QYLD - QYLD ETF: A Good Choice For Income Investors

2023-11-06 11:38:42 ET

Summary

• I go over the main details of QYLD, analysing its fundamentals and portfolio composition.
• I explain the potential concerns and benefits of investing in QYLD.
• All in all, I believe that QYLD is a great addition to any income investor's portfolio.

There are many different kinds of investors - growth investors, value investors, and many more! Among these many classifications lies the income investor, who is often more interested in regular and consistent cash flow, as opposed to capital gains earned from closing a position. For such investors, I do believe that the Global X NASDAQ 100 Covered Call ETF (QYLD) is a great investment in the long term due to distribution yield, monthly distributions, and stable capital appreciation over the past few years.

Global X NASDAQ 100 Covered Call ETF

The objective of QYLD ETF is to generate a consistent cash flow through writing covered calls for stocks in the Nasdaq 100 index. Its underlying index is the Cboe Nasdaq 100 BuyWrite V2 Index, which tracks the price of a theoretical portfolio that invests in and writes covered calls on stocks in the Nasdaq 100 index.

Fund performance

We observe that since inception in late 2013 (about a decade ago), the fund has returned 6.74% and 6.72% in terms of its net asset value and market price respectively, underperforming the index benchmark of 7.62%. The shortfall could be attributed to the hefty expense ratio of 0.60%, which is about 7 times that of the famous SPDR S&P 500 ETF (SPY). That being said, it's not a terrible annualized return, especially once we consider the consistency in the fund's distributions, which we will explore later in the article.

Valuation

The ETF boasts an impressive return on equity of 26.6%. We also see a current price-to-earnings and price-to-book value ratio of 25.09 and 6.38 respectively. Considering that tech is a rapidly growing industry, it's no surprise that the metrics are comparatively higher than ETFs tracking the S&P 500 index. For comparison, SPY ETF's price-to-earnings and price-to-book value ratio are 19.35 and 3.77 respectively.

Sector breakdown

As the Nasdaq 100 comprises the largest non-financial companies in the Nasdaq index, we see a huge focus on tech companies which have been leading the growth of the tech industry over the past decade. More than half of the fund's portfolio is allocated to stocks in information technology. While it's good that we invest in a highly lucrative industry that has grown exponentially in the past few years, we should also consider if this is an overexposure.

Portfolio breakdown

We see that the top 10 holdings of QYLD ETF are largely comprised of tech companies, all with close-to-billion-dollar valuations and beyond. A quick check on recent coverages by established analysts shows that the individual stocks themselves may not be too overvalued just yet, though this is not a firm indication that all 10 stocks are undervalued right now . Nonetheless, an investment in QYLD ETF is essentially a relatively large investment in the world's leading tech companies in market capitalisation, which could fit the investment objective of many investors in the space today, especially considering the current analyst ratings on these stocks.

Distribution yield

Here's the main attraction - the distribution yields. QYLD ETF has managed a massive 11.97% distribution yield, more than 5 times that of the popular SPY ETF. The reason for this largely ties in with the strategy of the ETF, which is to achieve consistent cash flow through writing covered calls on stocks in the Nasdaq 100. Historically, writing covered calls is known to generate greater yields during volatile market conditions. Another point to note is that the dividends are distributed monthly, further benefitting investors when we consider the present value of money compared to its future value.

Volatility

We observe that QYLD ETF is less volatile than most major indices, with all corresponding betas being well below 1. This could prove to be a good investment for those who prefer lesser exposure to volatility in the market.

Potential concerns

Now, with all the cards laid out, let's go over the potential concerns one should consider before investing in QYLD ETF.

Overexposure and overvaluation

The higher PE and PB ratios on the QYLD ETF are not a coincidence, as we have seen a boom in the tech industry over the past decades. The above graph is just an illustration of the rapid rotation into tech over the past few years, with the growth in number of workers in the tech sector being about double that of the overall economy. Following global technological advancements, people are rapidly finding favour in tech-related jobs. Tech giants like Apple (AAPL) and Meta (META) have seen exponential growth trends since a decade ago in 2013, and with the introduction of new technological breakthroughs in areas like electric vehicles and semiconductors, we see that companies like Tesla and Nvidia (NVDA) have also rapidly emerged as market leaders. As copious amounts of funds flow into tech-related investments, we need to consider if the companies themselves can grow in tandem with (or faster than) their valuations in the long run. Based on the relatively heavier exposure to tech in QYLD ETF's portfolio, we cannot overlook the potential risk of overexposure and overvaluation.

High expense ratio and substandard returns

The high expense ratio of 0.60% is far from manageable, considering most index ETFs have an expense ratio below 0.10%. It's likely that more operating charges are present due to the nature of the ETF - apart from portfolio adjustments, suitable covered calls need to be written on the underlying stocks to generate a consistent distribution yield. That being said, the returns of the fund definitely have room for improvement - an annualized return of 6.72% since inception is definitely not the best, being just 2 percentage points above current long-term treasury yields.

Why QYLD ETF is still a buy

With all that being said, I do believe that QYLD ETF is a good choice for most income investors.

Consistent distribution yield

The distribution yield of 11.97%, paid monthly to investors, is the main reason why I believe that such an ETF is suitable for income investors. Over the past decade, distributions have been consistent, and also among the highest in the market. The added liquidity provides income investors with the choice to reinvest or use this cash flow for other living expenses. Given the investment objective of income investors, I do believe QYLD ETF offers the perfect marriage between stable capital appreciation and consistent cash flow paid at a good frequency.

Strong portfolio

Despite a potential overexposure to tech, one cannot deny that there is strong confidence in the industry at the current moment. We see from the above that most analysts believe that these tech powerhouses have some room to run before reaching their fair values. While the price targets shouldn't be taken as gospel, it's still an indication of optimism and confidence in the growth potential of the underlying companies of the ETF's top 10 holdings.

Risk-to-reward

While we may not see the same rewards in market returns as compared to investing directly in index ETFs, we have to remember that we are also exposed to considerably lower risk. Even when compared to the diversified portfolio of the S&P 500, comprising 500 of the largest listed U.S. companies, QYLD ETF still exhibits a beta of 0.67. This makes QYLD ETF an attractive choice for more risk-averse investors who still wish to participate in market gains.

Investment decision

Being an investor who values the flexibility of consistent cash flow generation together with stable capital appreciation, QYLD ETF has certainly caught my eye. The ETF is friendly to more risk-averse investors who may not want to invest fully in an index ETF. The strong and consistent cash flow one can expect from holding QYLD ETF makes it even more attractive. The high distribution yields, together with decent historical growth of the fund's net asset value at a considerably lower risk, make QYLD ETF a solid addition to any income investor's portfolio.

For further details see: