The Proshares NASDAQ-100 High Income ETF (IQQQ) is a covered call ETF that generates regular income for its investors through the use of derivatives.
Sporting a very high yield, IQQQ looks appealing for those on the hunt for significant income in their portfolios.
The fund, however, also carries some fairly hefty risks that need to be considered. Let’s look at IQQQ to see whether or not it’s a good ETF to buy at the moment.
How Does IQQQ Work?
IQQQ generates income for its shareholders by tracking the NASDAQ-100 Daily Covered Call Index.
In a covered call, an investor simultaneously buys shares of a given stock and sells call options on those shares. If the stock price remains at or above the call option’s strike price at the time of expiry, the option generates income while the stock remains held.
In IQQQ’s case, the fund itself doesn’t trade options. Instead, it uses swap instruments to gain exposure to daily options activity without actively engaging in options trading. Goldman Sachs supplies the swaps IQQQ uses.
Although this strategy generates significant amounts of income, the virtual minefield cannot be overstated. If the stock’s price declines beyond a breakeven point, the call option results in a loss. Times of high volatility undoutbtedly increase this risk.
The upshot of IQQQ is that it uses the income it generates from its covered call swaps to fund distributions to its shareholders. As a result, the overall track record of the fund is driven more by the ability of the covered call swaps to generate liquid income than by the movements of the underlying stocks themselves.
IQQQ’s Price Track Record Is Not Super Impressive
Despite its income-generating covered call strategy, IQQQ hasn’t appreciated in terms of price the way a portfolio focused on stocks typically would.
Since its inception in March of 2024, IQQQ has actually dropped in price by 1.3%. While this doesn’t capture its significant distributions (see below) and the market has lost quite a lot of ground in recent weeks, this loss of principal should deservedly cause worry among some investors.
For reference, let’s consider IQQQ’s performance against the NASDAQ 100 index itself. In the last 12 months, the fund has generated a return of just 1.8 percent, which is an improvement on its returns since inception. The NASDAQ, however, has returned 5.0 percent in the last 12 months.
Although the main goal of IQQQ is to generate regular income rather than produce growth through appreciation, the fund’s underwhelming price performance appears less than ideal for investors with long time horizons.
How Concentrated Is IQQQ?
Another issue with IQQQ is its arguably excessive concentration mix, which may very well lead to outsized risks in the kind of market downturn we’re currently experiencing.
Over 51% of the fund is exposed to information technology stocks, with no other sector making up more than about 15 percent.
Although this strategy was very workable while tech stocks were soaring, it may prove problematic now that the market is repricing large tech companies on expectations of lower earnings growth rates ahead.
Unsurprisingly, this sector-level concentration also translates to the level of exposure to individual stocks within the fund. 8.6 percent of the fund’s holdings, for instance, are in Apple alone.
Microsoft and Amazon come in only slightly behind at 7.9% and 7.2%, respectively. With well over one-fifth of the fund’s exposure accounted for by only three stocks, investors take on significant concentration risk based on the performance of just a few mega-cap stocks when purchasing IQQQ.
What Kind of Income Does IQQQ Produce?
To its credit, IQQQ does a fairly good job of delivering on its promise of income. The fund has produced a trailing 12-month distribution rate of 12.2%.
More importantly for those relying on IQQQ for regular income, the fund pays out distributions monthly, though the size of the payout can vary substantially from month to month.
The undulations in payouts can be seen with the largest payout of $0.82 per share came in September, while November resulted in a much smaller $0.10 per share.
This presents investors with an interesting dilemma. On the one hand, the income produced by the fund over the last year has been far larger than most stocks other than a few REITs and energy pipeline companies can reasonably pay.
On the other, investors who have owned the stock since inception have actively lost principal, while those who bought it 12 months ago have seen an extremely modest price return that has undershot the NASDAQ.
While the payouts still give IQQQ a positive total return since inception, it hasn’t fared much better than the historical average of the S&P 500.
So, Is IQQQ a Good ETF to Buy?
As a vehicle for long-term growth, IQQQ likely carries too many risks and is too heavily concentrated. As an income-generating asset, IQQQ fares much better, though the fact that its monthly distributions vary considerably is concerning for investors hoping to use it for reliable retirement income.
By comparison, Realty Income, which pays monthly, offers a significantly lower yield of 5.4%, but the payments are predictable and fairly steady.
Ultimately, IQQQ doesn’t look like a particularly good fit for most investment strategies. The fund is extremely young and uses an options-based strategy, albeit through a swap mechanism, to generate income. This raises the risk involved, and most investors who mainly prioritize income tend to be closer to retirement age and therefore in a worse position to take on large risks.
Younger investors, meanwhile, will likely do better to own stocks that produce less income but compound year after year.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.
