QQQX: Technology And ‘High Yield’ To Beat The Markets After We Beat COVID-19 (NASDAQ:QQQX)

Co-produced with “The Value Portfolio”

Adjusting one’s portfolio post COVID-19 is key for future performance. We recently highlighted in a report right here on Seeking Alpha which sectors are set to outperform. While some sectors will emerge as very challenged ones, others are set to strongly outperform based on new facts of life including social distancing and an increased trend of working from home. Today, investors are offered the opportunity to start looking beyond COVID-19 and allocate their portfolio opportunistically.

Tech Sectors that Are Set to Outperform

As witnessed since the emergence of the virus and related lockdowns, usage of smart devices, and demand for additional Internet bandwidth and cloud storage, has surged. We believe that this is a trend that will continue in the future. Business owners and managers will reassess the need for employees to commute to the office. This is true today given that the business community was given a chance to test the efficient of work from home. Some functions will need presence in the workplace, but for others, working from home can result in cost savings (reduced office space) and possibly increased productivity. I’m sure many employees value this freedom. Furthermore, small businesses may decide that a separate office to operate is not a bad idea after all.

  • Amazon (AMZN) is a clear winner with its ability deliver almost all your needs to your doorstep. Amazon recently announced it’s hiring 100,000 new employees to keep up with demand. Just this week, the company said that it will be hiring another 75,000.
  • Google (GOOG) (NASDAQ:GOOGL) offers the ability search for reliable and critical information in addition to several related services to facilitate working and communicating remotely. Spending more time at home results in more time for browsing the internet. Google’s Verily division has launched COVID-19 screening and testing in California.
  • Microsoft’s (MSFT) cloud services have seen a 775% soaring demand as a result of social distancing orders. Microsoft’s Skype usage saw a stagerring increase of 70%, and now is used by 40 million people.
  • Facebook (FB) has announced it’s hiring 10,000 people in 2020 alone, with the population socializing remotely from home or remotely.
  • Cisco (CSCO) is uniquely positioned to build out the needed Internet backbone due to increased Internet access, including 5G. Cisco Webex offers a timely solution for global web conferencing businesses.

These are just a few examples of many technologies that have gained advantage today, and this is incredibly important because many of these companies have better services than their peers.

A great way to add a diversified exposure to these great companies is through Nuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX) which is a closed-end-fund with a focus on the largest tech companies.

About Nuveen Nasdaq 100 Dynamic Overwrite Fund

QQQX is one of the most interesting funds on the market at the current time. The fund attempts to replicate the Nasdaq 100 index while using Covered CALL options to generate significant income for shareholders. Since the start of the year, the fund is down more than 20% vs. 11% for the Nasdaq 100. That disconnect, combined with the potential of tech, and the fund’s income generating abilities make the closed-end-fund a powerful investment opportunity.

Credit: Technology Trends – Forbes

The Potential of Technology

One of the most substantial aspects of QQQX is the index fund it attempts to replicate, the Nasdaq 100. The Nasdaq 100 drove a substantial part of this recent bull market gains due to the power of companies like Apple (AAPL), MSFT, AMZN, and GOOG. The strength of these companies is unrivaled, with an unmatched ability to generate cash.

More importantly to their long-term sustainability, the companies each have unmatched moats around their businesses. Amazon’s AWS, Google, the iPhone, Microsoft Windows, etc., are all products that would take a well-capitalized company decades to potentially usurp. More importantly, not only would potential R&D competitors be competing against some of the world’s best capitalized companies, they’ll be competing against some of the heaviest R&D spenders.

Source: R&D Spending by Company – Idea to Value

The above image shows the world’s top 25 companies by R&D spending in 2018. Many of the names on here are the leading names on the Nasdaq 100 such as AMZN, GOOG, MSFT, Intel (INTC), AAPL, Facebook (FB), and so on. This heavy R&D spending and strong financial portfolio mean that these companies have an effectively insurmountable market position that will lead to continued dominance and shareholder returns.

As stated above, because of COVID-19, many of these companies are benefiting. The data released since the start of COVID-19 shows massive growth in the demand for many of these company’s products.

At the end of the day, many of these companies benefit in an unprecedented way from the shutdown, and will continue to benefit. People spending more time at home, working remotely, but also using the Internet, will help all the companies.

Fundamentally, when Internet traffic has grown by double-digit percentages, no one would expect the top internet companies not to benefit.

QQQX Top Holdings

When investing in a closed-end fund, it’s important to understand the companies that make up its top holdings. For QQQX, we want to highlight that at the current time the company’s share price is at ~6.7% discount from its NAV.

Source: QQQX Top 10 Issuers – Nuveen

The above image shows Nuveen’s top 10 issuers. Together, they make up a substantial 64% of the company’s portfolio. The classic big tech companies make up an astounding 49.6% of the company’s portfolio. That’s important because, as we discussed in the above section, all these companies stand to benefit significantly from the current COVID-19 crisis.

More importantly, these are some of the largest and financially strongest companies in the United States. Outside of AMZN, every company in the top five has tens of billions worth of cash and the financial ability to comfortably handle a recession. That means the chance of any significant percentage of QQQX going bankrupt is nearly zero. The only way that would happen is if a significant percentage of U.S. companies go bankrupt.

Covered CALL Strategy

Some investors must be wondering, how does QQQX provide investors with almost an 8% yield while owning technology stocks only yielding several percent?

Source: QQQX Option Portfolio – Nuveen

The company achieve these returns by utilizing short-term options. The company sells covered CALLs on the stock it holds. That means that if the stock price goes up, investors get their shares called away from them. However, if the stock stays constant or goes down, investors get to keep the additional income. At the same time, in a volatile market, with high option prices, the income can be much higher.

For example, FB stock is currently $158 / share. Right now, CALL options with a $160 strike price for FB stock and an April 17, 2020, expiration date are trading at ~$5.6 / share. That’s an annualized yield on options of 85%. Clearly, investors are pricing in significant volatility into the company’s share price. In our current environment, the company will generate significant cash flow due to volatility, while continuing to hold onto quality stock.

QQQX shareholders get broad exposure to technology in a market where they stand to grow significantly in the long run. However, there’s one significant downside to this strategy, one that we’ll discuss further in our shareholder return scenarios below. That means, in a market where the Nasdaq 100 is growing rapidly, QQQX could consistently see its stock called away limiting upside.

Shareholder Return Scenarios

For those who invest now, let’s discuss QQQX’s potential shareholder return scenarios.

Source: QQQX Hypothetical Growth – Nuveen

The above image shows the growth of a $10,000 investment in Nuveen since 2007. For those who had simply invested in the Nasdaq 100 that $10,000 would be worth ~$42,000 or roughly $10,000 more. However, there’s significantly more to the story that’s important to pay attention to here – especially for income-based investors.

So, investors might be wondering, why invest in QQQX, a fund that has underperformed the Nasdaq 100 index since its inception.

The reason to invest in QQQX is because the past several years represented QQQX’s largest weakness. That is, due to the fund’s covered CALL option strategy, the fund underperforms in a market that’s rising rapidly. However, it’s worth noting that until the 2016-2019 tech bull market, QQQX performed in line with the Nasdaq 100. From January 2007 to February 2016, investors in QQQX saw roughly the same return as the Nasdaq 100.

Since we do not expect the equity markets to gain rapidly over the coming months, as it did in the 2016-2019 tech bull run, we see the chance of QQQX repeating this underperformance compared to the Nasdaq index (QQQ) as low. In fact, QQQX’s option strategy outshines in a volatile market where the premiums on options are high. That’s great because we do expect volatility to remain in the markets over the coming months.

What’s important to pay attention to here is the 8.7% dividend that QQQX has paid out across this time period. In 2008, during one of the worst market crashes, it took investors only a year to recover their original investment. However, throughout that time, they continued to earn 8.7% cash flow from options.

Going forward, in down markets, which tend to be more volatile, investors will see returns go up as option pricing increases.

Forward Scenarios

Going forward, there are three scenarios for investors to pay attention to:

Scenario 1 – Market declines or stays constant

In this scenario, QQQX will continue to drop along with its NAV while continuing to earn income. As we discussed above, income from options should increase significantly, as investors price in more volatility for options. Those who invest today should earn a steady dividend yield of almost 8%, not affected by dividend cuts by the companies, and will see less volatility than the Nasdaq 100.

Scenario 2 – Market goes up

In this case, the rate of an increase really matters. In the event of rapid increases, the technology company shares held by QQQX will regularly get sold through options. That sell price will likely be lower than the current price, meaning that QQQX shareholders will, on average, earn less on a percentage of the portfolio. However, since we view the chance of the market going straight up over the next year as unlikely, this is a less realistic scenario.

Scenario 3 – Market goes sideways

In such a scenario, QQQX will also greatly outperform since it’s generating income from its call strategy.

QQQX Risk

One of the reasons why QQQX is such an interesting investment is because it outshines the broader market from a risk perspective in every scenario except the scenario where the market is going up rapidly. In a massively volatile market, like the current one, it can be expected to outperform. The only other risk not discussed here is bankruptcy, but by being composed of the 100 largest companies in the Nasdaq, the company has no significant bankruptcy risk – it can basically be expected to track close to the S&P 500.

In a scenario where markets are steady, investors are getting a 7.5% yield from selling these covered tech options.

In a scenario where markets are dropping, investors see the same drop, but gain significant cash from the selling of covered options. That means investors see a lower drop than the broader market.

In a scenario where markets are recovering, QQQX sees its stock holdings called away at lower prices, meaning the recovery isn’t as strong as the broader market.

However, investors who invest today in QQQX not only have strong income perspective, but they don’t need a specifically-timed market recovery to outperform. That means you get paid to wait. As the markets recover, investors realize strong capital gains from some of the strongest companies in the United States.

Conclusion

Our daily lives and the way of work will look much different after COVID-19. Some aspects will change permanently. We have identified in the article above a few of the tech giants that set to greatly benefit from this future trend. Investing in QQQX is one way to do it.

QQQX has seen its share price drop, along with all other companies, as a result of the bear market, making this CEF trade at significant relative discount to its historic NAV. Furthermore, QQQX has several things going for it that make it an exciting investment. Among these is the fact that it’s a technology-driven investment and technology stands to outperform in the current market environment.

QQQX has a unique ability to generate high income on top of its capital appreciation potential. Today, it offers a 7.5% yield that’s secure and not dependent on the dividends or financial performance of the companies it holds. In fact, during periods of volatile markets, the amount of income that this CEF generates gets a huge boost.

By investing in QQQX, you are repositioning your portfolio to beat the markets as we beat COVID-19.

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Disclosure: I am/we are long QQQX, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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