Covered-call exchange-traded funds (ETFs), which drew huge popularity last year, are being left out of the recent rally. Because their upside is structurally capped, they cannot fully track sharp gains in stock prices.
Stable dividends are a strength, but there is also a risk of principal loss in long-term investing. If you expect the stock market to steadily trend upward, some advise that it may be better to invest in a plain ETF that fully tracks the index.
As major domestic indexes have surged recently, returns on covered-call ETFs are lagging far behind simple index-tracking products. According to Korea Exchange on Sept. 25, this year (Jan. 2–Sept. 24) Samsung Asset Management's "KODEX200" ETF, which tracks the KOSPI200 index, rose 50.3%. In contrast, the "KODEX200 Target Weekly Covered Call" ETF climbed only 22.72%. Even considering the annual dividend yield (11.75%), the performance is disappointing.
The fact that the "PLUS High Dividend Weekly Covered Call" ETF (2.39%) underperformed the "PLUS High Dividend" ETF (37.34%) by a wide margin is in the same vein. Even taking into account an annual dividend yield of 17%, the performance gap is large.
The reason covered-call ETF returns are sluggish is that they combine tracking the underlying index with a strategy of selling call options (the right to buy a stock at a set price). When indexes fall, option premiums can reduce losses, but when indexes keep rising, they reveal a structural limit that caps upside revenue.
Covered-call ETFs have been popular as stable high-dividend products. Many products boosted their annual distribution rate to around 18% using stock dividend payouts along with option premiums as funding sources. Investors were particularly interested in the ability to generate steady cash flow when the market moved sideways or rose gradually.
However, as the stock market steadily climbs, covered-call ETFs that set excessively high target distribution rates amid fierce competition are being launched one after another, leading to cases where distributions are paid out of principal. That means the revenue investors actually pocket is not sustainable.
In fact, the "KODEX U.S. 30-Year Treasury Target Covered Call (synthetic H)" ETF saw its price fall 18.79% over the past year, resulting in a negative total return even after considering the annual dividend yield (12.9%). It achieved its target distribution rate, but effectively recorded a loss.
Experts advise approaching covered-call products touting annual distribution rates of 17%–18% with caution. An asset management firm official said, "If the target distribution rate is excessive, there is a possibility of principal loss in long-term investing even if the underlying asset does not fall," and noted, "If the market trends upward over the long term, plain index-tracking products may be advantageous in terms of returns due to the compounding effect."
This month, the Financial Supervisory Service said, "Even if the target distribution rate is achieved, if an ETF's net worth continues to decline, the distribution you actually receive may be lower than expected," and urged, "In long-term investing, the impact of expense on returns is significant, so you must check the cost structure."
Even within the industry, there is an assessment that the current level of excessive distribution rates is not sustainable. Kim Nam-gi, head of the ETF division at Mirae Asset Global Investments, recently launched a covered-call ETF with an annual distribution rate in the 7% range and said, "No covered call can exceed the revenue of the original index," adding, "If you save the monthly distributions, you can actually increase the number of shares."