Nicholas Wealth Management: Playing It Safe, with a Twist

While Nicholas Wealth Management has been on the leading edge in its use of ETFs—it has launched several of its own funds since 2021—the firm’s core clientele tends to be on the risk-averse side of the spectrum. The Atlanta-based firm, with $254 million in pure RIA AUM (it has another $421 million in AUM through its ETFs, securities and annuity holdings), serves primarily Fortune 500 employees in or nearing retirement. For them, current income is a far more important goal than future outsized returns, according to David Nicholas, founder and president of Nicholas Wealth Management.

Still, Nicholas prefers to deliver that higher yield when it’s possible. WealthManagement.com recently spoke with him about the strategies the firm uses to do so.

This Q&A has been edited for length, style and clarity.

WM: Can you describe your average client?

DN: We have a niche in the retirement market. We are generally working with clients who are 55 years old on the younger end and into their 70s. So many Americans have 401Ks. We are in Atlanta, so we have a lot of big Fortune 500 companies, like Coca-Cola, Home Depot, and private companies like Chick-fil-A that are still very large. [Our clients] may have been investing in their 401K for all their working career, and now they have to make these big decisions on retirement—"Who do I work with? How do I manage it?” That’s where we provide value. I would say our average [client net worth] is somewhere between $800,000 investable to $5 million.

WM: What’s your overall investment philosophy?

DN: Given the nature of who our clients are, this is not a 25-year-old who has high risk tolerance and 30 to 40 years before they’ll need the money. Our clients are at a point where they are either about to retire or in retirement. Income is a primary goal of theirs. So, we generally start at a 60/40 benchmark, and over- or underweight that for our clients. It’s 60% fixed income/40% growth equities. Depending on needs, goals and risk tolerance, we’ll treat that, but our typical client is going to have somewhere around 40% to 60% fixed income, 40% to 60% equities.

WM: If you can break down your model portfolio on a more granular level? What’s in it right now?

DN: On our equity piece of the portfolio, we really try to keep it simple. We have publicly-traded ETFs that are separate, but our SMA business, the largest allocations go to two strategies—Nicholas Large Cap Strategy and Nicholas Dividend Growth Strategy.

In our Nicholas Large Cap Strategy, we take 50 of what we feel are the best stocks out of the S&P 500, and we over- or underweight based on the 11 sectors. Every quarter, we are going to rebalance based on those sectors. S&P is up 9.5% year-to-date; our Nicholas Large Cap Strategy is up 21% year-to-date. Over the last year, S&P is up 15%; our Large Cap Strategy is up 33%. There are 500 companies in the S&P 500, but a lot of the returns are driven by the top 10% of those names, which is why we try to find that top 10% and overweight there.

Sector-wise, we are underweight in IT, technology. We are overweight in financials, consumer staples, materials. And we really underweight a lot of other areas—consumer discretionary, communication services, industrials, healthcare, utilities, energy, real estate. Some of this is interest rate-driven. Some of this we may be slightly underweighted. For example, IT—there’s a 35% weight in the S&P 500. We have a 33% weighting in the Nicholas Large Cap. We still have a healthy weighting; it’s just that we are slightly underweighting. For financials, the S&P has a 13% weighting; we’ve got a 21% weighting. In terms of the names, we have some private equity like Ares, but we have Bank of America, we have some of the insurers, like Chubb. We have Goldman, Robinhood, JP Morgan, Morgan Stanley, SoFi, Visa and XYZ.

Consumer staples is overweight. We’ve added Celsius Holdings recently, we’ve got Costco, we’ve added Dollar Tree to the portfolio. Some of [what’s driving that] is the slowing employment, we see job revisions coming down. We have Coca-Cola and Walmart.

All of the other sectors, we are underweighting anywhere between 0.2% to 3.0%. The highest underweight that we have is in healthcare at 3.12%. If we were going to change somewhere, it would probably be healthcare going into the fall, where we probably will overweight a little bit.

WM: Can you give us more details on the Nicholas Dividend Growth Strategy?

DN: Our Nicholas Dividend Growth is really driven by yield, but we also do something a little bit unique in our dividend growth strategies. We own equities that are paying dividends, like British American Tobacco. It’s a very stable cigarette tobacco company with a 5% yield. We own Lincoln National, an insurance company that’s got a 4.5% yield. Global Ship Lease has a 7% yield. So, we typically are going to own 20 to 30 names of dividend growers that are paying quality, steady dividends.

But there’s a whole new asset class emerging—it’s the high-income ETF asset class. And I really think this is going to be a whole new asset class. Wall Street has been a little slow to this, but retail has just eaten this up in droves. So, we have an allocation—two of them are our funds. GIAX is our Global Equity and Income ETF, but it has a 25% yield because of the options overlay. We also have a 2.5% allocation to MSTY, but the yield on MSTY is 90%.

Here’s what’s interesting about that. We have a 2% weighting to an ETF that has a 90% yield. What that essentially does to our entire dividend portfolio is it adds almost 2% of additional yield. We have a 20% weighting to GIAX, which has a 24% yield, so that weighting equates to about 5% average yield to the portfolio. When you just add GIAX and MSTY together, about 27% of the fund is accounting for 7% yield just from those two positions. It allows our Nicholas Dividend Portfolio to have a yield close to 12% because we are almost leveraging, using options income in this fund, to generate a high yield. I look at it as a risk-managed way to increase yield without taking on a lot of additional risk.

How do you get higher yield typically? You’ve got to go either into lower-valued stocks or high yield, which carries more risk. But we are using options to leverage some yield without taking on a lot of extra risk.

WM: Can you talk about your holdings on the fixed-income side?

DN: In the fixed-income bucket, we are generally looking at two different areas. We’ve seen a lot of success in what are called fixed-index annuities. One of the reasons I like these contracts is they fit the fixed-income sleeve nicely, but they offer something called trigger rates. Right now, you can get trigger rates of about 8% on a 10-year fixed-income annuity. If the S&P is up at all, the investor would earn the trigger rate, which is 8%. If the S&P is up 4%, they earn 8%. If the S&P is up 20% in a year, they earn 8%. So, if the market is positive at all, they get 8%; and if the market is negative, they don’t lose principle and they don’t lose any of the interest they’ve earned in prior years.

It’s a unique structure that clients really like. We would normally balance that with our fixed-income ETF, which is FIAX. It’s predominantly Treasuries, about 98% Treasuries, and then we do an options overlay to generate higher income. We are able to get exposure to higher-yielding sectors of the market, but do it in a risk-defined way. We have a trade on right now on HYG, which is a high-yield ETF, but we’ve limited our loss to 1%. So, whenever interest rates go the other way or we have a contraction in the economy, high yield spreads increase, we are protected on the downside.

But we can also do unique stuff there—we are long on volatility. A lot of the time, fixed income is looked at as a hedge to equity markets. If we see volatility on the equity side, we’ll benefit from that by our long volatility trade in FIAX. It’s really a way that we can get income from the Treasuries, but that’s yielding 4% to 4.5%. The fund is distributing 8%, so we are getting that additional yield through the options overlay. I like the safety of Treasuries, but I want to juice the yield a little bit, and we do that in a risk-defying way.

WM: It doesn’t sound like it, but do you have any allocations to alternatives in the portfolio?

DN: Depending on how you define alternatives. We don’t have any private equity. Our fixed-income fund is the Fixed Income Alternative ETF, so it’s technically in the alternative category just because of the options overlay, but no. The only alternatives that we use are crypto and real estate. We do have a small crypto allocation in BLOX, in our Nicholas Dividend portfolio.

Generally, we try to have a 10% allocation to real estate for clients. We historically use hospitality REITs because post-COVID, we saw a boom in hospitality, and then also multifamily REITs. We use the preferred shares, not the common shares. But we don’t have any private equity allocations, we don’t have any hedge fund allocations.

WM: Do you keep any cash on hand?

DN: We keep a minimum amount of cash on hand, just to cover management fees. But we don’t necessarily keep it on hand as part of a strategy. We just got burned in the past. We’ve gotten away from all types of tactical strategies.

We saw it recently, during the tariff sell-off, that when the market can go up 10% in a day, we don’t want to be holding cash. During COVID, the market went up 20% in two days! And we had some strategies that were on the sidelines in cash. You’ve got inflation, you’ve got the dollar declining, and cash is just too much of a drag.

WM: You mentioned that you rebalance the portfolio every quarter. Did you make a lot of changes during the previous quarter?

DN: This was not a full rebalance. We probably made three to four name changes during the quarter. A lot of it will be if we had a lot of profits, we’ll take some profit. One of the names that we added is O’Reilly Automotive. It’s a name that you don’t hear a lot, but in the last month, O’Reilly Automotive is up 9%. In the last three months, it’s up 13%. S&P is flat for the last month. Whenever the market is trading at a high multiple, like it is now, we want to own businesses that have a solid track record of creating a profit and having a high margin. You’d be hard-pressed to find a business that has a higher profit margin than an auto parts store. They are very profitable, and they trade at a reasonable valuation. There are a few more stories like that.

We are not traders. If we put money to work in a company, we are typically looking to hold that for a minimum of 12 months. We’ve now owned Palantir for about four years, and we are up 1,000% on that. That name has been in a portfolio for a while, it’s done well, and we don’t have any plans to sell it.

WM: Do you work with outside fund managers?

DN: It’svery limited. Most of our strategies are done in-house, except for the outside ETFs that we use in our actively managed strategies.

WM: On those, how do you determine which funds/asset managers you want to invest with?

DN: On the SMAs, it really comes down to—are we bullish on the stock? Some of these are single stocks. NVDY is a single-stock ETF that they do covered calls on. We have to believe in the growth story of the underlying, and then we balance that with the volatility and the yield that the fund kicks off. I would not buy an income fund just because it has a high yield if I thought the underlying was not going to perform well. The underlying drives it, and the yield is secondary, but it’s a parity equation.

On GIAX, we primarily use Vanguard funds for all of our general index exposure. Inside it, we’ve got VOO, VIG, VB. Why would I choose Vanguard for those? When I just want broad market exposure, I am going to go for the lowest cost.

We have Freedom, which is an emerging markets ETF. It’s called the Freedom 100. We like that because it owns emerging markets, but eliminates nations that have strong state ownership in the fund. It’s truly a free market emerging market ETF.

And then we use iShares to give us exposure to regions that there are not a lot of other options for. So, iShares gives us exposure to Spain, Germany and Sweden.

We also use Global X. They have defense, so we have SHLD, which is a defense tech fund and then their Argentina fund, mainly because they are a little bit more active. But they had the best offering for defense and, also, for South America.

For index funds, it’s mainly cost. For the other funds that are active, it’s more what’s available, and iShares and Global X are two of the best [managers] to do it.

WM: Broadly speaking, where do you see risk on and risk off at this point in the cycle?

DN: We are on the front end of what is hopefully going to be a Fed that’s lowering interest rates. It’s an anticipated event; in many ways, the market has run up in anticipation of it. But we are also balancing it—we are going into September, which is generally one of the top two worst months in terms of returns for the market. So, we’ve tried to derisk our strategies—add a little bit more consumer staples, remove some of the higher beta names in the portfolio, which are typically technology and communication services. It’s not that we are going to go fully risk-off, but we just want to lower the beta in the center deviation of the portfolio going into September.

But we are fully expecting that even though we may see some volatility, for the fourth quarter of this year, we feel bullish on the upside potential for the market. S&P hitting 7000 or above is still intact.

We are never going to fully go risk-off. But when you have a market that’s trading right now with S&P multiple at 25 times the earnings, it’s not like markets are cheap. So, for example, that move to O’Reilly Auto Parts—I want to find some of the names that are great businesses that are very profitable that are trading at a reasonable multiple.

Then, if we do get a sell-off and things get more reasonable, we can go back and buy more of those higher beta names.

WM: Is there anything else that you feel is important to note about your approach to investment strategy?

DN: The U.S. market has been an absolute powerhouse for growth, which is why we’ve predominantly stayed with the U.S. International has had its year, which is why we have international exposure in GIAX. But as the dollar stabilizes, I think U.S. domestic large cap stocks are going to outperform. Strong balance sheet, high-growth names that we are seeing are going to outperform going into the fourth quarter.

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Original Source At Yahoo Finance