XYLD - Why We Prefer BXMX's 7.7% Yield Over XYLD's 11.3%

2023-11-14 17:56:19 ET

Summary

• BXMX and XYLD write covered calls on the index as an offset to their equity holdings.
• BXMX is a closed end fund, whereas XYLD is an exchange traded fund.
• We review them on key characteristics, performance, and yield and provide our pick between the two.

Who does not love a good income stream? There are plenty to choose from in the market as well. We talk to you about two well-followed covered call funds and tell you why one wins versus the other.

Nuveen S&P 500 Buy-Write Income Fund ( BXMX )

Formed in 2004, this closed end fund holds a portfolio of global equities that follow the price gyrations of the S&P 500 Index. It also writes call options on close to or 100% of the equity portfolio in a bid to reduce its portfolio volatility and earn its investors some good old fashioned, "risk adjusted returns". In bear markets, the buy-write exercise creates a limit on the capital loss in the event the price of the security declines below cost. On the flipside and in bullish periods, it also puts a ceiling on the capital appreciation that the fund can enjoy from price increases. When the market is flat, the premiums add to the income stream of the fund, along with the dividends from the underlying equities, enhancing the returns enjoyed by its unitholders.

At September 30, BXMX held 264 securities, almost all of which were large cap in nature. This is not surprising, as the beacon index for this fund, is known for the goliaths in its composition. In a similar vein, the fund's sector selection too would not cause any batting of even a single eyelid.

The top 10 BXMX positions made up over 30% of the portfolio, and this list includes names that have collectively held up the index, despite the brutality witnessed in smaller names.

Using the September 30 data again, this time for the option holdings, we can deduce that on an average the fund writes calls only slightly out of the money. This is based on the average call strike vs spot price of 102%.

The options are short term in nature, with the average number of days to expiration around 26 days. At September 30, calls were written on 99% of the equity portfolio.

Global X S&P 500 Covered Call ETF ( XYLD )

Formed in 2013, XYLD is very similar to BXMX, except that it is an exchange traded fund. XYLD buys the equity incumbents of the S&P 500 index and sells call options on the index. It achieves this by generally investing at least 80% of its assets in the components of the CBOE S&P BuyWrite Index. As noted in the fund's prospectus , this index is made up of two parts:

(1) all the equity securities in the S&P 500 Index (the "Reference Index") in substantially similar weight as the Reference Index; and

(2) short (written) call options on up to 100% of the S&P 500 Index.

XYLD is a passive fund, which means that it does not try and out perform its index. The fund usually follows the replication strategy, which means that it allocates funds to the securities in the same proportion as its index. It falls back to the representation strategy, when exact replication would harm the interests of its unitholders in terms of higher costs, illiquid securities, legal restrictions etc. On a side note, we recently covered one of its siblings, Global X Nasdaq 100 Covered Call ETF ( QYLD ), and that one followed the same strategy using the other behemoth index, as noted in the name of the fund. Except for the difference in the indices, the two Global X funds follow the same strategy in relation to options.

Bringing our focus back to XYLD, the top 10 holdings are the same at the ones we saw earlier in this piece for BXMX. The proportions and the order differ, in part since, being an ETF, the data available for XYLD data is more current.

At last count, this one has close to double the holdings (504) compared to BXMX, however, the top 10 positions form approximately the same proportion of the net assets. Since both the funds use the same index to for security selection, we can also assume there would not be too much of a divergence of the XYLD sector allocations to those of BXMX presented earlier in this piece. At September 30, the XYLD sectors and their hierarchy was the same as BXMX.

Distributions

BXMX has managed distributions, which means that the unitholders receive steady payments. The amount is updated periodically, depending on the management expectation of income and capital appreciation. BXMX currently distributes 23.65 cents every quarter, which comes to a yield on price of around 7.68% (current price $12.31).

Since BXMX trades at a discount to its net asset value or NAV ($13.66), the yield on NAV is lower, around 6.92%. XYLD on the other hand, has a variable monthly distribution, which was 38.35 cents for October. Using the current price of $38.95, it yields a chunky 11.82% in comparison.

Monthly versus quarterly, and double digits to boot. No wonder, BXMX pales in popularity compared to XYLD.

Performance

Like XYLD, BXMX also measures its performance relative to the CBOE S&P 500 BuyWrite Index. The closed end fund is actively managed however, and that has paid off over the last three years, in terms of total return on market price.

The hierarchy of returns remains the same if we look at the total returns on NAV.

Since BXMX trades at a discount, the returns on price beat the returns on NAV. While BXMX is no stranger to trading at a discount, 2023 took away the hope that 2022 had bestowed on it.

This gave XYLD a chance to shine in terms of total return on price. It still could not match up to its index.

Nothing changed in terms of performance on NAV and BXMX continues to occupy the top spot amongst the trio.

The data published by the two funds, show the same trajectory as the charts above . The semi annual report, while not current like the above charts, also show BXMX out performing the index.

Similarly, XYLD lagging its benchmark index (in all time frames except one) is reflected in the performance published on its website.

BXMX has annual expenses of 0.90% versus 0.60% for XYLD. The index does not have any. The former's outperformance is even more impressive in light of this.

Why Sell XYLD And Buy BXMX?

Just like its sister funds QYLD and Global X Russell 2000 Covered Call ETF ( RYLD ), XYLD also indulgences in blind covered call selling. To be fair, it has chosen an index to follow passively and its literature explicitly states that the fund will make no attempt to beat the performance of its index. How bad does one need to be to not even match the index though? Yes, you pay a little extra in annual fees to hold BXMX, but you still come out comfortably ahead with the actively managed fund versus holding the "lost cost" ETF. XYLD's double digit dividends have kept the total returns in the positive territory, since the price ain't doing jack.

BXMX has outperformed XYLD on NAV and we think this differential will widen in the coming bear market.

Calm, logical covered call selling will do better than blindly squandering upside just to get more income. Icing on the cake for the switch, is that you get to buy BXMX at a 10% discount to its NAV.

As the Z scores and the above chart indicate, this discount is higher relative to where this fund normally trades, giving rise to a good probability of alpha on this front. XYLD investors have collected double digit yields, but BXMX investors have had the last laugh in returns. It is not too late to switch.

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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