VOO - QYLD: Impressive Total Returns Make This An Attractive Fixed-Income Play

2023-08-29 01:05:22 ET

Summary

• The Global X NASDAQ 100 Covered Call ETF is a popular option for investors looking to generate income from ETFs.
• QYLD is a covered-call ETF that sells options on its holdings, limiting upside potential but providing high dividend yields.
• QYLD has a history of consistently high dividend yields, averaging around 10% or higher, making it attractive for income-focused investors.

When it comes to making income from ETFs, a popular option for many investors is the Global X NASDAQ 100 Covered Call ETF ( QYLD ). Indeed, most days in recent months have seen millions of shares traded each day. Investors have not made much in terms of price growth, and some have lost quite a bit in share price, although the actual number will vary based upon when they purchased shares. Even though the fund is down nearly 32% since its inception, I actually have a positive return on my holding because I bought most of my shares late last year, and shares have rebounded in recent months.

What QYLD Does

QYLD is a covered-call ETF that's based upon the NASDAQ 100 index ( QQQ ). Most of the largest stocks on this exchange are tech stocks that have grown rapidly in recent years. The fund sells options on its holdings. When the index closes the option period higher than the strike price, the fund has to sell the shares at the strike price. This limits the upside that the fund will provide to investors in terms of price appreciation and capital gains. The fund still receives the options premium, which it then uses to pay investors a high dividend.

In a sideways or down market, there is protection because the fund still collects the option premium, which it then distributes to its investors. If the option closes and the market price is lower than the strike price, the company keeps both the shares and the option premium. In the crash associated with COVID in early 2020, QYLD dropped from about $24/share to just north of $18 a share, a drop of around 25%. At the same time, the S&P 500 ( VOO ) lost about a third of its value from peak to trough. Last year, the results in the market drawdown were basically flipped.

QYLD Total Return

QYLD hit a low of $15 a share in late 2022, but it's rebounded in the months since and now sits at $17.30, which is a decent increase from its low. Overall, the fund has dropped 3.51% in price over the past 12 months. However, the dividend yield has averaged 12.1% over this year, while prices have appreciated 9.08% YTD. If this yield were to continue for the entire year and the share price remain flat, investors would experience a total return in excess of 21%.

A high return like 21% is not a likely scenario for most years, as QYLD is primarily focused on providing income while protecting on the down side. A flat share price is actually not a bad outcome over the long run for investors in QYLD. Overall, the average annual drop in price has been between 3% and 4% over the past decade (the fund is nearing its 10-year anniversary since inception).

As the above chart shows, in every full year since its inception, with one exception, QYLD has had an average dividend yield approaching 10% or higher. There was a 7.72% average yield in 2017, while the yield every other year has been at least 9.84%.

The fund has definitely achieved its goal of providing dividend income. Over the past three years, the yield has been in the 12% range. When deducting the negative price appreciation from the share price, the total return is in the 8% to 9% range, which is not terrible. This is where the fund becomes interesting.

The average return of the S&P 500 over the past ten years is about 10.44% in terms of share price appreciation. With an average dividend yield that's been around 1.5% over the past three years, this is a total return of about 12%, although QYLD actually outperforms in total return over the past year. Its share price has dropped by 3.51% over the past 12 months, offset by the dividend yield of approximately 12-13% (although this varies by day). This is a total return of approximately 9%. The S&P has appreciated by 4.79% in share price, while its dividend yield has held relatively steady at around 1.5%. This gives an approximate total return of a little more than 6.2% over the past 12 months for the S&P.

QYLD will benefit those who are looking for monthly income. The fund pays pretty much every month, although there are usually a couple of months without a payment each year. The fund makes up for this with two payments the next month (one near the beginning of the month and one near the end). Those looking for a semi-stable income will appreciate this, although the actual dividend will vary from month to month. When the price of shares drops, the dividend also drops. When it goes up, the dividends increase.

I previously noted the massive income that QYLD provides investors. That income can grow over the long run through dividend reinvestment. With a yield of 10-12%, investors could expect the dividend to double over the course of six or seven years if they reinvest all dividends. Dividend growth stocks like Johnson & Johnson ( JNJ ) and Lowe's ( LOW ) might double their dividend payments organically without reinvesting the dividends over the same period. However, they are starting from a yield in the 2-3% range. This means a couple of hundred dollars a month in dividend income for every $100,000 invested, vs. about $1,000 a month for QYLD with the same investment. That $1,000 could very possibly increase to $2,000 over a relatively short time because of the higher starting yield. This is with a stable payout.

Even a slightly lower payout would still likely see a doubling of the dividend with reinvestment within a decade. This will be cut a bit because of the treatment of QYLD dividends as ordinary dividends vs. the more tax-advantaged treatment of LOW or JNJ.

Conclusion

While I own a bit of Vanguard's S&P 500 ETF, I also own QYLD for the income. I am likely 15 to 20 years from retirement, and I view the income as an opportunity to reinvest the dividends, either into more shares of QYLD or another dividend-paying stock that might provide more growth like Johnson & Johnson ( JNJ ) or Lowe's ( LOW ). If I reinvest all my dividends into QYLD, I might expect my income to grow by 8% to 9% a year, in line with the total return. That means I could see my annual income and my share count quadruple (or more) over the next couple of decades. Those with 30 or 40 years to go might opt more for investments that are tied to growth, rather than income, but those looking for immediate income could benefit from higher-yielding investments that provide real income on a monthly basis. It takes a relatively low investment to return a solid income. For example, a $300,000 investment in QYLD would likely return $2,500 to $3,000 a month, a livable income for some, especially those with a paid-off house in an area with a low cost of living and low taxes. Of course, it is likely not a good idea to put all of your eggs in QYLD, but it can be useful for juicing income.

For further details see: