World X Nasdaq 100® Coated Name & Progress ETF (NASDAQ:QYLG) is a coated name fund that writes month-to-month at-the-money coated calls on the Nasdaq 100 index (QQQ) but it surely comes with a twist as in comparison with its extra well-known sister QYLD (QYLD). The fund really writes coated calls solely in opposition to 50% of its holdings versus QYLD which writes calls in opposition to 100% of its portfolio, so the upside isn’t capped. In consequence, it provides half the yield of QYLD however provides higher returns general as a result of it will get to take part in an upside.
On the unfavorable facet, when the bear market strikes, it provides much less safety as in comparison with QYLD as a result of it wrote fewer coated name contracts, which have a tendency to melt the blow when issues go south. In 2022 when Nasdaq was in a bear market the place it dropped by as a lot as 35%, QYLD was down -19% and QYLG was down -26% in complete returns together with dividends. The distinction between the 2 funds was additionally near their dividend yield distinction since QYLD yielded 12% throughout 2022 whereas QYLG yielded about 6% which created a 6% yield distinction which explains many of the 7% hole between the full efficiency of the 2 funds.
In different phrases, QYLG will outperform its friends throughout a bull market however underperform after we are in a bear market or experiencing a flat market. Because the markets are typically up extra usually than they’re down (the typical bull market lasts 7 years versus the typical bear market lasting 1 yr), this fund ought to (a minimum of in idea) outperform extra usually than underperform its friends. This gained’t cease it from underperforming the Nasdaq index although as a result of the upside remains to be partially capped for 50% of its portfolio. Then once more, one can’t assist however marvel how usually QQQ will rise 50% in a yr. You in all probability gained’t see this occurring yearly.
One huge downside with QYLD is that its dividends preserve shrinking yr after yr because of NAV decay. In idea, QYLG ought to have much less of an issue with this as a result of its NAV decay isn’t as robust. As a matter of truth, in the event you have a look at the precise NAV efficiency of every fund within the final couple of years you’ll discover that QYLG’s NAV was up virtually 10% throughout this time indicating no NAV decay in any respect whereas QYLD skilled a fairly substantial NAV decay at 18%.
Right here is the attention-grabbing factor. Many individuals purchase QYLD due to its excessive yield which often ranges from 10% to 12% whereas QYLG provides about half of this yield which ranges from 5% to 10%. As demonstrated above, QYLD’s NAV decays considerably even when the Nasdaq is rising as a result of its upside is just about capped whereas its draw back potential isn’t as capped. Because of this QYLD’s dividends can even shrink together with its NAV, which has been occurring. Simply 3 years in the past, QYLD’s share worth was $23, and it was paying 23 cents per share in month-to-month distributions. Now QYLD’s share worth is $17 and it’s paying 17 cents in distributions. In the meantime, QYLG’s dividends remained the identical throughout this era. It has been paying about 14 cents per 30 days give or take a cent or two for the final 3 years or so, which implies throughout all of its existence.
While you have a look at the fund’s distribution historical past you will discover that it made an enormous distribution in 2021, and it virtually seems just like the distribution acquired minimize considerably in 2022 however as a matter of truth these month-to-month distributions had been the identical through the years of 2021, 2022 and even 2023. What occurred was that the fund made a particular distribution of $1.61 on the finish of 2021 pushed by capital beneficial properties. When a fund books capital beneficial properties it has to distribute these beneficial properties to shareholders on the finish of the yr except it desires to pay taxes on these beneficial properties. By sharing these capital beneficial properties with traders, funds are passing the tax invoice to traders but it surely’s not essentially a foul factor since you’re getting paid extra.
Mainly, if this fund retains its distributions fixed or raises them a bit over time, the fund’s month-to-month earnings will cross the month-to-month earnings of QYLD in the long term though QYLD began out with a yield of 12% whereas QYLG began out with a yield of 6%. In the long term, rising or secure dividends will all the time beat these dividends which can be declining. In the meantime, declining dividends by themselves will not be the “illness” however solely a “symptom” of a illness. The actual illness right here is the NAV decay.
Many instances I hear high-yield chasing traders inform me that NAV isn’t vital and traders shouldn’t care about NAV decay and solely concentrate on month-to-month earnings, however when NAV begins decaying, distributions begin decaying too and people beneficiant dividend checks preserve getting smaller and smaller. That is why QYLD’s month-to-month distributions dropped from virtually 25 cents to 17 cents in the previous couple of years, even with QQQ performing so nicely. If QYLG can preserve defending and rising its NAV over time prefer it’s been doing this yr, the fund ought to have room for rising its distributions sooner or later.
On the finish of the day, would you moderately get a beginning yield of 12% coupled with NAV decay of 3-4% per yr and declining distributions over time or get a beginning yield of 6% coupled with NAV beneficial properties of 3-4% per yr and secure distributions? In case you are short-term targeted, you may like the primary possibility, however traders with long-term focus will choose the second possibility.
Since QYLG writes coated calls in opposition to 50% of its QQQ positions, some folks additionally created their very own model of QYLG by placing half of their cash into QQQ and one other half into QYLD. Within the short-term, this could replicate the outcomes of QYLG, however in the long run, the outcomes is perhaps totally different except you retain rebalancing your portfolio on a month-to-month foundation. Let’s say you began out with 50% QQQ and 50% QYLD, and we had a powerful month the place QQQ rose by 10% and QYLD solely rose by 2%. Now your portfolio is 54% QQQ and 46% QYLD. If this retains occurring, your portfolio gained’t be as balanced. If you wish to preserve it at a 50%-50% steadiness always, QYLG is already doing that for you.
I like this fund as a result of it participates in a minimum of 50% of QQQ’s upside whereas nonetheless offering a wholesome, sustainable and secure yield of 5-6%. The one query for the long run is, can this fund additionally present dividend progress? In idea, it ought to be capable to as its NAV grows, and it has extra assets to put in writing calls in opposition to, however thus far we haven’t seen a lot dividend progress from this fund which is the one regarding level I’ve concerning this fund.