Market Analysis by covering: SPDR® S&P 500® ETF Trust, Nuveen S&P 500 Dynamic Overwrite Fund. Read 's Market Analysis on Investing.com
Today we’re going to talk about a closed-end fund that not only helps us protect our portfolio as this market wobbles—it gives our income stream a boost, too. The situation in the Middle East is behind our opportunity here.
That and the fact that this fund has proven that its strategy is purpose-built for times like these. But that said, this isn’t a fund we can “set and forget”: Timing matters —and the current moment is particularly well suited to its portfolio and strategy.These options let the buyer purchase this fund’s stocks at a fixed future price and date. No matter how those trades play out, the fund uses the fees it charges for these rights to fund its 8.4% dividend.service, this likely sounds familiar, since we regularly hold funds that sell covered calls. They tend to be popular at times like these because covered-call strategies do best in volatile markets., has gone the other direction: As the market has gotten more panicky, this fund has gotten cheaper. And now its discount is so deep—11.6% as of this writing, miles below its 2.7% average over the past decade—that it’s hard to ignore:That widening discount has, in turn, caused SPXX to lag SPY on a total-return basis this year, even though both funds hold the same stocks and, yes, this kind of market should be fuel for the covered-call fund:That mispricing exists for a couple of reasons. First, market anxiety is running so high that it’s not only caused investors to generally pull back from stocks—it’s also caused them to sell some stock-focused funds designed to hedgeMoreover, investors are also likely responding to the fact that covered-call funds tend to lag in rising markets . As a result, those positioning for a rebound are probably looking elsewhere. My take? The longer this fear goes on, the more likely investors are to come back to SPXX and bid its discount closer to the usual level, especially when they can get an 8.4% dividend from this fund—far above the 1.1% SPY pays.Now, to be sure, neither SPY nor SPXX have looked great this year, but note the purple line above. That’s the performance of SPXX’sIt’s showing us that on a NAV basis, SPXX is modestly outperforming SPY year to date. In other words, relatively speaking, the fund’s holdings and option strategy are holding up well in the current market. This also tells us that the fund’s underperformanceThat’s at the heart of our opportunity here, and as long as SPXX’s portfolio continues to perform well, the fund’s wide discount will be under pressure to return to the norm. That makes SPXX particularly appealing now. But that’s not quite the end of the story. Remember a second ago, when I said timing matters with this fund? Well, one downside of its covered-call strategy is that in a rising market, it tends to lag the benchmark index. That’s because more of its options are exercised, and its best performers are sold, or “called away.” This highlights a key takeaway about covered-call funds: They tend to perform best in sideways or volatile markets, but lag during sustained rallies. That doesn’t diminish SPXX’s appeal now, but it does put something of a stopwatch on the fund. Once we see sentiment improve, and the S&P 500 start to climb in a consistent way, we’re better to sell SPXX and move into a “pure” equity fund. Fortunately, there are plenty of those in the CEF world, many of which sport yields as high—or higher—than SPXX.Brett Owens and Michael Foster are contrarian income investors who look for undervalued stocks/funds across the U.S. markets. 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Nuveen S&P 500 Dynamic Overwrite Fund
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