A lot of people here treat a fund's distribution rate as a
quality signal — 11%, 12%, must be doing something right. I
wanted to know if that was true in any forward-looking sense,
so I pulled the history on one of the big covered-call income
ETFs and checked it.
It isn't. The distribution tracks the PREVIOUS couple of months
of volatility almost perfectly, and tells you essentially nothing
about the next couple. Correlation running backward was strong.
Correlation running forward was basically zero.
Once you say it out loud it's obvious. The fund sells calls,
collects premium, and pays it out. Premium is high when
volatility is high. So a fat distribution is a receipt for
volatility that has already been monetized — the option was
already sold, the upside was already capped, the money is
already spent. You're reading a rear-view mirror and calling
it a forecast.
Which means the yield number at the top of the fact sheet is
the one figure in the product that carries no information about
what you're buying. It's backward-looking by construction.
I don't think this makes these funds bad. I hold one. But I
stopped treating a rising distribution as good news about the
fund and started treating it as news about the market it just
went through.
Anyone here using distribution rate as an actual input to a
decision rather than a description of the past? Genuinely
asking — I might be missing a use for it.