XYLD - XYLD: Powell's Recent Decision Shows Why The Fund Should Continue To Outperform

2023-03-27 00:16:57 ET

Summary

• The market is likely to remain range bound in the current inflationary economic environment. Growth estimates continue to fall.
• Volatility levels are likely to stay elevated. The Fed remains committed to raising rates and only minimal earnings growth this year is expected. Bank failures continue.
• This fund has the right risk balance for most investors focused on income.

The more difficult that market conditions become, the greater the importance of being creative as an investor. With the Fed committed to raising rates and inflation still at high levels, growth estimates in the US and worldwide continue to fall. The S&P 500 and most of the broader performed very well over the last decade, but most traditional index investing strategies have offered minimal income and total returns over the last year.

Market conditions have changed significantly over the last year. There is now a lot uncertainty currently in the markets because of Fed policy and inflation risks. Growth estimates also continue to fall, and the recent bank failures of have further created further uncertainty. The S&P 500 is flat since late June of last year.

Costs remain high and earnings estimates continuing to be lowered, this is much more difficult investing environment than what we saw over most of the last decade. Still, in this kind of investing environment where the economy is stable and volatility levels are likely to remain elevated, there are different kinds of opportunities. One type of fund that should outperform in this kind of market environment is a covered call fund. The Global X S&P 500 Covered Call ETF ( XYLD ) is a buy and write fund that is indexed to the S&P 500. This is a passive managed fund that sells covered calls to make monthly payouts.

I last wrote about this fund in April of 2022, and I wanted to update my coverage of this fund now that the Powell has made clear the Fed is likely to continue to raise rates even despite the notable recent bank failures of the Silicon Valley Bank and Signature Bank.

The Global X S&P 500 Covered Call ETF buys the S&P 500 and sells monthly at the money calls at the money against the index using a buy-write strategy. This ETF sells calls up to 100% of the value of the equities the fund holds. The income from the calls is used to payout monthly distributions. This fund's core holdings, which are indexed to the S&P 500, are 26% technology, 14% health care, 12.69% financials, 10.39% consumer cyclicals, 8.18% communication, 8.43% industrials, 7.17% consumer defensives, 4.6% energy, 2.62% real estate, 2.85% utilities, and 2.36% basic materials.

This exchange traded fund has an expense ratio of .6%, which is normal for a more complicated asset structure as we see with this ETF. The total assets under management of this fund are $2.45 billion, and payouts are made monthly. These distributions will vary based on the income the fund receives from selling covered calls, and the payouts will mostly vary with the volatility levels in the monthly call options being sold. The annual dividends and income this fund offers have been consistent and impressive since the fund's inception 8 years ago. The current yield of the fund is 12.67%.

The monthly payouts of this fund have ranged from $.33 a share to $.50 a share since 2020. Over the last year monthly payouts have ranged $.40 a share to $.50 share. This fund has returned nearly 71% of their original to shareholders in monthly payouts since its inception. This ETF also sells off most of the upside of the fund, so excessive volatility levels can make long-term risks to capital preservation outweigh the income benefits. Still, the slightly elevated levels of volatility in the market we are seeing right now are ideal for a buy and write fund such as this one. Most income investors also are likely focused on consistent long-term payouts, not short-term capital gains.

The Fed remains committed to raising rates, inflation levels are still significantly above Powell's stated target of two percent, and growth estimates continue to fall. The IMF recently lowered growth estimates in 2023 from 3.4% to 2.9% in 2023. In this kind of economic and investing environment the market is likely to remain rangebound and volatility levels should remain elevated. The recent bank failures and the prospect of more failures of financial institutions should also continue to create additional uncertainty.

Still, all investments have risks, and the elevated volatility levels means that total returns in this exchanged traded fund should be minimal in the short-term since this ETF offers no downside protection. The original capital a person must put up to own this fund is at risk the same as with any investment in the a fund indexed to the S&P 500. Index funds such as this one have been very resilient over the long-term, but short-term risks to capital are obviously elevated in this kind of uncertain investing environment.

The Global X S&P 500 Covered Call ETF is similar to a high yielding bond, except this investment has much lower risks than most high grade debt. This fund is well positioned to continue to offer impressive income without taking excessive risks. While uncertainty will likely make this fund continue to be volatile, the current market conditions are still ideal for long-term investors whose primary goal is income.

For further details see: