Closed-End Funds: Overview Of Nuveen's Option-Based Funds

Jul. 14, 2020 12:16 PM ETBXMX, DIAX, QQQX, SPXX52 Comments24 Likes

Summary

  • The four option-based funds by Nuveen include; BXMX, SPXX, DIAX, and QQQX.
  • These four funds have underperformed what they state as their objective.
  • Looking at these funds as an income-oriented investor, though, means they might be more attractive.
  • This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Get started today »

Written by Nick Ackerman, co-produced by Stanford Chemist

Previously, we have covered both Eaton Vance's option funds and BlackRock's (BLK) option funds. Readers showed interest in the quick overview of those articles. Nuveen also has its own set of option-based equity funds. The Nuveen funds all focus on a particular index. These include the S&P 500 (SP500), 'Dow30' (DJI), and the Nasdaq 100 (NDX). These tend to be quite diversified, similar to Eaton Vance and BlackRock. However, since they are generally tracking these indexes, they can become a bit more concentrated. The Nasdaq 100, for example, tends to lean heavily in the tech sector. We do see some of their peer funds also lean heavily tech, just this one might be the most tech leaning overall.

Both Eaton Vance and BlackRock funds have a mixture of either writing covered calls on single positions or indexes. In the case of Nuveen, all four of these funds write against an index, though. This means that they are 'cash-settled' options. This would be due to not being able to hold an actual index, but instead writing against the portfolio in certain notional amounts depending on the fund. This does mean that, in theory, there is unlimited loss potential as indexes can climb to infinite. In reality, this is unlikely to ever happen for obvious reasons. Protecting against these "unlimited losses" is the fact that the underlying portfolio of individual positions would also presumably be rising to infinite alongside the index. Additionally, since they are actively managed funds, it is likely the portfolio managers would move the portfolio around to reduce the exposure.

None of these positions is currently in the CEF/ETF Income Laboratory portfolios.

(Source)

Nuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX)

Starting with the most popular, QQQX. This fund has almost 8k Seeking Alpha followers. This actually surprised me quite a bit seeing as I was contemplating starting this article off along the lines of "Nuveen's option-based funds aren't quite as popular as Eaton Vance or BlackRock funds." That would have been false, at least according to that Seeking Alpha follower metric. QQQX is the most followed option-based CEF I was able to find. I just wasn't one of those followers yet I guess!

This fund is designed to "offer regular distributions through a strategy that seeks attractive total return with less volatility than the Nasdaq 100 Index by investing in an equity portfolio that seeks to substantially replicate the price movements of the Nasdaq 100 Index, as well as selling call options on 35%-75% of the notional value of the fund's equity portfolio (with a 55%long-term target) in an effort to enhance the fund's risk-adjusted returns."

Currently, the average call option overwritten is shown at 58% as of their latest Fact Sheet. This certainly puts them in line with their wide targeted range. A lower overwritten portion generally signals a bullish sentiment, while a higher overwritten percentage could indicate a more defensive stance.

QQQX is a considerable size, at around $920 million in total assets. The expense ratio is also reasonable at 0.92%.

So far, the fund has underperformed its stated objective quite significantly. This is almost to be expected, though. Overall, an option-based strategy benchmarked against an index is going to lag.

Chart

Data by YCharts

This was looking at the total NAV returns over the past 10-year period. The lag is primarily attributed to the fact that an options strategy drags on performance during good times. Though, it can help potentially offset losses during flat to slightly down markets. In the YTD case, it certainly wasn't enough to offset the sharp losses we witnessed. Nor should it be expected to when the selling comes so quickly.

Additionally, the fund intends to track the index's returns. It isn't the index itself. For example, the Nasdaq 100 is comprised of 104 holdings due to different share classes. In the case of QQQX, the fund holds 167 positions as of March 31st, 2020, when they last reported. The fund does heavily favor tech-heavy positioning, though.

(Source - Fact Sheet)

The fund's top 5 industries that it invests in make up almost 72% of the overall portfolio.

What you can get from QQQX, though, that you can't from the Nasdaq 100 is a much greater distribution yield. Additionally, you can buy CEFs at a discount. QQQX currently trades at a slight premium of 1.11% at this time.

In the case of the distribution rate, the fund currently pays a quarterly $0.39 or 6.70% of the share price and NAV price in this case. In the last round of announcements, they maintained this fund's rate.

(Source - CEFConnect)

This fund would certainly be for those that are looking to pick up a significant amount of tech exposure via one fund. In fact, it has performed favorably compared to Eaton Vance's tech-heavy fund, the Eaton Vance Enhanced Equity Income Fund (EOS) over the longer term. Though, EOS is certainly more than just an almost exclusive tech fund.

Chart

Data by YCharts

Nuveen Dow 30SM Dynamic Overwrite Fund (DIAX)

This fund similarly targets a "35-75% of the notional value of the Fund's equity portfolio (with a 55% long-term target) in an effort to enhance the Fund's risk-adjusted returns." The fund manages ~$534 million in total assets. They charge a reasonable 0.96% expense ratio.

As the name would suggest, though, with this fund, we are looking at returns relative to the Dow Jones Industrial Average. Of course, even the DJIA is made up of a healthy amount of tech positions. Currently, at 25.2% tech, followed by 15.5% in healthcare. This is almost the same exact allocation that is found in DIAX as well, except for one basis point more in tech.

(Source - Fund Website)

Currently, the percentage of the portfolio overwritten was last reported at 55% for DIAX. The fund is also made up of 35 holdings compared to DJIA's 30.

Chart

Data by YCharts

In the case of DIAX, we get a little closer to similar returns. At least, much closer than what we saw in QQQX above. I believe this primarily has to do with the fact that the tech sector over the last 10 years has been on absolute fire. Of course, this is an even longer-term trend of tech outperforming most other sectors in general. That means the components making up the DJIA are less likely to make DIAX show those greater losses on their options strategy as opposed to QQQX.

Simply put, the DJIA spends more time going slightly up or sideways than the Nasdaq 100. It is quite obvious too just looking at the total return for DJIA at 179.9%, compared to Nasdaq 100's 439% over the same 10-year period.

This isn't surprising as the DJIA is made up of large-cap companies that are past their growth phase. They are just cash producing machines now.

In this case, DIAX might be attractive to some investors that are more focused on these old cash cows. An investor does get the benefit of a discount too, for DIAX, as the fund currently trades at a 9.12% discount. The distribution rate is quite attractive at 8%, while the fund's NAV has to produce a little less at 7.27% to cover it. This fund received a trim of 7.5% in its latest announcement. The current distribution is $0.273, paid quarterly.

(Source - CEFConnect)

Something to help this fund become even more attractive would be to switch back to a monthly paying CEF.

Nuveen S&P 500 Dynamic Overwrite Fund (SPXX)

This is one of the two funds that put a focus on the S&P 500 index. In this case, the fund has the same exact target of "35-75% of the notional value" overwritten. The fund is on the smaller size with $234 million in assets. The expense ratio for this fund comes in at 0.99%.

This fund is similarly last reported relative to the other funds at being overwritten by 56%. Currently, this fund holds 194 holdings. This is quite short of the S&P 500's 505 positions. This comes to more than 500 due to several of the underlying companies having more than 1 share class.

Chart

Data by YCharts

In this fund, we do see a significant underperformance in the same 10-year period we have been looking at. Tech does make up a large amount of the funds positions as well, as we are used to seeing by now. They account for the top sector at 26.8% of the fund's portfolio, followed by 15.2% in healthcare.

SPXX similarly trades at a healthy discount like that of DIAX, currently coming in at 9.02%. The distribution rate is 7.47%, while its NAV distribution rate is 6.80%. This was after a recent cut from a quarterly rate of $0.265 to the now $0.245.

(Source - CEFConnect)

The fund launched with a monthly schedule briefly. It then quickly entered the GFC of 2008/09 where the fund switched to quarterly and stayed there ever since. This certainly does mean that the fund can be much more attractive for income-oriented investors.

Nuveen S&P 500 Buy-Write Income Fund (BXMX)

BXMX shakes it up a bit in their strategy. The fund still writes calls against the S&P 500. In this fund though, it is against "approximately 100% of the fund's equity portfolio value with a goal of enhancing the portfolio's risk-adjusted returns." This is the largest fund of the four, at $1,280 million in total managed assets. That large of an asset base allows for a sufficient amount of average daily volume for most investors at 365k. The expense ratio comes in at 0.92%.

In BXMX's latest Fact Sheet, they reported 99% being overwritten. The fund currently reports 277 positions. Again, this is much less than the actual benchmark it tracks.

This should provide for a more defensive posture than the other funds. However, it still won't help significantly when we are heading sharply lower. Additionally, it leads to even more lag in performance.

Chart

Data by YCharts

It isn't a considerable amount more of underperformance, but it is still there in a small amount.

BXMX does trade at the steepest discount currently at 10.61%. The fund's distribution rate comes in at 7.68%, with an NAV rate of 6.86%. Their last announcement also came with a reduction.

(Source - CEFConnect)

Again, we see the same pattern of the other funds, initially starting out at the more enticing monthly distribution - only to be switched to a quarterly rate in the GFC. However, you might notice that the other funds have been more of a flat trendline. For BXMX, it does appear that their distribution is trending downwards since that time. That is worth considering if you are looking to enter a position.

Conclusion

(Source)

All four of these funds write calls on varying amounts of the notional value of their portfolios. What we have seen is over the longer-term these funds typically underperform the benchmarks they state as trying to "replicate the price movements" with. This is unfortunate, but also isn't too much of a surprise. The option strategies put in place are generally the most enhancing in a flat to slightly down or slightly up market. When the indexes are rising continually, they drag on performance. Additionally, they don't mirror their benchmarks holdings specifically. Only that their objective is to "replicate the price movements."

Chart

Data by YCharts

Above, we do see that, even from February 19th, 2020, to the low on March 23rd, 2020, QQQX only performed marginally better than the Nasdaq 100.

Chart

Data by YCharts

This is similar with DIAX, compared to DJIA.

Chart

Data by YCharts

Then, again, with both SPXX and BXMX. One thing of interest to note is that BXMX's almost 100% option writing did help mitigate the furthest drawdowns in the most effective manner. Overall, the fund has lagged considerably over the longer term, though. So, it might be interesting for more of a defensive play should investors start to get nervous but still want equity exposure.

These would primarily be viewed as much more attractive for income-focused investors, though. As we illustrated, they aren't generally defensive enough in a sharp selloff. Additionally, as they all have quite attractive distribution rates that can be enticing to income investors. They certainly aren't growth investments, which is the case for almost any CEF out there.

Of course, similar to any other equity CEF, a large portion of their distributions will be made up of capital gains or ROC. These are paid throughout the years instead of an individual investor having to buy and sell positions themselves to realize those gains.

Looking at ROC more specifically, income-focused investors might also be quite interested if held in a taxable account. These funds have been able to produce a significant amount of ROC. The table below is for 2019's tax classifications.

(Source - Nuveen Tax Center)

This is quite similar to the Eaton Vance funds that are able to generate a large amount of ROC from their funds as well. This ROC can help defer tax obligations for an investor. This is because the distribution reduces an investor's cost basis, thus, only realizing the tax liability upon the sale of the holding.

With all that being said, overall, I believe the fund could have a place for an investor. At a steep discount, these funds are worth exploring. They can be utilized in a taxable account as a way to defer tax obligations through ROC distributions. This is as well as an attractive income play. Perhaps, they should drop the objective of meeting their respective index price movements. They haven't been able to come close to that objective. It really isn't a surprise either since the indexes aren't selling calls and giving up that potential upside. So, if an investor is looking for that particular objective, I wouldn't look at these funds. They need to be thought of in a different way.

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This article was written by

Nick Ackerman profile picture
10.24K Followers
CEF/ETF income and arbitrage strategies, 8%+ portfolio yields
Nick Ackerman is an avid student of the markets and has been investing in his own accounts for over 12 years. He is a former Financial Advisor and has previously qualified for holding Series 7 and Series 66 licenses. These licenses also specifically qualified him for the role of Registered Investment Adviser (RIA), i.e., he was registered as a fiduciary and could manage assets for a fee and give advice. Since then he has continued with his passion for investing through writing for Seeking Alpha, providing his knowledge, opinions, and insights of the investing world. His specific focus is on closed-end funds as an attractive way to achieve income as well as general financial planning strategies towards achieving one’s long term financial goals.

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Disclosure: I am/we are long EOS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article was originally released to members of the CEF/ETF Income Laboratory on June 25th, 2020.

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