds is more evident than ever.
Too bad that there aren't many good alternatives (no pun intended).
Thanks for reading.