As an investor, I only care about one thing: how much return are my assets generating? I don’t care what the source of the return is, and there’s really only two:
- The price of the asset can increase (price appreciation)
- The asset can pay out dividends (yield)1
The combination of these two is the total return of your investment, assuming that you reinvest any dividend into more of the same asset.
My focus on total return means that every month I have to sell some shares to generate cash. This does not bother me. Yes, I’m “eating into my capital”, but so far in retirement (nearly 1.5 years in), that hasn’t prevented my net worth from increasing nonetheless:
Covered call ETFs are a product that’s exploded in the past year or two. The idea is to sell call options for stocks/ETFs you own. The benefit is a stream of monthly income. The downside is a loss in overall return. The strategy generates very eye-catching yield results, if that’s the sort of thing you care about. For me, yield is fine, but what about the total return?
I asked Google what the most popular covered call Canadian ETF was, and it turned out to be ZWB, a covered call ETF that focuses on Canadian banks. I took a look at what it held and saw that 20%2 of it was wrapped up in ZEB, a similarly named ETF that is an “equal weight Canadian bank ETF”. Under the hood, they look rather similar. But ZWB has a lovely 6.23% yield which makes ZEB’s yield of 2.5% look downright miserly. But what about the total return3? Oh, my:
The covered call strategy is completely obliterated by the “buy the 6 banks and hold them” strategy. I tried to see if there was any time period where the covered call strategy outperformed the totally passive strategy. Turns out there was one year in the last ten:
The covered call strategy caused you to lose a little less in 2018 than you would have otherwise. Lest you think that the covered call strategy always works in down markets, it didn’t in the other negative return year — 2022:
Given the carnage covered-call ETFs cause, why are they so popular? Per Ben Felix, the preference for some investors have for recurring income over total return can play a big role here. For me, total return is always preferred. I don’t mind selling shares to get access to cash as I need it!
- Or the asset can give you back your own money. This is called “return of capital”. ↩︎
- I’m not sure why ZWB doesn’t just invest fully in ZEB; the remaining ZWB holdings are roughly equally split among the holdings of ZEB. ↩︎
- Comparative chart generated by https://www.dividendchannel.com/drip-returns-calculator/ ↩︎
