2023-03-22 16:00:00 ET
Summary
- QYLD offers passive income investors an eye-popping dividend yield.
- The ETF writes covered calls to generate option income.
- The fund’s long-term performance record and declining net asset value should be of concern to investors.
Passive income investors are frequently drawn to the eye-popping yields offered by some exchange-traded funds, such as Global X NASDAQ 100 Covered Call ETF (QYLD) . This ETF currently has a dividend yield of 13.6%, which is paid to investors monthly.
While the yield may be adequate to combat high inflation, the underlying investment strategy has not resulted in superior total returns.
As a result, I believe the QYLD is a yield trap, and investors would be better off buying a stock like Realty Income Corporation (O) as part of a long-term focused buy-and-hold strategy.
QYLD Fund Profile, Investment Strategy And Appeal To Passive Income Investors
The Global X NASDAQ 100 Covered Call ETF is a technology-focused exchange-traded fund with assets of $6.94 billion as of March 16, 2023.
The ETF primarily invests in a portfolio of technology stocks that includes some of the world's most well-known technology companies. Microsoft (MSFT) , Apple (AAPL) , Amazon.com (AMZN) , Alphabet (GOOG) , and Nvidia (NVDA) are among the fund's top holdings. Microsoft and Apple are the ETF's two largest holdings, accounting for 24.9% of net assets.
Because the majority of the ETF's holdings in technology pay very low dividend yields, the fund must supplement its income in unconventional ways. In the case of the Global X NASDAQ 100 Covered Call ETF, income is generated by using option strategies.
The ETF sells call options to generate additional income for the fund and collects option premiums in a strategy known as a 'covered call', which means the fund owns the underlying securities. Fund managers use this strategy to generate income in a market that is expected to remain mostly flat.
The underlying index from which the ETF picks its investments is the NASDAQ 100 and the exchange-traded fund charges investors a net expense ratio of 0.60%.
The fund's implicit promise is straightforward: investors in the ETF can earn a 13.6% dividend yield and thus, ostensibly, stable dividend income over time.
Many passive income investors are drawn to this implicit promise. A dividend yield of 13.6% is very appealing, especially in a rising-rate environment characterized by out-of-control inflation, which puts pressure on investors to earn higher returns.
Even though inflation has slowed since peaking at 9.1% in June 2022, high consumer prices continue to be a challenge for American businesses and consumers.
However, there is a problem with focusing solely on the ETF's high yield, and one only needs to look at QYLD's past performance record to see what that is.
Since its inception in 2013, the exchange-traded fund has produced an annualized average return of only 5.64% (based on NAV). QYLD has underperformed the NASDAQ 100 benchmark index since inception, and its performance over time, including shorter time periods, has been dismal.
Instead of purchasing QYLD's superficially appealing double-digit yield, passive income investors would have fared far better if they had simply invested in a high-quality U.S.-based REIT such as Realty Income Corporation, which I have extensively discussed here .
The chart below compares the price returns of Realty Income's stock to QYLD without taking into account the benefit of receiving and reinvesting dividends.
Having said that, despite offering a significantly higher dividend yield on the surface, a simple buy-and-hold investment in Realty Income with its boring 4-6% annual yield (depending on the time you buy) outperformed the Global X NASDAQ 100 Covered Call ETF.
Declining Net Asset Value
The Global X NASDAQ 100 Covered Call ETF, like most exchange-traded funds, trades at net asset value. As of March 16, 2023, the fund's net asset value was $16.89, which was equal to the fund's market price.
However, the fund's net asset value growth has been very low since inception, implying that passive income investors should not focus solely on the ETF's high dividend yield.
Why QYLD Could See A Higher Valuation
The net asset value trend is not particularly inspiring, nor is the ETF's longer performance history, which, in my opinion, severely undercuts the case for purchasing QYLD for yield considerations.
Having said that, the Global X NASDAQ 100 Covered Call ETF's net asset value and market price could potentially rise if the market's sentiment shifts.
A resolution to the current banking crisis in the United States would almost certainly be required for such a scenario to occur.
My Conclusion
To be honest, I believe the Global X NASDAQ 100 Covered Call ETF is too risky for passive income investors looking to build wealth.
Furthermore, the market is currently on very shaky ground, as we could be on the verge of a new financial crisis.
While the QYLD has a 13.6% dividend yield and a slick 'covered call strategy', the overall impression of the ETF is negative, and passive income investors should avoid it.
For further details see:
QYLD: Avoid This Risky 13.6% Yielding ETF