Is it necessarily a good thing that there’s an ETF for just about every niche sector, sub-index or concept nowadays? That’s debatable, although I suppose it’s in the American spirit to offer more choices, albeit not always better choices.
Now 30 years after State Street introduced the first ETF — the good old S&P 500-tracking fund SPY (NYSEARCA:SPY) — and now there are more ETFs than you can shake your proverbial stick at. Whether it’s sensible or not, you’re free to make a double-leveraged bet on rising volatility with the 2x Long VIX Futures ETF (BATS:UVIX), milk the agri-market for what it’s worth with the VanEck Agribusiness ETF (NYSEARCA:MOO), or take a puff of the perfectly legal ETFMG Alternative Harvest ETF (NYSEARCA:MJ), which tracks the cannabis business.
As you might expect, there are also ETFs for income-focused investors. While many dividend collectors may gravitate toward steady-Eddie funds, there’s an intriguing intersection of traders who seek yield while harboring a speculative bent. Thus, since apparently no itch can remain unscratched, along came a pair of decidedly modern fund providers: YieldMax and Defiance.
It’s a sign of the times that ETFs sporting yields of 50% or greater are in demand, but the allure of such high annualized returns can’t be denied. Of course, it’s up to individual investors to consider the risks and potential rewards of these mega-yielding funds. As always, “caveat emptor” is the phrase that can spare us from broken dreams and decimated accounts.
The high-yield arms race begins
Of YieldMax and Defiance, it appears that YieldMax was the first to gain prominence among speculative yield chasers. Besides the company’s catchy name, what sets YieldMax apart is its approach: take already popular stocks and turn them into distribution-paying machines.
Tapping into young traders’ short attention spans, YieldMax’s ETFs typically pay dividends every month instead of on the typical quarterly schedule. Moreover, these funds generally use options strategies such as writing covered calls to generate income from stocks (or more accurately, options combinations that approximate stock-share ownership).
Do-it-yourselfers might choose to bypass the ETF’s expense ratios and simply imitate the options strategies themselves. However, this requires a certain measure of options-trading sophistication, so some investors will gladly pay a 1%-ish annual fee and let the fund managers do the heavy lifting.
As of Oct. 5, YieldMax’s website states that the TSLY ETF (NYSEARCA:TSLY), which loosely tracks Tesla (NASDAQ:TSLA) stock, offers a distribution rate (which is, for all intents and purposes, an annual dividend yield) of 50.73%. Meanwhile, NVDY (NYSEARCA:NVDY), which more or less tracks NVIDIA (NASDAQ:NVDA) stock, evidently distributes 49.98% per year to its boldholders.
Not to be outdone by YieldMax, Defiance claims a distribution rate of 55.17% for its S&P 500 Enhanced Option Income ETF (NYSEARCA:JEPY) and an eye-watering 67.55% for its Nasdaq 100 Enhanced Option Income ETF (NASDAQ:QQQY). Again, options strategies are what make these annual yields (or at least, these claims) possible.
Buy now, pay later?
Even if these yields are possible, sensible investors should wonder whether they’re sustainable. Alas, these are young funds lacking appreciable track records, so it’s too soon to draw any conclusions — and this, in itself, is a reason to avoid these funds altogether.
Just for kicks, I went through the steps of buying the aforementioned YieldMax and Defiance ETFs in my Schwab brokerage account but stopped short of actually hitting the “Confirm” button. Every time, Schwab’s trading platform stated that it would impose a “special maintenance requirement of 100%” margin for the ETF purchase. Thus, it seems that I’m not the only one who’s concerned about the risks associated with funds of this ilk.
Take the TSLY ETF as an example. If TSLA stock goes down a lot, not only would TSLY stock decline substantially, but it’s fair to assume that the ETF’s annual distribution rate wouldn’t stay in the 50% range. In other words, I suspect that these funds are a black-swan event away from imploding.
TSLY, NVDY and other high-yielders haven’t really been tested. Many of these funds have inception dates that only go back a year or so. They haven’t been through the COVID crucible of 2020, not to mention the 2008-2009 debacle.
Therefore, I wouldn’t touch any of these funds with a 10-foot pole until they’ve endured a crisis or two. Only then can their durability and sustainability be assessed. Until then, you’re encouraged to seek moderate yields with caution and consideration.
