Sumit Roy at ETF.com wrote about what he referred to as ETF slop focusing mostly, but not entirely, on single stock covered call funds. Anymore, so little of the ETF.com content adds any value, this one is worth one of your free articles. It was a good article but I look at this niche with a different lens.
...these option-selling “income” funds almost always underperform.Underperform what? I think most of the pundits look at these the wrong way. The crazy high yielders have plenty of drawbacks, plenty, but I think it is still important to look at them, or anything, correctly in order to draw an informed conclusion.
He is obviously comparing a YieldMax product to its underlying reference security. In the article he cited Tesla (TSLA) and YieldMax Tesla (TSLY) and yes, TSLY has a much lower CAGR than the common stock but TSLY is not the common stock. As we've looked at quite a few times, TSLY and the other crazy yielders bundle the common stock and selling the volatility of the common stock. I mentioned this point on Twitter recently and someone prominent in the ETF industry said they liked my framing but that they believe the suite is still wildly flawed. That's fair. There are issues including what has been reported in quite a few places as distribution recharacterization between ordinary income and return of capital. Depending on the characterization, that would play into another issue raised by Roy about tax inefficiency.
The price of the crazy high yielders are extremely unlikely to keep up with their distributions. A few weeks ago we cited ULTY from YieldMax which had ripped higher on a total return basis which allowed the fund on a price basis to trade almost perfectly sideways. On a price basis, TSLY is down 80% since inception and has done one reverse split so far which is a pretty good expectation to have, down a lot and then a reverse split. We've seen that with a couple of crazy high yielders from other providers too.
I've alluded to the following idea with crazy high yielders but haven't backtested it so here we go.
Trying to paint as unfavorable a light as I can I assume no rebalancing so the portfolios capture whatever erosion there was and I did not have dividends reinvest to show the distributions being taken out. Portfolio 1 is 90% plain vanilla, Portfolio 2 uses a couple of fixed income substitutes that we use regularly for blogging purposes and Portfolio 3 is AOR which I used instead of VBAIX because VBAIX has paid out a couple of larger capital gains which muddies the water for how I think we should look at this.
Looking at the one full year in the backtest, Portfolio 1 yielded 7.72%, Portfolio 2 yielded 9.59% and AOR yielded 1.52%. The various volatility measures are right in line with just putting it all in AOR which makes sense, the other two portfolios have 90% in AOR.
The only thought I put into selecting which crazy high yielders to use was funds that are relatively older, don't have crazy CEO risk (Tesla and Strategy) and business that are unlikely to fail. Google and Meta stocks may do well or do terribly but going under anytime soon doesn't seem like a reasonable probability. The very small weightings I use for them also mitigates issuer risk.
If this makes sense for anyone, I think it could be for the person we've looked at many times, mid-50's to early 60's who has their hand forced at work and is borderline ready financially to retire. $9500 of "income" per $100,000 invested with 90% in a very simple portfolio seems very sustainable (the portfolio even if not the income) while trying to wait to take Social Security per whatever their original plan was. If the 10% allocation to crazy higher yielders erode 80% on a price basis in three years like TSLY, the plain vanilla 90% has a good chance of more than offsetting the erosion. I'll add my belief that an 80% price decline in just three years is more of an outlier. OARK which tracks ARKK has been around just as long as TSLY and is only down 56% on price basis. FTR, OARK's total return has compounded at 12% while the ARKK ETF has compounded at 30%.
You might read that last section and think, why not just have a large allocation to ARKK and the other stocks underlying the crazy high yielders instead? For some people that could be a better solution but the volatility of going heavy into the referenced underlyings would be brutal. ARKK was down 67% in 2022 and lagged the plain vanilla portion of the portfolio by 38% in 2021. Some volatility for the 61 year old forced to retire earlier than they wanted probably goes with the territory but the upper limit for how much volatility in that circumstance is probably going to be low.
It is pretty clear that these fascinate me but I don't use any of the crazy high yielders and don't know that I ever will but that doesn't mean there isn't a real use case. We'll revisit these portfolio in the future to see how they holds up.
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6 comments:
Thank you, Roger - always very insightful.
What are your thoughts on using the Covered Call ETFs (like SPYI, QQQI, GPIX, GPIQ, JEPI, JEPQ) for a retired person to generate high monthly income from a small portion of the taxable portfolio (say 10-15%)?
These funds are yielding 8%-14% yearly pretty sustainably, and the ones that have been around for several years trade mostly sideways and do not show erosion of price.
Furthermore, the Neos funds (SPYI, QQQI) have compelling tax treatment (mostly Return of Capital which is not taxed when received but reduces the cost basis of the funds and becomes Long term Capital Gains if and when you decide to sell, Stepped-up in cost basis when inherited).
Seems to me like a good way to annuitize this part of the portfolio, generating the income I need to live on, while leaving the rest of it to grow.
Your thoughts and input will be much appreciated.
The various flaws of the crazy high yielders have smaller magnitudes in the type of funds you've mentioned. I would guess that JEPI would be less tax efficient than one of the ones that tracks the S&P 500. Maybe not all of those but some for sure are taxed 60/40 not ordinary income. In a low enough bracket, that might no matter but worth exploring if you haven't allocated yet.
The distributions for JEPI and JEPQ don't look that lumpy, a little variance but not bad. Some of the other ones though can be all over the place. Hope that helps
Super interesting walk through. I keep looking at your portfolio 3 line and still not understanding why it's not hte obvious winner: it seems to be both. lower drawdown, higher return, and lower vol, so I continue to just not get it, i guess. Esp when you consider you have to assume every dollar in income is current income, not ROC (because that happened ot MSTY last year, despite last minute estimates of 100% ROC.).
Hi Dave,
3 might be the best way to go. This was a followup to a vague idea I brought up a couple of times before. The one drawdown for 'max drawdown' was the panic this past April which may not be a great test for how quickly it came back. Maybe that would paint AOR in an even better light or inferior.
I try to convey the point at the end that this post is part of an ongoing attempt to figure out whether there is a way to use these, similar for me to risk parity which is a post I am working on for Mon or Tues. The answer might end up being no but the digging is part of the fun.
The issue with YieldMax funds is that the NAV almost always trends down over time. And there is a very clear correlation between the NAV and the distribution each month. When NAV is up, the distribution is higher. And the distribution is lower when NAV is down. In my own analysis, over time, the NAV declines at a steeper rate than the distribution, but they both trend down overall, which is not a recipe for income reliability. I say that as a current holder of several who is in the process of strategic divestment.
Yes, they do not keep up with the distribution. Check out the ULTY example from the post. Total return it went up a lot, really a lot, could only trade flat on a price basis. Whenever ULTY's total return slows down, I would expect the price only return to turn lower. YieldMax used to talk frequently about reinvesting the distributions but I see less of that lately.
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