The race among ETF issuers to find new ways to squeeze the most income out of their stock portfolios intensified again Tuesday with the launch of Pacer’s new dividend-boosting fund. The firm launched the Pacer Metaurus Nasdaq-100 Dividend Multiplier 600 ETF (QSIX), a sister fund to the US Large Cap Dividend Multiplier 400 ETF (QDPL), which has grown to more than $500 million in assets since its inception in 2021. The funds target distributions equal to six times the dividend payout of the Nasdaq-100 Index and four times the dividend of the S&P 500, respectively. Income strategies have been a big growth area for ETF issuers in recent years, with covered call funds arguably the most popular niche. The Global X Covered Call ETFs, which track the S&P 500 (XYLD) and Nasdaq-100 (QYLD), now have combined assets of more than $10 billion, according to FactSet. Also, JPMorgan’s premium income ETFs (JEPI and JEPQ), which employ variations of the covered call strategy, have assets totaling more than $50 billion. A potential drawback of covered call funds is that they place a hard cap on the portfolio’s upside for the portion that is “covered” by the call options. The idea behind the Pacer fund is that the fund captures much of the upside when the market rises, according to Sean O’Hara, president of Pacer ETF Distributors. For example, QDPL currently has about 89% exposure to S&P 500 stocks, according to the fund’s website, with the rest being used to trade dividend futures to earn more income. There is no hard cap on the upside of the stock portion. “What we’re looking to do is get a total return close to the S&P 500 and cash flow that’s exactly four times the dividend yield of the S&P 500,” O’Hara said of QDPL. QSIX is similar, but focuses on Nasdaq 100 stocks. Portfolio While mimicking the holdings of the underlying stock index, the Pacer fund also buys long positions in dividend futures contracts covering the next three years. The ratio of equity exposure to dividend futures exposure is adjusted at annual rebalancing to maximize the dividend target multiplier, O’Hara said. By holding all index stocks in the portfolio, the fund hopes to avoid some of the sector and style risk that comes with funds that only buy dividend-paying stocks. “Typically, you’re going to hold a lot of financials, utilities and real estate. And those are sectors that typically don’t see a lot of earnings growth,” O’Hara said of a fund focused solely on dividend stocks. Over the past three years, QDPL has outperformed several popular dividend-focused funds, including ProShares S&P 500 Dividend Aristocrats ETF (NOBL) and Schwab US Dividend Stock ETF (SCHD), on a total return basis, according to FactSet. But it has underperformed the Vanguard Dividend Valuation ETF (VIG). Dividend futures are based on an index that tracks the total amount of dividends paid over a year for a set of stocks, designated as “points” by S&P Dow Jones Indexes. According to CME Group, the futures contract is essentially a bet on how much the total points will be by a specified date. Revenue Details However, the cash distributed by income ETFs are not all the same, and investors should be aware of those differences and their potential impact on their annual tax bill. For example, the income generated by the Pacer fund comes from three different areas, which can affect after-tax returns. For 2023, Pacer estimated that the QDPL fund’s income will be 23% from S&P 500 dividends on the underlying holdings, 8% from capital gains from the futures contracts, and 69% from return of capital. According to YCharts.com, QDPL’s website currently lists a distribution yield of 5.79%, more than four times the S&P 500’s dividend yield of about 1.3%. However, the fund’s 30-day SEC yield, which does not include returns of capital from futures contracts, is 1.01%. In comparison, JEPI derives much of its income from fees earned on selling call options, and its 30-day SEC yield is over 7%. One potential positive is that the return of capital from the Pacer fund may not be counted as taxable income. A negative is that it may only be a return of the fund’s principal, not necessarily new cash, which could lead to a shrinkage of assets under management. As a result, long-term performance may suffer. According to O’Hara, capital gains from dividend futures stem from the fact that the contracts are often priced at a discount to expected dividends to compensate investors for risk. Dividend futures could see even bigger gains if companies in the index start paying more dividends. “Most of the big Nasdaq companies aren’t paying dividends right now,” O’Hara said, which means there could be room for upside if some of those companies, such as Amazon or Tesla, suddenly announce dividends. Meta Platforms’ first dividend payment last March may be a sign of this; Apple began paying dividends in 2012 and Microsoft in 2003. To be sure, dividend futures contracts can also lose value in times of economic stress. For example, many companies, including several large banks, suspended dividend payments during the COVID-19 pandemic.
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