QYLG - QYLG: The Better Cousin Of QYLD

2024-01-02 07:26:11 ET

Summary

• Global X Nasdaq 100 Covered Call & Growth ETF writes covered calls on 50% of its holdings, offering better returns and participation in upside compared to its sister QYLD.
• QYLG offers less protection in bear markets compared to QYLD, resulting in lower total returns during market downturns.
• QYLG's NAV has shown no decay and its dividends have remained stable, making it a potentially attractive option for long-term investors.

Global X Nasdaq 100® Covered Call & Growth ETF (QYLG) is a covered call fund that writes monthly at-the-money covered calls on the Nasdaq 100 index (QQQ) but it comes with a twist as compared to its more famous sister QYLD (QYLD). The fund actually writes covered calls only against 50% of its holdings as opposed to QYLD which writes calls against 100% of its portfolio, so the upside is not capped. As a result, it offers half the yield of QYLD but offers better returns overall because it gets to participate in an upside.

On the negative side, when the bear market strikes, it offers less protection as compared to QYLD because it wrote fewer covered call contracts, which tend to soften the blow when things go south. In 2022 when Nasdaq was in a bear market where it dropped by as much as 35%, QYLD was down -19% and QYLG was down -26% in total returns including dividends. The difference between the two funds was also close to their dividend yield difference since QYLD yielded 12% during 2022 while QYLG yielded about 6% which created a 6% yield difference which explains most of the 7% gap between the total performance of the two funds.

In other words, QYLG will outperform its peers during a bull market but underperform when we are in a bear market or experiencing a flat market. Since the markets tend to be up more often than they are down (the average bull market lasts 7 years versus the average bear market lasting 1 year), this fund should (at least in theory) outperform more often than underperform its peers. This won't stop it from underperforming the Nasdaq index though because the upside is still partially capped for 50% of its portfolio. Then again, one can't help but wonder how often QQQ will rise 50% in a year. You probably won't see this happening every year.

One big problem with QYLD is that its dividends keep shrinking year after year due to NAV decay. In theory, QYLG should have less of a problem with this because its NAV decay is not as strong. As a matter of fact, if you look at the actual NAV performance of each fund in the last couple of years you will notice that QYLG's NAV was up almost 10% during this time indicating no NAV decay at all while QYLD experienced a pretty substantial NAV decay at 18%.

Here is the interesting thing. Many people buy QYLD because of its high yield which usually ranges from 10% to 12% whereas QYLG offers about half of this yield which ranges from 5% to 10%. As demonstrated above, QYLD's NAV decays substantially even when the Nasdaq is rising because its upside is pretty much capped while its downside potential is not as capped. This means that QYLD's dividends will also shrink along with its NAV, which has been happening. Just 3 years ago, QYLD's share price was $23, and it was paying 23 cents per share in monthly distributions. Now QYLD's share price is $17 and it's paying 17 cents in distributions. Meanwhile, QYLG's dividends remained the same during this period. It has been paying about 14 cents per month give or take a cent or two for the last 3 years or so, which means during all of its existence.

When you look at the fund's distribution history you will find that it made a huge distribution in 2021, and it almost looks like the distribution got cut significantly in 2022 but as a matter of fact those monthly distributions were the same during the years of 2021, 2022 and even 2023. What happened was that the fund made a special distribution of $1.61 at the end of 2021 driven by capital gains. When a fund books capital gains it has to distribute those gains to shareholders at the end of the year unless it wants to pay taxes on those gains. By sharing those capital gains with investors, funds are passing the tax bill to investors but it's not necessarily a bad thing since you are getting paid more.

Basically, if this fund keeps its distributions constant or raises them a bit over time, the fund's monthly income will pass the monthly income of QYLD in the long run even though QYLD started out with a yield of 12% while QYLG started out with a yield of 6%. In the long run, growing or stable dividends will always beat those dividends that are declining. Meanwhile, declining dividends by themselves are not the "disease" but only a "symptom" of a disease. The real disease here is the NAV decay.

Many times I hear high-yield chasing investors tell me that NAV is not important and investors shouldn't care about NAV decay and only focus on monthly income, but when NAV starts decaying, distributions start decaying too and those generous dividend checks keep getting smaller and smaller. This is why QYLD's monthly distributions dropped from almost 25 cents to 17 cents in the last few years, even with QQQ performing so well. If QYLG can keep protecting and growing its NAV over time like it's been doing this year, the fund should have room for increasing its distributions in the future.

At the end of the day, would you rather get a starting yield of 12% coupled with NAV decay of 3-4% per year and declining distributions over time or get a starting yield of 6% coupled with NAV gains of 3-4% per year and stable distributions? If you are short-term focused, you might like the first option, but investors with long-term focus will pick the second option.

Since QYLG writes covered calls against 50% of its QQQ positions, some people also created their own version of QYLG by putting half of their money into QQQ and another half into QYLD. In the short-term, this should replicate the results of QYLG, but in the long term, the results might be different unless you keep rebalancing your portfolio on a monthly basis. Let's say you started out with 50% QQQ and 50% QYLD, and we had a strong month where QQQ rose by 10% and QYLD only rose by 2%. Now your portfolio is 54% QQQ and 46% QYLD. If this keeps happening, your portfolio won't be as balanced. If you want to keep it at a 50%-50% balance at all times, QYLG is already doing that for you.

I like this fund because it participates in at least 50% of QQQ's upside while still providing a healthy, sustainable and stable yield of 5-6%. The only question for the long term is, can this fund also provide dividend growth? In theory, it should be able to as its NAV grows, and it has more resources to write calls against, but so far we haven't seen much dividend growth from this fund which is the only concerning point I have regarding this fund.

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