Introduction
In a series of articles evaluating CEFs (Closed-End Fund), I started by looking at two from Cornerstone with very high yields. I evaluated them looking at their ability in the past to support their very generous distributions and to pay a shareholder a dependable stream of income in the future. I concluded neither fund had been supporting the distribution in " How To Evaluate A CEF: A Look At CLM" and " Evaluating CEFs: A Look at CRF." Both funds are overpaying their distributions and this is the primary cause of the declining NAV and distribution payments.
I want to own CEFs that pay me a stable flow of income. I have developed a method of determining whether a specific CEF could provide a reliable stream of income. I developed my method after reading this article. Each article in the series looks at a specific CEF and applies that method to determine if the fund has been supporting the distribution. Then based on current holdings and past performance, I predict whether or not the fund will be able to support the distribution in the future. You can read an explanation of my method and get links to the other articles in the series, here.
The series doesn't just cover funds that I don't think are covering their distributions. I have looked at funds that are covering their distributions. In " Evaluating CEFs: A Look at USA" and " Evaluating CEFs: A Look at DNP" I found two funds that I like that are covering their distributions: Liberty All-Star Equity Fund ( USA) and DNP Select Income Fund ( DNP). I liked USA so much that I ended up buying shares in the fund. And I recently bought shares in DNP as well based on my research.
This article will take a look at Nuveen Nasdaq 100 Dynamic Overwrite Fund (NASDAQ:QQQX). QQQX is from a set of funds run by Nuveen that seek to replicate the price movements of a major index while using covered calls to generate income. QQQX uses the Nasdaq 100 index. QQQX has a yield of 6.4% which is quite attractive if it can convert the gains of the Nasdaq 100 index into income with a reasonable level of efficiency.
Nuveen Nasdaq 100 Dynamic Overwrite Fund
Nuveen has several funds that track indexes and use a covered call strategy to generate cash which is then paid out to shareholders. The fund makes money from selling these calls as long as the index doesn't go up more than the fund managers expect. QQQX is aptly named as it focuses on the NASDAQ 100 which is followed by the ETF QQQ. The strategy also adjusts how much of the portfolio has calls sold against it with the fund selling more calls when volatility is high (and call premiums are high as well) and fewer calls when volatility is low.
The first step in determining if the distribution is covered is to look at how the total NAV return has been done over a recent 1 year period.
Looking at the total NAV return for the calendar year 2020, we can see that the total NAV return was 16.62%. That is well above the 6.4% current yield of the fund, giving us some indication that the distribution is covered. But we need to move on and look at how the NAV did during that period as well.
NAV increased for QQQX during 2020. And while the NAV at year-end was not at the peak of $26.53 it was less than 1% lower at $26.32.
Source: CEFData
Looking at the distributions during 2020, one good sign is that the fund did not reduce them. A good portion of the distribution is designated as ROC, but since the fund uses options this isn't surprising. I also note that very little of the distribution comes from income, but then the NASDAQ 100 isn't the home of high dividend payers. Again, this is also as expected.
The total distribution for 2020 was $1.56. Based on the average NAV of $23.96, the yield on NAV was 6.51%. Based on the peak NAV of $26.53 the yield on NAV was 5.88%. Both of these are significantly below the total NAV return of 16.62% so the distribution was well covered.
With a CEF, you are paying management to do a better job than what just following the index would give you. And there is an ETF that does a passive implementation of what QQQX does. It is called Global X NASDAQ 100 Covered Call ETF (QYLD). And as we can see, it produced about half the total NAV return that QQQX returned. With that ETF you are trading getting half the total return for getting about twice the income. Over a single year, that may look attractive.
Long-Term Trends
While looking at the distribution coverage over a 1-year span can tell us many things, the fact is that any year might be atypical. The fund could have gotten lucky (or unlucky). Looking at distribution coverage over a longer span of time reduces the impact that luck can play. 3 years seems to be a good balance for both how the fund is doing currently and enough time that more than luck will account for the performance.
So how has QQQX done on total NAV return over the last 3 years?
A total NAV return of 34% (for the whole time, not an annualized number) is pretty good. How did the NAV change?
NAV has increased over the last 3 years by almost 20%. That is a very good sign for distribution coverage. Remember, that the fund generates much of its income from writing covered calls. The higher the value of its portfolio, the higher the potential for generating premiums from calls.
The total distributions paid over the last 3 years are $4.68. While the quarterly distribution was cut from 42 cents to 39 cents in 2019, the latest payment was increased to 44.85 cents. Based on the 3 years of distributions and the average NAV of $23.72 the yield on NAV (not an annualized number) was 19.73% which is quite a bit below the 34% total NAV return. The distribution is well covered.
Finally, I like to look at how the NAV has been growing over the last 10 years. Good funds paying a well-supported distribution grow NAV. And that is what QQQX has done.
Future Distribution Coverage
Source: CEFData
I know this might surprise people, but QQQX holdings pretty much match the NASDAQ 100. While many people think that it is over-valued, and in many ways it is, I think for the next couple of years that what that means is that the growth will not be dramatic. And we may see a couple of fairly short-lived pullbacks. But those are exactly the kinds of conditions in which writing covered calls work best.
Conclusion
QQQX has been around since the start of the Great Recession and has seen many different market conditions. They have shown they can adapt to market conditions and keep generating income. Management has even been able to handle COVID without a distribution cut. A yield over 6% is quite attractive and with the distribution well covered seems pretty safe. With NAV continuing to trend upwards, the price of QQQX looks reasonable to me.
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