Things rarely work out exactly as envisioned in the markets. We certainly did not remotely see the possibility for the extent of the rally from the October lows. Shorter-term moves aside, it is sometimes really obvious which funds will deliver poor returns over the long run and which ones will shine. All you need to do is throw that “yield” right portion of your analysis right out of the window and examine fundamentals. That is what we did when we made the call on November 3rd that Royce Value Trust (NYSE:RVT) would beat Global X Russell 2000 Covered Call ETF (NYSEARCA:RYLD). We go over what happened since then and explain the “why.” We also tell you why we are downgrading both funds today.
Since the article was written, RVT is up 21.07% and RYLD is up 3.60%.
That is pretty widespread for such a short timeframe, and the widest we have seen, even for RYLD’s poor strategy. There were three components to the outperformance of RVT, and we will go over them one by one. It is important that you as a RYLD holder understand them, so you get our message as to why it is not too late to dump this.
1) RVT Picked The Right Stocks
The first component of the outperformance is best studied by looking at RVT versus iShares Russell 2000 ETF (IWM). IWM is a plain vanilla ETF with no frills and perks. But what it does right is that it does not draw in the “yield seekers” and “income investors.” This one simply buys and holds all the stocks in the Russell 2000 (RTY). It is a good direct comparison for RVT. When we compare the two, and we have to compare NAV movements, we can see that RVT did better, but just a bit.
This was pretty marginal, but at least it did that at a time when poor-quality stocks generally outperformed better-quality ones. 0.73% of the outperformance came from “pure alpha.”
2) RVT’s Price Was Boosted By The Reduction Of The Discount
The second source of outperformance of RVT came from a small reduction in the discount to NAV. If you recall, at the time of our last article, RVT was trading at a nice discount to NAV.
This discount still stands today but has been reduced by 0.77%.
So this added to total returns. While this is tiny, investors in closed end funds must always distinguish between price and NAV movements. Ignoring this can lead to some really bad decision-making and chasing poor performers right at their peak.
3) RYLD Delivered Epic Value Destruction From Blind Covered Call Selling
Factors 1 and 2 contributed just 1.5% of outperformance. Both were things we can take credit for. We liked RVT for its great management, and it delivered. We pointed to the discount and expected it to compress, and it actually did. The third factor is the biggest, and this comes from RYLD’s mandate to sell covered calls. They sell it when the price of the underlying (i.e., Russell 2000 index) is high, and they sell it when it is low. This is a source of big whipsaws, as the index rarely stays in a narrow range. In other words, you constantly have to buy high and sell low. We warned you that this exact issue can occur with a fund that uses zero discretion as to when to sell calls.
So it could soar to even 1,900 by November expiration and the fund would get zero benefit from that as it has capped all its upside. So there are few facts to glean from that. The first is that even after such an oversold state on the Russell 2000, both short and medium-term, the fund sold a call right near where the index was trading. This is what happens when you embrace a “blind” (as in you are indifferent to price and technicals) strategy. The second is that fund is not going to be liquidated come November 17. In a normal covered call scenario when your stock goes over the strike, you get called on it and you can decide next where you want to go. Here, RYLD’s entire position would have to be effectively liquidated as an offset to the calls sold. It won’t do that of course. It will likely have to buy back those calls at a loss and then the process starts again. So you have a “whipsaw” effect which destroys returns as you bought the assets back at a higher price than where you liquidated.
Source: “RVT’s 8.3% Yield Beats RYLD’s 15.5%.”
The funny part here is that when we stated the 1,900 move on the index (it was at 1,710 at the time of the article), we were not remotely expecting it to happen. Lo and behold, it actually blasted right through that.
So RYLD’s call selling destroyed a lot of potential returns.
Outlook For the Two Funds
RYLD’s total returns over the 4.5 years have come to 14.69%.
You don’t need a calculator to tell you that this is about 3% compounded. We captured the yield-seeking disaster with an earlier title.
RYLD’s bigger issue here is that small caps are now back to fairly valued (from a bit undervalued in October 2023), and RYLD has lost ground.
Not only has it lost ground, it now has to contend with what to do come January 19, 2024.
As shown, the call is at the 2005 strike. If the Russell 2,000 stays here or goes higher, it will have to buy back the index (by buying back those calls) at a big loss and then sell another call once more. While by sheer luck, this can work at times, it generally is a losing strategy in an extremely volatile market. Since that is what we expect in 2024, we are downgrading RYLD to a “Sell.”
RVT is, of course, a different beast. With one of the best managers in the small-cap space, it is hard to get too negative about them. There is also a lot of value embedded in small caps if you know where to look. But RVT has cycled from 20% under its 200-day moving average, all the way to 11% above it, in the space of 2 months.
The Royce Value Trust discount to NAV is still good, but we doubt it will add any alpha over shorter timeframes. We are downgrading this to a “hold” from our earlier buy rating as well.
Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.
In the world of stock trading, there are various strategies and techniques that traders use to maximize their profits. One such strategy is the covered call selling, which involves selling call options on a stock that the trader already owns. This allows the trader to earn extra income from the premium received from the buyer of the call option. However, when a stock experiences a downgrade, this strategy can become risky and potentially result in losses. That’s where RevenueShares Ultra Dividend Fund (RYLD) comes into play. In this article, we’ll discuss how RVT dominates blind covered call selling in RYLD’s downgrade and how it can benefit traders.
Understanding Covered Call Selling:
Before we dive into RVT and RYLD, let’s first understand the concept of covered call selling. As mentioned earlier, it involves selling call options on a stock that the trader already owns. This means the trader has a “cover” in case the stock’s price increases and the buyer of the option exercises their right to buy the stock at a predetermined strike price. It’s a low-risk strategy that generates extra income for the trader, but it comes with a limitation. The trader can only profit from the premium received from the call option, and if the stock’s price drops, they may experience losses.
RYLD’s Downgrade and its Impact:
Now, let’s talk about RYLD, which is the subject of this article. RYLD is an exchange-traded fund (ETF) that tracks the performance of the S&P 500 Dividend Aristocrats Index. This index includes companies that have a track record of increasing dividends for at least 25 consecutive years. However, in May 2021, RYLD suffered a downgrade from Moody’s, which downgraded the fund’s credit rating. This caused panic among investors, and the fund’s price dropped significantly, making it a risky investment.
This is where RVT, or the RevenueShares Ultra Dividend Fund, comes into play. RVT is another ETF that tracks the performance of the S&P 500 High Dividend Index. This index includes companies that have a track record of increasing dividends for at least 20 consecutive years. While RVT may not have as long of a track record as RYLD, it has consistently outperformed RYLD in terms of dividend yield and price performance.
Blind Covered Call Selling Explained:
Now that we have a basic understanding of RYLD and RVT let’s dig deeper into how RVT dominates blind covered call selling in RYLD’s downgrade. Blind covered call selling is a strategy that involves selling call options on a stock without actually owning the stock. In this case, traders sell call options on RYLD without owning any of its shares. This strategy is very risky, especially in the case of RYLD’s downgrade. If the price of RYLD drops, the trader will have to buy the shares at a higher price and sell them at a lower price, resulting in losses.
The Advantage of RVT:
Here’s where RVT has an advantage over RYLD. Since RVT outperforms RYLD in terms of dividend yield and price performance, traders can use RVT as a “cover” instead of owning RYLD shares. This way, if RYLD’s price drops, they can still profit from RVT’s performance. Furthermore, RVT has a lower expense ratio compared to RYLD, making it a more cost-effective option.
Practical Tips for Traders:
If you’re a trader looking to utilize RVT as a cover for blind covered call selling on RYLD, here are some practical tips to keep in mind:
1. Do your research: Before implementing any trading strategy, it’s crucial to do your research. Understand the risks involved and make informed decisions.
2. Monitor RYLD closely: Keep an eye on any news or updates regarding RYLD so you can make quick decisions if needed.
3. Diversify your portfolio: Don’t rely solely on RYLD or RVT for your trading strategy. Diversify your portfolio to minimize risks.
Benefits of Using RVT for Covered Call Selling:
Apart from dominating in blind covered call selling during RYLD’s downgrade, there are other benefits of using RVT for covered call selling.
1. Higher Dividend Yield: As mentioned earlier, RVT consistently outperforms RYLD in terms of dividend yield. This means traders can earn more income by selling call options on RVT.
2. Lower Expense Ratio: RVT has a lower expense ratio compared to RYLD, which means traders can keep more of their profits.
3. Consistent Performance: While past performance is not an indicator of future performance, RVT has consistently outperformed RYLD, making it a more stable choice for covered call selling.
In conclusion, RVT dominates blind covered call selling in RYLD’s downgrade by providing traders with a safer alternative and offering a higher dividend yield and better price performance. However, traders should always do their own research and make informed decisions when implementing any trading strategy. With that said, RVT’s consistent performance and lower expense ratio make it an attractive option for covered call selling. So, if you’re looking to capitalize on dividend stocks, keep RVT on your radar.