STK - STK: One Of The Best Covered Call Funds Out There

2023-09-07 00:50:08 ET

Summary

• Columbia Seligman Premium Technology Growth Fund is a covered call fund that has consistently outperformed the market by a large margin (up 473% in the last decade).
• STK is the best-performing major covered-call fund in 2023, with total returns up almost 40% year to date.
• The fund invests in growth stocks in the technology sector and uses a bottom-up fundamental analysis approach to select reasonably valued stocks.
• Its yield is only around 6-8%, but its dividend growth and share price appreciation make up for it with its 14% annualized return since inception.

Columbia Seligman Premium Technology Growth Fund ( STK ) is a less known covered call fund that's been around for more than a decade with impressively strong returns so far. Usually when people think of covered call funds, they think of funds that underperform and constantly face NAV decay because they limit their upside potential in return of an option premium which means they participate in most of the downside but very little of the upside in market movements. STK seems to be one of the few covered call funds that has been actually outperforming the overall market ( SPY ) by a large margin for more than a decade (474% vs 226%) and this makes this fund a buy in my book.

In addition to beating SPY in the long run, this is also the best performing major covered-call fund in 2023 as it's up almost 40% in total returns year to date so far and outperforming others by a pretty wide margin as their performance ranged from 7% to 28% so far.

The fund mainly invests its assets into growth stocks in technology sector. The fund's management conducts bottom-up fundamental analysis based on valuation models to pick growth stocks that are reasonably valued as compared to their peers. Then it writes monthly call options on Nasdaq index. Technically this is not "covered call" because the fund doesn't hold the index and it holds a different set of stocks than it writes calls against. This can be a problem if the fund's overall beta is significantly different from beta of Nasdaq index but apparently it isn't so this might not be a big issue. The fund's holdings are "conviction-weighted" meaning the highest weight of the fund goes to stocks where the management team has most conviction and so on.

As the fund is actively managed, it will write calls against anywhere from 25% to 90% of its total asset value depending on a variety of factors such as overall volatility and market valuations. For example when volatility is higher, the fund could sell more call options to milk those inflated premiums but when the management feels bullish about stocks overall, they will sell fewer calls so that upside is not capped. This can create an interesting situation since some of the most volatile times also happen to be near market bottoms, which leaves the fund's managers with important decisions to make. On one side they can opt to milk the high volatility, on the other hand they can position themselves for a lot of upside since stocks would be on discount after a sharp correction that comes with high volatility. Below is a table summarizing general guidelines the fund uses for its covered call strategy. Notice that it uses VXN instead of VIX because it writes calls against Nasdaq which means Nasdaq's volatility is more relevant for the fund.

The fund doesn't have a general rule about the strike price where it sells its call options. Depending on market conditions it could sell options in-the-money, at-the-money or out-of-money based on discretion of the fund managers. The fund typically doesn't hold options until expiration and either closes or rolls them out if at least 70% of the option's original time value has been eroded but this is just a general guideline and the fund doesn't follow it strictly 100% of the time.

One way or another, the fund's past performance speaks volumes about its management's ability to navigate difficult times and deliver results. Since the fund is actively managed, you have to have faith in the ability of the fund's management in order to invest into this fund. The fund's management team is led by Paul Wick who has 36 years of experience in the field. Mr. Wick has been managing this fund since its inception in 2009. If you don't feel comfortable with an actively managed fund, this might not be the best fund for you to invest in.

The fund has a relatively high expense ratio of 1.13% and it sells for a NAV premium of 10%. Some people might be turned off by these but it shouldn't be a big deal as long as the fund continues outperforming. The fund is also authorized to use up to 33% leverage opportunistically if it finds opportunities at compellingly cheap valuations.

The fund doesn't have a double-digit dividend yield like many other covered call funds do as its yield has been around 6-8% for most of its existence. Many people invest into covered call funds in hopes of getting higher yields like QYLD's ( QYLD ) 12% or JEPI's ( JEPI ) 10% yield. Having said that this fund has a couple things other funds don't. First, it has dividend growth over time. Thee fund's dividends don't necessarily grow at a steady rate year over year but in the long run they generally trend higher.

If you invested $10k into STK in 2010 and reinvested dividends until today, your investment would now generate an annual dividend of $5,300 which is a 53% yield on your original cost. It shows you the power of compounding driven by a combination of dividend growth and dividend reinvestment. If this type of growth continues you could see 100% annual yield on your original cost before this decade ends (based on the scenario above assuming it's held in a tax-sheltered account).

Another thing this fund has that other covered call funds typically lack is price appreciation driven by NAV growth. Typically covered call funds tend to see their NAV and share price decline over time for two reasons. First, their upside potential is capped so they are typically unable to participate in upside movements in the market. Second, they typically have very high dividend yields which get subtracted from NAV and share price. When a fund trades at $20 and pays out a dividend of $2, its price automatically drops to $18 after the ex-dividend day. When a fund has double digit yield year after year, its NAV will erode and investors will have to rely almost entirely on dividends for their total returns. As you can see in the chart below STK's share price has appreciated by 134% in the last decade as compared to QYLD, whose share price is down -31% during the same period.

This fund is not ideal for traders or short-term holders. It's designed for buy-and-hold investors with long term horizon who also like to reinvest their dividends. The fund will perform the best in a tax-sheltered account such as a 401k account. Since the fund invests into growth and technology stocks, it will be more volatile than the overall index and you can see it drop by 25-30% in one year (like it did last year). Investors should be prepared for this kind of volatility and be comfortable with it if they are going to hold this in the long run.

All in all, this is a solid fund and possibly one of the best covered call funds out there. The fund's long term performance (compounded annual growth rate of 14% vs SPY's 10%) speaks for itself.

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