QYLD has been gaining popularity among income investors as a bullish-yet-defensive play on the NASDAQ 100. Here we’ll review it and look at why it’s probably not a great choice for a long-term buy-and-hold portfolio.
Disclosure: Some of the links on this page are referral links. At no additional cost to you, if you choose to make a purchase or sign up for a service after clicking through those links, I may receive a small commission. This allows me to continue producing high-quality, ad-free content on this site and pays for the occasional cup of coffee. I have first-hand experience with every product or service I recommend, and I recommend them because I genuinely believe they are useful, not because of the commission I get if you decide to purchase through my links. Read more here.
Introduction – What Is QYLD?
QYLD is an ETF from Global X that holds the NASDAQ 100 index and also sells covered calls on it to generate income. To my knowledge, it is the largest covered call strategy fund with over $3 billion in assets.
As a brief refresher, covered call writers own the underlying and collect a premium on the option, and the buyer of the call option has the right to buy the underlying at the strike price at or before expiration.
QYLD holds stocks in the NASDAQ 100 and writes 1-month at-the-money calls on them. It’s pretty simple; nothing proprietary going on. QYLD charges a fairly hefty 0.60% for this strategy. QYLD is popular because this allows the fund to have a distribution yield upwards of 10% that pays monthly, making it attractive to income investors.
Is QYLD a Good Long-Term Investment? Probably Not.
While QYLD uses the NASDAQ 100, Global X also offers RYLD for the Russell 2000 and XYLD for the S&P 500. All 3 funds work the same way.
These funds seem to be popular among income investors and FIRE folks, but I have yet to see a compelling reason for investors’ fascination any of these funds. I have to assume most simply aren’t looking past the extremely high yield and perhaps don’t know what they’re buying.
First, specific to QYLD, the NASDAQ 100 is poorly diversified and is basically a tech index at this point. The market is already over 1/4 tech, and large cap growth stocks are looking extremely expensive relative to history (and relative to Value). Moreover, the valuation spread between Value and Growth is as large as it’s ever been. Because of all this, we’ve got potential concentration risk and lower future expected returns for large cap growth stocks.
Secondly, dividends/distributions aren’t free money. QYLD’s share value appreciation component is virtually flat on average and has actually been negative since inception:
Even with its dividends reinvested, the underlying QQQ has delivered a greater risk-adjusted return since QYLD’s inception:
I can easily think of 2 other portfolios off the top of my head that are cheaper, more diversified, more tax-efficient, and that have had much higher general and risk-adjusted returns, lower volatility, and smaller drawdowns than QYLD. If one wants a high dividend yield to use as income, I’d think you could think of combinations of dividend funds, high yield corporate bond funds, etc. that would be objectively superior to QYLD in almost every way. You’d likely even come out ahead after taxes with high-div REITs considering QYLD’s high fee. Moreover, its return has even severely lagged income-focused CEF’s. I designed a dividend portfolio for income investors here that may appeal to you.
The situation for QYLD is exacerbated in a taxable environment as you’re taxed on every distribution. I’m a fan of simply selling shares as needed for any “income” needed, which should be mathematically preferable anyway if you don’t actually need the income on a monthly basis, as it allows you to leave more money in the market longer.
Lastly and arguably most importantly, covered calls cap the upside at the strike price, and the premium received does not protect the downside. If the underlying drops, so does the covered call fund, along with its distribution yield. I personally don’t think QYLD’s 12% yield is sustainable. So far the fund hasn’t had to endure a major crash like 2008 or 2000. Market conditions (a raging bull market for the most part, particularly for Big Tech) have been ideal for these funds in their relatively short lifespans thus far.
Furthermore, covered calls don’t protect the downside. In terms of downside protection, there’s an objectively better, simpler, cheaper solution that existed long before these funds came about: decrease stocks and add bonds.
The only appropriate scenario I can see for buying these types of funds is if the investor for some reason consciously wants to implement a rolling covered call strategy without handling the logistics of writing the options themselves. But if income is the concern, I’d say just go with CEF’s.
There’s no free lunch outside of diversification. If you are reducing risk with these expensive option hedging strategies, you are by definition also accepting lower expected returns.
Disclaimer: While I love diving into investing-related data and playing around with backtests, I am in no way a certified expert. I have no formal financial education. I am not a financial advisor, portfolio manager, or accountant. This is not financial advice, investing advice, or tax advice. The information on this website is for informational and recreational purposes only. Investment products discussed (ETFs, mutual funds, etc.) are for illustrative purposes only. It is not a recommendation to buy, sell, or otherwise transact in any of the products mentioned. Do your own due diligence. Past performance does not guarantee future returns. Read my lengthier disclaimer here.