QQQX - QQQX: Ride 2023's Tech Bull Market With A 7%+ Yield

2023-04-05 10:27:07 ET

Summary

• Nuveen NASDAQ 100 Dynamic Overwrite Fund is a nice covered call closed-end fund that is only about half hedged at any given time.
• The fund's yield is quite high, but the chart is overbought after a big rally.
• I like QQQX for 2023's market conditions but would wait for a lower price.

The bear market of 2022 called into question the long-term viability of stock market returns for many. This is typical bear market behavior, wherein many investors can't take the pain anymore and simply sell, or reallocate to funds with lower volatility. There is a time and a place for such funds, and I've noted some of them in the past, particularly with respect to covered call funds.

These funds are great for generating income and reducing volatility, at the expense of potential upside participation. Not all are created equal, however, and in this article, we'll take a look at the Nuveen NASDAQ 100 Dynamic Overwrite Fund ( QQQX ) to see if it may be right for you.

Before we get into this closed-end fund ("CEF") itself, let's touch on why one might want to own QQQX, or something like it. The fund generates significant income by selling covered calls on its underlying stock positions. This generates a premium that is distributed to holders of the fund, but it also reduces the volatility of total returns and slightly reduces downside exposure. During sideways or down periods in the market, this kind of fund will generally beat a pure index fund, like the QQQ this one is based on. Thus, this kind of thing certainly has a place, even if you're not a pure income investor. If you are, a 7%+ yield is probably pretty enticing as well.

What is QQQX?

This one is a fund that seeks to offer regular cash distributions to holders that also produces less volatility than the Nasdaq 100 index that it's based on. The fund buys Nasdaq 100 stocks and sells calls against those positions worth 35% to 75% of the notional value of the equity portfolio, with a long-term goal of hedging 55% of the fund's value. In other words, over the long term, the fund will have roughly 55% of a Nasdaq 100 portfolio hedged with covered calls, and the other 45% unhedged, just like a pure index fund. This one is a mix of an index fund and a covered call fund, in other words.

As I mentioned, this should generate less volatility than a pure index fund, as the covered calls serve to reduce both upside and downside exposure. It obviously generates income as well.

Speaking of income, here's a look at the most recent information available on distributions.

QQQX is on a quarterly distribution schedule, which is a bit unusual for a covered call fund, as those tend to be monthly. Obviously, monthly is more desirable than quarterly as those funds can be used for living expenses, reinvested, etc. more often than quarterly distributions. That's a knock against QQQX, but a small one.

Here's the distribution history for the past 10 years, and we can see that QQQX has managed to produce generally rising distributions on a per-share basis. There's going to be volatility in the distributions because of the way they're generated, so that's something you must be okay with if you're going to own this or any other covered call fund. The most recent distribution was 42 cents per share, after it was much higher during 2022, and we can see there have been reductions in the past as well. This is not a dividend fund that will see constantly rising income over time, but in exchange for payout volatility, you get a superb yield.

In addition, since the fund's inception in 2007, it has returned $24.90 per share in distributions, or just over 100% of the current share price. And, had those distributions been reinvested, total returns would be 349% since inception, according to the fund's website . That's not too shabby for what this fund is.

This chart shows trailing twelve months yield, not forward yield, but the principal is the same. The point is that today's yield on QQQX is about as good as it's ever been, with the exception of the start of 2023, when the price of the fund was depressed. It rallied strongly in 2023, along with the Nasdaq 100, and reduced the yield. A yield this high argues the fund is probably pretty cheaply valued right now, even after the big rally we've seen.

Let's now turn our attention to the holdings of the fund, and given we know it's a Nasdaq 100-based fund, it's completely filled with tech stocks.

Software is 18%, Semis are 15%, and so on. These are concentrated positions, so if you're someone that likes thousands of stocks in a fund to smooth returns, this is not for you. This fund is a concentrated bet on large- and mega-cap tech stocks, and nothing more.

The good news is that over long time frames, this strategy has worked.

Average annual total returns since 2007 (a period which has encompassed all kinds of market conditions) is 10%. Over the last ten years, it's 11.8%, and over the past five, it's 6.8%. One-year returns are well into negative territory, given the massive bear market we saw in the Nasdaq early last year. However, six-month returns are staggering at nearly 22%.

How does the chart look?

Now that we have a handle on what this fund is, how it produces returns, and how it's performed, let's take a look at the chart to see if now may be a good time to buy it. I said based on the current yield that the fund appears to be somewhat cheap, but the chart says there's cause for caution shorter term. For that reason, I'm recommending that if you do want to buy QQQX, you wait for a better price. Permit me to explain.

We can see on the price chart I've drawn a blue line that connects a higher high from February to March. I've also drawn a line on the PPO that connects those same periods, but we see there's a markedly lower high on the PPO. That's called a negative divergence, and it simply means the price is moving higher while momentum is failing to confirm the high. That is not a death knell by any means, but it very often portends a period of consolidation or trend change. In this case, I don't think a trend change is coming, but I do think some consolidation is likely and necessary to work off the overbought condition.

Logical support levels include the rising 20-day exponential moving average at $23.31, and the rising 50-day simple moving average at $22.91. You can use those levels to place orders if you're looking to layer into your position. Based on what I'm seeing, I think a 50-day simple moving average test is pretty likely, so I wouldn't go all-in on the 20-day exponential moving average test.

Finally, I think it's important to see how this fund compares to the Nasdaq 100 that it tracks during bull and bear periods, which we see below. The pure Nasdaq 100 is on top, with the relative performance of QQQX against that index below.

We can see that there's a somewhat inverse relationship between the two funds, which you would expect given QQQX limits both upside and downside participation (more so limiting upside). That means that during raging bull market periods, QQQX is going to potentially vastly underperform the underlying index. During just about any other period, however, it should do quite well against the index, particularly once distributions are considered.

Final thoughts

I've made it clear in recent posts, primarily this one , that I think U.S. equities will end this year much higher than they are today. This is particularly true of growth-oriented and tech stocks, so I'm quite bullish on the Nasdaq 100.

However, it is clear many people disagree with my assessment, and if you happen to be one of those, you can gain hedged exposure to tech and growth stocks through QQQX. Given I'm bullish, I don't necessarily want to hedge, but I see a place for this fund, especially if generating income is important to your investment goals.

I mentioned I'd wait for a lower price before buying Nuveen NASDAQ 100 Dynamic Overwrite Fund given the way the chart looks, so for that reason, I'm putting a hold rating on QQQX for now. But once we get the pullback, I like this fund enough that given the right chart setup, I'd have no problem putting a buy rating on it.

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