QQQ - SPXX: 8% Yielder Likely To Outperform QQQ And SPY But There Are Even Better Choices

2023-09-20 10:00:00 ET

Summary

• The journey from a large premium to a large discount can be extremely harrowing.
• It also sets up some good entry points for those exercising prudence.
• We look at SPXX today and tell you why this covered call fund is the lesser of a few evils when it comes to investing in this market.

We covered PIMCO Corporate & Income Opportunity Fund ( PTY ) recently . The premium it commands is mind boggling.

Each new investor buying here today has to have a serious disregard for safety of their capital. As we can see above, the premium has turned into a discount on multiple occasions over the years, presenting a painful journey for those that went "hand over fist" chasing yield. While, not as popular as PTY, Nuveen S&P 500 Dynamic Overwrite Fund ( SPXX ) made that journey over the last year as a 16.12% premium turned into a 8.88% discount.

And the investors that thronged into this fund at the peak, experienced this on the way down.

Today, we will delve further into SPXX and see if the current discount makes it a compelling bargain.

The Fund

SPXX's portfolio is made up of two types of securities. The equities portion of the portfolio is designed to replicate the returns of the S&P 500 Index ( SPY ). That means it is comprised of domestic securities, with the industry composition looking like this.

The top 10 holdings include the behemoths that dominate the index, including Apple Inc. ( AAPL ) and Microsoft Corp. ( MSFT ).

The options portion of the portfolio is made up of covered calls on 35%-75% of the value of the equity portfolio, with a longer term target of 55%. The options are primarily sold on the index and the June 30 commentary alluded to the fact that the fund also sells put options from time to time. At August 31, SPXX was close to its long term target, having sold covered calls on 54% of the value of its equity portfolio. SPXX provides periodic updates on how it distributes its call options, and this was the picture on 3 weeks ago.

The weighted average days to the options expiration was between 6.63 days and 17.02 days, which tells us that this fund writes weekly and front month options. On an average, the options were slightly out of the money, while the lowest option strike in the portfolio was not deep in the money.

Overall, SPXX held 492 securities at that timepoint, mostly of the large cap variety. Mid and small cap companies made token appearances only.

The overarching goal of the "combo" portfolio is to deliver "attractive total returns" to its unitholders, with a check on volatility via options. The team at the helm also has an eye out for improving the after-tax returns and notes this in the June 30 commentary .

They consider opportunities to engage in tax-loss harvesting (periodically selling positions that have depreciated in value to realize capital losses that can be used to offset capital gains realized by the Fund) and other tax management considerations to improve after-tax shareholder outcomes.

SPXX distributes 29.40 cents every quarter and yields just over 8% on the recently traded price.

As we noted at the beginning of this piece, currently this fund trades at a discount, as a result of which the yield on NAV is slightly lower at 7.35%. Which brings us to the next section, its performance.

Performance

We presented the market price change at the onset of this piece, however, that number is a slave to the gyrations in premium or discount over the period shown. It also does not include the distributions. On a total return on NAV basis (which fixes both those flaws), SPXX has made quite a decent return over the last decade. Below, we show performance over different timeframes versus SPY and the CBOE S&P BuyWrite Index.

And done similarly well over half the timeframe.

This fund uses a blended benchmark , 55% CBOE S&P 500 BuyWrite Index and 45% S&P 500 Index. It has consistently done better than the former and trailed the latter. This is expected in bull markets, as the BuyWrite Index (weighted at 100%) will trail SPY. This also works in the reverse during bear markets, as we can see in the 12-month performance below.

Here, SPXX trailed the BuyWrite Index and outperformed the index. We had recently covered one of SPXX's sibling, the Nuveen Dow 30SM Dynamic Overwrite Fund ( DIAX ). Despite being actively managed, DIAX, just like SPXX could not sidestep the negative impact of a bear market. That prevented us from giving DIAX a buy rating, as the rest of the fund features stacked up. It traded at a discount, had some alpha from a return to NAV and had a decent managed distribution. The 0.93% annual expenses that came with owning DIAX, are almost the same that SPXX charges.

DIAX is, however, tethered to a more defensive index, the Dow Jones Industrial Average ( DJI ). As a result, it outperformed SPXX by over 10% in 2022.

Outlook & Verdict

We like SPXX relative to SPY and a lot relative to Invesco QQQ ETF ( QQQ ). The rationale here is that SPXX is the most defensive market based fund you can find, with options providing some protection. The other thing in favor here is the discount, which likely gets reversed at some point and the fund should trade at NAV. That adds additional alpha. So overall, relative to SPY and QQQ, we see this as a lesser of evils at this point in time. That said, if you are looking for a covered call fund with a larger yield, DIAX is the one we would get behind. The discount is now at 12.32% for DIAX and its underweighting of the technology sector bodes well for a relative outlook.

There is no reason to give SPXX a buy in light of our expectations of an upcoming bear market. SPXX too gets a neutral rating from us, but of the two, at present we prefer DIAX.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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