Covered call ETFs offer tempting yields but quietly surrender your upside every time the market rallies. Two fixed-income alternatives push past 11% without that hidden cost, though the trade-offs they demand deserve a hard look before you buy.
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Covered call ETFs generate their eye-catching yields by monetizing future upside. In exchange for selling call options, investors receive option premiums today, but they also agree to give up some of tomorrow’s potential capital appreciation if the underlying asset rallies beyond the strike price.
Whether that trade-off is worthwhile depends on several factors, including how effectively the manager selects option strikes and expirations, as well as the level of implied volatility available in the market. Over long periods, however, covered call strategies have generally lagged comparable long-only equity portfolios after accounting for fees, taxes, and the upside they’ve surrendered.
Personally, I tend to prioritize total return over headline yield. Still, I understand why many retirees and income investors prefer higher cash flow. If your goal is generating income without putting a ceiling on your upside, it may be worth looking outside equities altogether and into certain areas of the fixed-income market.
The trade-off is different. Instead of giving away future gains, you’re taking on greater credit risk by lending to weaker borrowers. That’s precisely why these securities offer much higher coupons. Fair warning, though: some of the higher-yielding fixed-income sectors can experience drawdowns approaching those of equities. There is no free lunch.
The Lowest-Rated Corner of the High-Yield Bond Market
Our first ETF that doesn’t rely on covered calls is the BondBloxx CCC Rated USD High Yield Corporate Bond ETF (XCCC). To understand what makes this fund unique, it helps to review how bond credit ratings work.
Investment-grade bonds are generally rated BBB or higher. Anything below BBB falls into the high-yield, or “junk bond,” category, where investors accept greater default risk in exchange for higher interest payments. CCC-rated bonds sit near the bottom of the investable credit spectrum.
According to S&P Global, CCC-rated bonds have experienced a three-year cumulative default rate of 45.67%. In plain English, nearly half of issuers with this rating have historically defaulted within three years. By comparison, BBB-rated investment-grade issuers have posted a default rate of just 0.91% over the same period.
If you’re going to invest in CCC-rated bonds, an ETF structure makes considerably more sense than purchasing individual issues. XCCC limits each issuer to 2% of the portfolio, helping reduce the impact of any single default. The fund charges a 0.40% expense ratio, which is reasonable given the specialized exposure it provides.
Naturally, investors demand substantial compensation for assuming that level of risk. Today, XCCC offers a 30-day SEC yield of 11.94%. One important caveat is taxation. The distributions consist primarily of ordinary interest income, making XCCC considerably more tax efficient inside a Roth IRA or other tax-advantaged account.
Investing in Business Development Companies
Another way to generate high income without using covered calls is through business development companies, or BDCs. Think of BDCs as a bridge between Wall Street and Main Street. They operate much like publicly traded private credit firms, lending primarily to privately owned middle-market businesses that often have limited access to traditional capital markets.
Unlike private credit funds, however, BDCs themselves trade on public exchanges. Because their underlying loans are privately valued and typically updated around quarterly earnings, a BDC’s market price can trade at a premium or discount to its reported net asset value (NAV).
Recent concerns surrounding private credit have weighed on the sector, but that has also pushed yields higher. One way to access the space is through the VanEck BDC Income ETF (BIZD). BIZD passively tracks a market-cap-weighted index of business development companies. I actually prefer this approach because it naturally allocates more capital to the larger, more established BDCs, which generally have longer operating histories, greater scale, and broader access to financing than many smaller competitors.
Despite investing in higher-risk lenders, BIZD hasn’t historically moved in lockstep with the stock market. The ETF currently carries a five-year beta of approximately 0.43, meaning its price has historically been much less sensitive to movements in the S&P 500. The current income remains attractive. BIZD offers a 11.75% trailing 12-month distribution yield.
One statistic that initially surprises many investors is the stated 9.69% expense ratio. Fortunately, the headline number is misleading. BIZD’s actual management fee is just 0.40%, plus 0.02% in other operating expenses. The remaining 9.27% reflects acquired fund fees and expenses generated by the underlying BDCs themselves. Those costs are embedded in the economics of the BDC structure and would ultimately be borne by investors even if they purchased the underlying companies individually rather than through the ETF.
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