QYLG Or QQQ + QYLD: Which Is A Better Investment?

The Nasdaq 100 Covered Call & Growth ETF (NASDAQ:QYLG) invests in the underlying components of the Nasdaq 100 index, and sells covered calls on 50% of its holdings. Doing so serves to increase the fund's yield to 5.2%, while reducing upside potential by around 50%. Doing so is also extremely similar to a 50% allocation to the Invesco QQQ ETF (QQQ) plus a 50% allocation to the Global X NASDAQ 100 Covered Call ETF (QYLD). Due to reader interest, thought to do an article comparing QYLG to a 50/50 QQQ/QYLD investment.

QYLG is a bit more expensive than QQQ plus QYLD, with a 0.60% expense ratio versus a 0.40% average for the two other funds (0.20% plus 0.60%).

QYLG is a much smaller, illiquid fund, with only $73M in AUMs, versus $171B for QQQ, and $7B for QYLD. QYLG sometimes trades with a small spread and / or discount, while the same is almost never true for QQQ and QYLD.

QYLG automatically rebalances itself so as to consistently approximate 50% QQQ plus 50% QYLD. If you invest in QQQ and QYLD directly, rebalancing would have to be done manually by the investor.

In my opinion, going 50/50 QQQ/QYLD is slightly better than going QYLG. The first choice is slightly cheaper, and investors don't have to worry about illiquidity issues. Sporadic rebalancing are simple enough to do, can be funded with QYLD's distributions, and are not strictly necessary either.

QYLG - Quick Overview

QYLG invests in underlying Nasdaq-100 components, and sells covered calls on 50% of its holdings. Said strategy serves to boost the fund's yield to 5.2%, significantly higher than QQQ's yield, and a good yield all around.

Said strategy also serves to moderately reduce upside potential. The call options themselves reduce upside by around 50%, although distribution policies and partial retaining of distributions somewhat reduce this percentage. As an example, QYLG's share price has increased by 14.2% YTD, compared to 19.4% for QQQ.

On a total return basis, QYLG tends to outperform when equity capital gains are low to non-existent, as has been the case since early 2022.

On the flipside, QYLG tends to underperform when capital gains are strong, as was the case in 2021.

QYLG's long-term performance is dependent on several factors, including equity capital gains and option prices. Covered call funds tend to underperform, as has been the case for QYLG since inception.

There are several other covered call funds out there, with similar, although not identical, strategies and holdings to QYLG. One of these is QYLD, which invests in the underlying components of the Nasdaq-100 index, but sells covered calls on 100% of its holdings, versus 50% for QYLG. As is hopefully obvious, QYLG is basically the same as 50% QYLD plus 50% QQQ. In case it is not, a quick table showing why this is the case.

Looking at the total returns of these funds is also instructive. QYLG's returns are in the middle of QQQ and QYLD.

QYLG is very similar QQQ plus QYLD, but there are some differences. Let's have a quick look at these.

QYLG versus QQQ and QYLD

Expenses

QYLG is a bit more expensive than QQQ, same expenses as QYLD. Due to this, investing in QYLG is a bit more expensive than in a portfolio of QQQ plus QYLD.

QYLG's higher expenses directly reduce shareholder returns, a negative for the fund and its shareholders. Expect QYLG to slightly underperform, as has been the case for the past year, and since inception. Underperformance is extremely similar to the difference in expenses, as expected.

Avoiding expensive funds and focusing on cheaper ones is almost always a good idea. In this case, that means avoiding QYLG, and choosing QQQ plus QYLD instead.

Liquidity and AUMs

QYLG is a relatively small, illiquid fund. QQQ, on the other hand, is a mammoth. QYLD is somewhere in between, but reasonably large by industry standards.

QYLG's small size leads to low liquidity, with two important implications for investors.

Illiquid funds tend to have higher bid-ask spreads, so investors get worse prices when investing in these. Spreads are particularly important for short-term traders, or for investors with high portfolio turnover rates. QYLG's spreads are higher than those of its peers, although not terribly high on an absolute basis.

Illiquid ETFs sometimes trade with small discounts or premiums to NAV, liquid ETFs almost never do. Comparing QYLG's discounts to QQQ might prove instructive.

QYLG's more volatile discounts and premiums means investors might get a worse price when buying and selling compared to QQQ or QYLD. As these discounts are volatile and short-lived, it is difficult to purposely take advantage of them. By the time investors notice the fund is trading with a discount, the discount might very well be gone. As such, these discounts are simply a form of excess volatility, and should be construed as a negative.

Rebalancing

QYLG sells covered calls on 50% of its holdings, and its strategy is such that it is effectively always 50%, without any sort of investor intervention. Investing in QQQ and QYLD is effectively the same in the short-term, but the exact percentages will vary as share prices move through time. In practice, QYLD has significantly reduced potential capital gains, so QQQ weights should rise through time, QYLD weights should decrease for the same.

Due to the above, if investors wish to approximate an investment in QYLG using QQQ and QYLD, they would need to rebalance their portfolios every now and then. Although this isn't too complicated, some investors might wish to avoid the hassle, and invest in QYLG instead.

From what I've seen, rebalancing have not been necessary since QYLG's inception in late 2020. Meaning, the performance of QQQ plus QYLD without rebalancing closely tracks that of QYLG. Figures below are without rebalancing, and there does not seem to be any issues.

Conclusion

QYLG's strategy and holdings are extremely similar to a 50/50 investment in QQQ and QYLD. QYLG is a bit more expensive and illiquid, so choosing the portfolio is a slightly better choice, in my opinion at least.

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