2023-05-23 06:15:57 ET
Summary
- QYLD is underperforming in 2023, and I think there's more to come.
- Nearly 100% of distributions have been investor capital.
- Selling upside potential during a raging bull market is the wrong strategy.
Anyone that has read my work knows that I seek out the best relative returns I can find. That means following where money is rotating, using technical analysis religiously, and trying to take the emotion out of investing (which admittedly is difficult). Part of this pursuit is to fine tune exposure, which you can do quite easily using the countless exchange-traded products available today.
For instance, the popular SPDR S&P 500 fund ( SPY ) and Invesco’s Nasdaq product ( QQQ ) have numerous offshoots, including leverage, income options, etc. The subject of this article is one of the many income-oriented derivatives of QQQ, being the Global X Funds - Global X NASDAQ 100 Covered Call ETF (QYLD). I’ve explained what the QYLD is in prior articles, including the most recent one I wrote about QYLD last July . Basically, the fund sells calls against long positions in order to generate options income, and then return that income to shareholders. The idea is a good one, and one that I’ve used personally many times. It works if you don’t mind selling your upside.
The fact sheet lays this out, touting the 9 years of distributions, and saying it offers higher yields in periods of volatility. If the past three years have been anything, they’ve been volatile. I have said in the past that I liked QYLD at times as I thought it would offer better relative returns than the QQQ. At times, that’s been the right call. Today, it’s not.
I said in my July 2022 article that it was time to swap out of QYLD and into QQQ. There’s been a lot of volatility, since then, and QQQ declined into the fall last year. However, since then, QYLD has returned about 10%. That’s nice, but QQQ is up 20% since then. And I believe there’s plenty more where that came from, so rather than reiterate my hold rating on QYLD, I’m moving to sell.
Before we get to that, let’s look a little deeper at QYLD.
The holdings look largely the same as the QQQ, which is no accident. Just remember, however, the fund is selling calls against these positions in order to generate option income. That means that during bull markets, like the one I believe we’re in, QYLD is selling potentially massive upside for peanuts. Not cool.
The chart looks great, as you’d expect given how the Nasdaq has been an unstoppable machine so far this year.
All the signs of bullishness are there, and I’d be surprised if the QYLD didn’t do fairly well for the rest of the year. The underlying index is one that I think is going to do extremely well for the balance of the year, so you could do fine by owning QYLD. But ‘fine’ is not what we’re here for; let’s try and do better.
I said in this article about two months ago that we were in a confirmed bull market, and that TQQQ, which is a leveraged way to own the QQQ, would do well. Whether leverage is your thing or not is a discussion for another day, but the point of the article was that I thought (and still think) stocks would be very bullish this year. TQQQ is up 24% or so since that article, and there’s more to come if I’m right.
Below is a chart of QYLD’s price against that of the QQQ for the past year or so, and I’ve highlighted 2023 with the percent change depiction.
QYLD has underperformed by about 10% this year, which makes sense given QQQ is flying and QYLD sells that upside potential via short calls. There are definitely times QYLD is the way to go, and you can see August to December was one of those periods last year. Right now is not one of those times.
I won’t rehash the bull argument for growth stocks because the linked article from March details all of that, and nothing has changed from my standpoint. But if you’re bullish, you don’t want QYLD, and I certainly don’t right now.
A strategy that’s not working
What I just laid out in terms of relative price performance is plenty enough for me not to want QYLD in my life for the foreseeable future. However, if we look at the way the fund has been making shareholder distributions, I’m afraid the picture gets much worse.
This is the distribution schedule from the most recent distribution (April 2023) and it shows that 97% of the capital returned so far this year has been investor capital. That means 3% was actual investment income. In April alone, it was actually 100% return of capital and zero investment income. If you’re keeping score at home, QYLD is just taking money investors put in and giving it back to them a bit at a time. This is almost certainly not what investors are signing up for with QYLD, but that’s what they’re getting.
The idea is that the calls sold against the fund’s positions would fund distributions. However, that’s simply not happening, and I can’t make the case for this being something I'd want to subject myself to.
That’s also why the fund’s yield on cost actually goes down the further out you get from today. With a traditional dividend stock that raises its payout each year, you’ll see yield on cost go up and to the right on the chart below; that’s not what QYLD has been doing.
The reason is because QYLD is returning capital to shareholders instead of generating income that gets returned. Over time, this has forced smaller and smaller distributions. I don’t have any reason to think this is going to correct over time; QYLD has been unable to generate enough income to cover even a small fraction of its distribution.
Stocks > QYLD
If we take a look at QYLD today, I simply cannot fathom wanting to own it. I realize I’ve recommended it before, and I stand by those calls. However, we’re in a different environment today, and QYLD is destined to underperform simply holding stocks right now.
I offered up TQQQ back in March as one possible way to take advantage of the bull market, but what I’m really saying here is that covered call funds are not your friend during a bull market. QYLD isn’t even a particularly good covered call fund, so I certainly don’t want it. I think QYLD is going to underperform, potentially significantly, and that’s why I’m moving from hold to sell.
For further details see:
QYLD: Run Far, Far Away (Rating Downgrade)