The race among ETF issuers to find new ways to squeeze the most out of stock portfolios intensified again on Tuesday, with Pacer launching a new fund aimed at expanding dividends. The firm launched the Pacer Metaurus Nasdaq-100 Dividend Multiplier 600 ETF (QSIX), a sister fund to the U.S. Large-Cap Dividend Multiplier 400 ETF (QDPL), which has grown to more than $500 million in assets since its launch in 2021. The distributions are equal to six times the Nasdaq 100 Index’s dividend payout and four times the S&P 500 Index’s dividend payout, respectively. Income strategies have become a huge growth area for ETF issuers in recent years, with covered call funds arguably the most popular niche. The Global X Covered Call ETF for the S&P 500 Index (XYLD) and Nasdaq 100 Index (QYLD) currently has more than $10 billion in total assets, according to FactSet. JPMorgan’s Premium Income ETFs (JEPI and JEPQ) employ a variation of the covered call strategy and have a total size of over $50 billion. One potential negative aspect of covered call funds is that they place a hard cap on the portion of the portfolio that is “covered” by the calls. Sean O’Hara, president of Pacer ETF Distributors, said the idea behind the Pacer funds is that the funds will capture more upside during market rebounds. For example, QDPL currently has about 89% of its exposure invested in S&P 500 stocks, with the remainder trading dividend futures for additional income, according to the fund’s website. There is no hard cap on the upside of the equity portion. “We want to achieve total returns close to the S&P 500 with cash flow that is exactly four times the S&P 500 dividend yield,” O’Hara said of QDPL. QSIX is similar but focuses on Nasdaq 100 stocks. The Pacer fund’s portfolio mimics holdings in the underlying stock index, while also buying a long position in dividend futures contracts covering the next three years. The ratio of the equity position to the dividend futures position is adjusted during annual rebalancing to best achieve the target multiplier for the allocation, O’Hara said. By holding all index stocks in a portfolio, these funds hope to avoid some of the industry and style risks that come with funds that only buy dividend-paying stocks. “You typically have a lot of financials, a lot of utilities, a lot of real estate. And those sectors typically don’t show a lot of earnings growth,” O’Hara said of funds that focus only on dividends. – Payout stocks. Over the past three years, QDPL’s total returns have outperformed several popular dividend funds, including the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) and the Schwab US Dividend Equity ETF (SCHD), according to FactSet. However, it underperformed the Vanguard Dividend Appreciation ETF (VIG). Dividend futures are based on an index that tracks the total dividends paid by a group of stocks over a year, designated as a “point” by S&P Dow Jones Indices. According to CME Group, futures contracts are essentially bets on total points by a specified date. Income Details However, the cash distributed by income ETFs are not created equal, and investors should understand their differences and the potential impact on their annual tax bills. For example, the Pacer fund generates income from three separate areas, which affects after-tax returns. Pacer estimates that by 2023, the QDPL fund’s income will boil down to 23% dividends from S&P 500 underlying holdings, 8% capital gains from futures contracts, and 69% capital returns. QDPL’s website currently shows a distribution yield of 5.79%, more than four times the S&P 500’s dividend yield of about 1.3%, according to YCharts.com. However, the fund’s 30-day SEC yield (excluding capital returns on futures contracts) is 1.01%. In contrast, JEPI, which generates most of its revenue from fees earned from selling call options, has a 30-day SEC yield above 7%. One potential positive is that the capital portion of the Pacer fund’s return may not be included in taxable income. The disadvantage is that this is not necessarily new cash, but simply a return on the fund’s principal, which may result in a reduction in assets under management. This in turn could harm long-term performance. O’Hara said capital gains on dividend futures come from the fact that the contracts are often priced below expected payouts to compensate investors for the risk. Dividend futures could also see bigger gains if more companies in the index decide to start paying dividends. “Most of the big companies on the Nasdaq don’t pay dividends right now,” O’Hara said. That means there could be upside if some of these companies, like Amazon or Tesla, suddenly announced a dividend. In a possible harbinger, Meta Platforms began paying its first dividend last March. Apple began paying dividends in 2012, and Microsoft began paying dividends in 2003. For example, many companies have suspended dividends during the Covid-19 pandemic, including several major banks.
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