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M* JR looks at the use of covered-calls vs ELNs (equity-linked notes) that affect these funds' 30-day SEC yields. So, he suggests looking at TRs, not distributions. He also suggests that a better description may be Derivative-Income funds (vs traditional dividend-oriented funds). Mentioned are JEPI, XYLD, FTHI; BMCIX, SCIUX, etc. https://www.morningstar.com/stocks/covered-call-stock-funds-are-popular-should-they-be
Full para by JR provides context for that statement on funds with high derivative-income:
"Happily, the statistic of total return measures the entire package. It accounts not only for the moneys that derivative-income funds receive for surrendering potential capital growth but also for the extent to which that growth is forfeited. If the latter exceeds the former, derivative-income funds are merely a parlor trick. Investors who seek upfront cash would be better off purchasing a conventional fund and then periodically selling its shares. In that fashion, they could duplicate the derivative-income funds’ ongoing payouts while achieving a higher future return."
The debate is one of simplicity and utility. Bonds receive income from an underlying asset. Options do not. With covered funds, buffered funds, and so many others of the ilk, the idea is always "let me create a better mouse trap". Its important for the end investor to understand that the derivative funds are an attempt to create something from nothing.
The debate is one of simplicity and utility. Bonds receive income from an underlying asset. Options do not. With covered funds, buffered funds, and so many others of the ilk, the idea is always "let me create a better mouse trap". Its important for the end investor to understand that the derivative funds are an attempt to create something from nothing.
As far as I know, DIVO holds actual stocks in its portfolio, and does the option mojo on some of them. They have also held varying chunks of money market funds over the time I have been following it.
JEPI is the only other fund of this type that I have looked at. Unless I am missing something, they also own individual stocks in their portfolio, in addition to what they do with ELN's.
So in those cases at least, I don't understand what the nothing is that something is being created from.
1. Options are a fantastic product but have a lot of embedded costs - execution, advisory, regulatory, etc. ETF/ETNs have a curtain on some of those costs. 2. In a tail risk scenario to the downside, think 2000-2002, 2007-2009, Bonds MAY be godsend and truly rescue a portfolio (we saw they were not in 2023). Covered calls will not. Ultimately, if an investor is happy with the payoff structure in any product, then that's good enough for the investor. Finding the "best" portfolio structure is overreaching.
The "nothing" part: Bonds and stocks have an underlying fundamental source of return in interest income or growth. Options don't.
Option-income funds have been around for a long time, GATEX, 1977- ; GCPAX, 2014- . There have been several others.
They didn't catch on until JPM put its marketing muscle behind its now humongous ETF JEPI, 2020- & its large variant JEPQ, 2022-. Their ERs are reasonable.
But beware that many options-writing funds aren't cheap. So, if they achieve in an expensive way what allocations funds may achieve at lower costs, investors should ask questions. I think that is what M* JR did.
@yogibearbull, Yogi Berra must have had something to say about investors that don't pay attention to the price they're paying.
Selling options against entire cap-weighted indexes is a bridge too far for me.
@Devo. Thank you for the explanation. In the world of Lipper, DIVO is actually an equity income fund. In that world it is one of a handful of "Great Owls." I suspect that it's benign performance in 2022 had more to do with portfolio construction than whatever options it deployed at the time.
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For example, try JEPI and DIVO versus VWELX, PRWCX, and FBALX.
M* John says: Sure sounds easy doesn't it? Why would anyone ever bother with bonds, allocations, or all those other types of funds?
"Happily, the statistic of total return measures the entire package. It accounts not only for the moneys that derivative-income funds receive for surrendering potential capital growth but also for the extent to which that growth is forfeited. If the latter exceeds the former, derivative-income funds are merely a parlor trick. Investors who seek upfront cash would be better off purchasing a conventional fund and then periodically selling its shares. In that fashion, they could duplicate the derivative-income funds’ ongoing payouts while achieving a higher future return."
JEPI is the only other fund of this type that I have looked at. Unless I am missing something, they also own individual stocks in their portfolio, in addition to what they do with ELN's.
So in those cases at least, I don't understand what the nothing is that something is being created from.
2. In a tail risk scenario to the downside, think 2000-2002, 2007-2009, Bonds MAY be godsend and truly rescue a portfolio (we saw they were not in 2023). Covered calls will not.
Ultimately, if an investor is happy with the payoff structure in any product, then that's good enough for the investor. Finding the "best" portfolio structure is overreaching.
The "nothing" part: Bonds and stocks have an underlying fundamental source of return in interest income or growth.
Options don't.
They didn't catch on until JPM put its marketing muscle behind its now humongous ETF JEPI, 2020- & its large variant JEPQ, 2022-. Their ERs are reasonable.
But beware that many options-writing funds aren't cheap. So, if they achieve in an expensive way what allocations funds may achieve at lower costs, investors should ask questions. I think that is what M* JR did.
Selling options against entire cap-weighted indexes is a bridge too far for me.
@Devo. Thank you for the explanation. In the world of Lipper, DIVO is actually an equity income fund. In that world it is one of a handful of "Great Owls." I suspect that it's benign performance in 2022 had more to do with portfolio construction than whatever options it deployed at the time.