A Place for Income Funds or Covered Call Strategy

[ImThinkin2019]

In the last QYLD thread which got a bit heated and closed, there was a lot of discussion about whether this type of fund/approach was appropriate for anything.

The thread was very useful to me and caused me to think.

I had previously researched covered call funds because I have a friend who has been doing this "manually" for over 30 years. He says he has always beaten the S&P 500, at least the last time I talked with him.

When I looked at these funds in the past I gave up on them because their gains underperformed the stock market as a whole.

After thinking about this, for us, this type of investment fits better in our income bucket rather than our equity bucket. Comparing it to the current income bucket contents - individual bonds and private placement debt - we think there's a place for income funds/covered call strategy. For us. Not saying good for everyone.

In our view they are higher capital risk than bonds, but with higher income %. And the capital risk may be reduced by a long holding time.

We probably would start our with a fraction of our income bucket in these - maybe 10% or so. Not sure if we would start to DIY but we might be open to it in the future. Just want whatever we do to be possible when our faculties dim...


Thank you to everyone, especially the original poster, jim, and ERD, for your comments on this. Once again, the group experience and minds have helped us!!

 

[pb4uski]

Also see https://www.early-retirement.org/fo...alls-and-naked-puts-109853-9.html#post2675504 re ACIO

NUSI and JEPI are also interesting to me for income.

 

[gauss]

You need to remember two things when looking at these securities that are not usually discussed.

#1) The monthly distribution is often believed to come from selling covered calls. If you look at the financial statements and the required disclosures, you will see that the majority of income is tax-classified as "return of capital" not "income". What is likely going on here is that when new money flows into the fund and the asset base grows, not all of the new money is invested in the underlying security. Some of the new money is being used to pay the monthly distribution. When I first read this I thought, "Ponzi Scheme!". Well no, not actually. No fraud is being used with the covered call funds. The income generated from selling the covered calls is nowhere near the level needed to support the monthly distributions.

#2) Folks often like these funds due to the apparent stability or hopefully even increasing monthly income. I initially thought that I would not worry about the underlying asset prices if I were not selling, as long as the income carried on. The problem is that the 11% payout rate is based on the current market value. If the market price of the asset drops, in all likelihood so will the income. Not a problem if you didn't "need" the income for a specific purpose, but that seems to be contrary to why many folks buy these funds.

-gauss

 

[pb4uski]

Nope... all income, no return of capital.

https://screener.fidelity.com/ftgw/etf/goto/snapshot/distributions.jhtml?symbols=NUSI
https://screener.fidelity.com/ftgw/etf/goto/snapshot/distributions.jhtml?symbols=ACIO
https://screener.fidelity.com/ftgw/etf/goto/snapshot/distributions.jhtml?symbols=JEPI

 

[ImThinkin2019]

Also see https://www.early-retirement.org/fo...alls-and-naked-puts-109853-9.html#post2675504 re ACIO

NUSI and JEPI are also interesting to me for income.

Thank you for this. The thread you linked was interesting.

I looked at the three funds. NUSI and JEPI show about 7.75% yield today. ACIO, although income is a stated goal, shows less than 1%.

7.75% yield with equity based capital risk is attractive to us. It's about 3 percentage points higher than our current income bucket overall. But more risk.

Our current income bucket only has default risk, no equity market risk. (That's assuming we hold to maturity which typically is what we do. We almost always buy individual bonds rather than bond funds.)

ACIO, however, has the collar strategy which might - should? - reduce downside risk. This is very interesting to us. But it would have to be a large portion of our portfolio to really reduce our risk. And with it's current yield and performance, at least so far, we could not put a large % into it. Am I missing something?

The ACIO white paper you linked was really interesting. These are smart people and I don't mind paying an expense ratio for them to do this type of work. But results are the final metric.

It will be interesting to see how everything performs in a sideways market. We well remember these having lived through several of them. That's probably a subject for a new thread....

I will be interested to see your thoughts on the above. Thank you in advance!!!!!!!

 

[ImThinkin2019]

You need to remember two things when looking at these securities that are not usually discussed.

#1) The monthly distribution is often believed to come from selling covered calls. If you look at the financial statements and the required disclosures, you will see that the majority of income is tax-classified as "return of capital" not "income". What is likely going on here is that when new money flows into the fund and the asset base grows, not all of the new money is invested in the underlying security. Some of the new money is being used to pay the monthly distribution. When I first read this I thought, "Ponzi Scheme!". Well no, not actually. No fraud is being used with the covered call funds. The income generated from selling the covered calls is nowhere near the level needed to support the monthly distributions.

#2) Folks often like these funds due to the apparent stability or hopefully even increasing monthly income. I initially thought that I would not worry about the underlying asset prices if I were not selling, as long as the income carried on. The problem is that the 11% payout rate is based on the current market value. If the market price of the asset drops, in all likelihood so will the income. Not a problem if you didn't "need" the income for a specific purpose, but that seems to be contrary to why many folks buy these funds.

-gauss

Thank you gauss for this.

#1) It's always good to look for Ponzi scheme characteristics. We sadly contributed some of our savings to one some years ago. Looked like a real organization but ended up with the officers in jail and a lot of people with there hard earned savings gone. Luckily we had time to recover.

https://www.nh.gov/banking/frm/index.htm

#2) Yes, we agree that we should understand what happens to the income if the market drops. Gary looked at that in one of his videos, for the Covid dip.