In this episode, Ben and Dan take a deep dive into covered call strategies—popular ETFs often marketed on their eye-catching distribution yields. While these products promise steady “income,” the reality is more complicated. Drawing on recent research from the Journal of Alternative Investments (“A Devil’s Bargain: When Generating Income Undermines Investment Returns”), Ben and Dan unpack why covered calls often reduce expected returns, cap the upside of equities, and leave investors fully exposed to the downside. They explain how covered calls work, why yields are misleadingly presented as “income,” and why long-term investors may find themselves worse off over time compared to simply holding equities or combining equities with cash. The conversation covers live fund performance, behavioral biases that drive demand for yield, and the rise of extreme products like single-stock covered call ETFs with 40%+ “yields.” While covered calls may offer psychological appeal for investors who crave distributions, the evidence shows they often deliver lower total returns, higher costs, and asymmetric risk. If it sounds too good to be true, it probably is—and nowhere is that clearer than in the world of covered call ETFs.
Key Points From This Episode:
(0:01:09) Why “14% yield” claims on covered call funds are misleading.
(0:02:35) Revisiting covered calls: “A Devil’s Bargain” and new research insights.
(0:05:24) The deep-seated investor preference for income—and how fund companies exploit it.
(0:10:10) What a call option is and how it caps upside while leaving downside intact.
(0:14:53) Why selling calls lowers expected returns and distorts stock return patterns.
(0:20:25) The volatility risk premium: theory versus retail investor reality.
(0:22:17) How crowded trades since 2011 erased much of the benefit of covered calls.
(0:24:56) Why stocks’ mean reversion makes covered calls especially damaging for long-term investors.
(0:28:11) The illusion of “income”: distributions versus true total returns.
(0:34:41) Evidence from live funds: BMO utilities and banks covered call ETFs.
(0:40:53) Underperformance across rolling periods—covered calls vs. their underlying.
(0:46:17) JEPI and cult-like covered call products: big marketing, poor long-term results.
(0:47:36) The rise of single-stock covered call ETFs—and why they’re worse.
(0:53:45) Higher costs: MERs and trading expenses add to the drag.
(0:57:25) Why marketing yields as “income” is financial BS.
(0:58:47) Final verdict: covered calls are more likely to harm than help investors’ outcomes.
Read The Transcript:
Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision making from two Canadians. We're hosted by me, Benjamin Felix, Chief Investment Officer and Dan Bortolotti, Portfolio Manager at PWL Capital. Welcome to episode 375.
We've got an interesting topic today. Dan, you and I were just chatting about how both of us enjoyed taking the time to learn about this topic, which is something that I used to get asked about a ton. It's a bit esoteric, but hopefully it's useful to listeners.
We're going to talk about covered calls.
Dan Bortolotti: This is a product that has been around now for quite a while in terms of VTS. Covered calls have been around for a lot longer than that. Seem to have really widespread appeal to retail investors, but as we're going to talk about it, you and I were both saying we had this general unease that anytime something sounds too good to be true, you know it is, but you might not know exactly why.
The research that you've uncovered here and the explanation you put together details exactly why these products are something to be skeptical about.
Ben Felix: It's not the first time we've covered this topic, but someone asked me in a Twitter DM recently, someone who's a highly intelligent person asked me how it can possibly be a bad thing to get a 14% yield from an investment product, because it feels like you're getting a 14% return. I think that's where the sleight of hand is with these things. We'll get to that in a sec.
We're going to deep dive on that. I do want to mention before we get into that, that we have not abandoned the AMA format. I know we haven't done an AMA episode in a while.
We do still have lots of questions in our AMA question bank to get through. It's just been easier for whatever reason recently to prepare for episodes with single main topics than it has been to do the AMA preparation. The whole point of the AMA preparation is that it was easier than the other one.
For whatever reason recently that's been flipped and I've just had other topics ready. We will come back to AMAs probably in the next couple of episodes.
Dan Bortolotti: Those are always fun episodes to do. We seem to have this very long list of questions and we only get through a fraction of them in the time allotted, but we're getting better at it, I think.
Ben Felix: I did look forward to some of the future AMA questions for the episodes that we would prepare. I think this might have been scheduled to be an AMA episode. I was like, these are great questions and I want to do them justice, but I just didn't have time to sit down and properly think through what I would say.
I had this topic on covered calls ready to go, so that's what we're doing. Should we jump into the main topic?
Dan Bortolotti: Yeah, let's do it.
Ben Felix: I've called this topic, Covered Calls, A Devil's Bargain. I stole that name from a recent paper. We covered this topic in 2023, the first time, but this new paper, it's in the Journal of Alternative Investments by Roni Israelov and David Dong.
It was a good enough paper, like the explanation of what's going on under the hood in the paper was good enough that I was like, wow, that's a lot of stuff that I wish I'd covered the first time we covered this topic. That plus the Twitter DM with the 14% yield question, I was like, okay, it's time to revisit. There's been just a ridiculous proliferation of these products.
We talk about single stock covered call ETFs later on in the episode, but there's been a suite of those launched in Canada recently. It was just time. It was time to cover the topic again.
Dan Bortolotti: It seems like there's no end to how exotic new ETF products can be. It blows my mind sometimes how far we've gotten away from the original idea of the index ETF, which now seems like a hundred years old. Single stock covered call ETFs is pretty bizarre.
Ben Felix: I did see data recently about the proportion of ETF launches that are active versus passive, and the vast majority now are active.
Dan Bortolotti: Well, the passive space is full. I acknowledge that. I mean, I don't know that anybody's going to create a new passive ETF that doesn't already exist, but most of these products are just things nobody needs.
Ben Felix: No, but the companies selling them need the margin.
Dan Bortolotti: Indeed.
Ben Felix: They're going to keep coming.
The title of that paper, just if anybody wants to look it up, is A Devil's Bargain When Generating Income Undermines Investment Returns. I'm not going to mince any words here. The idea that covered calls generate income is financial bullshit.
These strategies are mechanically expected to underperform their underlying equity, and increasingly so at higher targeted levels of distributions. When I see those 14% distributions, I really cringe once you understand what's really going on under the hood. For long-term investors, covered calls, in my opinion, increase risk by leaving the downside unprotected or mostly unprotected while capping the upside.
That eliminates the mean reverting behavior of stocks, which particularly for long-term investors, is a really important feature of stock returns. The preference for income though, is one of the strongest behavioral biases in investing. I mean, Dan, you had this, I would go as far as calling it a famous blog post series back in the day, on dividend investing, which was just like incredible.
This is not new. The preference for income goes back all the way through financial market history. I've read some pretty long dated historical accounts of the preference for income.
Dan Bortolotti: It makes some sense. Income, as opposed to the potential for capital appreciation, definitely has some intuitive appeal. That's not unreasonable.
It's one thing to say, I prefer stocks that pay dividends to stocks that don't. That might be a suboptimal investment decision as we've talked about many times, but it's not a crazy one. There's certainly nothing wrong with investing in dividend stocks or even focusing on them.
Again, it's not necessarily the best strategy, but it's not irrational or it's not going to cause you much harm other than potential lack of diversification. When we look at income oriented structured products, for lack of a better word, they just exploit that to the nth degree. Obviously, people creating financial products know about the preference for income.
They shamelessly create products with exorbitant, unsustainable yield because they know they will have wide appeal. You mentioned at the top, the person who messaged you about the 14% yield, it's not a person who's unintelligent. It's a person who doesn't necessarily understand how these financial products are created in order to exploit that preference.
You and I both know anything with a 14% yield has to be extremely risky or just BS. It's hard to understand, I think, exactly where that BS comes from. That's why I think this paper and what you've put together here today is a great explanation of how that works.
Ben Felix: I think in the case of covered calls, the 14% example is even more egregious than it would be with a high yield bond or something. Because in the case of the high yield bond, you're taking a lot of risk, but you have a high expected return. In the case of the covered call, the 14% yield, it does not even indicate a high level of risk.
It indicates something else altogether.
Dan Bortolotti: Well, and on the contrary, it might indicate a low expected return.
Ben Felix: Exactly. It does. That's what we'll talk about.
It indicates a really low expected return, which is problematic, especially if you're going to treat that 14% cash distribution you're getting as income. That preference for income, like you said, Dan, it can make people do really silly stuff. Now, the least silly end of the spectrum is maybe dividend investing, which as you said, we don't really agree with and wouldn't really get behind as a strategy we would implement for our clients, but it's not the craziest thing in the world.
Then you've got maybe covered calls on the other end of the spectrum. Some investors look for high distributions, regardless of where they come from. Now, you mentioned this too, Dan, that this is known by fund managers.
There's a paper from Sam Hartzmark that shows that some mutual fund managers, in the paper, they call it juice their dividend yield by buying stocks before their ex-dividend date to increase the distribution yield of the fund. That ends up, in their paper, ends up making investors worse off rather than better off, but it makes the distribution yield look really attractive to investors, which results in more flows into the fund. It's just another silly example of yield chasing and yield selling because people are chasing it.
In the case of covered calls, I think the really big problem is that marketing the yields as income or as expected returns is complete BS. I won't say the actual word again. I said it once, that's enough.
Dan Bortolotti: We've already got the E rating, so it's too late.
Ben Felix: Cameron doesn't like it when I use that word, even when I'm referencing an academic paper. BS is not a lie. That's an important point.
There's a whole literature on BS as a topic. It's indifference for the truth. You're not lying when you're BSing.
You're saying things that show an indifference for the truth. Selling a high distribution yield from a covered call fund as an expected return ignores the fact that yields on covered call strategies are inversely related to their expected returns. Higher yields mechanically mean lower expected total returns.
Total returns are, of course, what you need to buy groceries, to put food on the table. Yields don't buy groceries. Total returns do.
I'm going to walk through why that's true, why distribution yields are not returns in the case of covered call funds specifically, how covered calls reduce expected returns, and why I think the return profile of covered calls makes them particularly risky for long-term investors. Then to avoid being too theoretical and just talking about an academic paper, I'm also going to go through the performance of a bunch of covered call funds that exist, ETFs, to show that what I'm saying is not just theory. It's exactly what is happening in live funds.
I want to start with some background, but Dan, before I jump into that, you explained this just so elegantly to me earlier. Can you say how you explain to our listeners what a call option is?
Dan Bortolotti: Yeah, it's funny, right? Because this is not a product that we ever deal with day to day, so I'm relying on those courses that we took years ago. I think it's really important to understand what a call option is before we start talking about how they are incorporated into ETF products.
A call option is you are selling somebody else the right to buy a stock from you at a future price. Let's use a hypothetical example. Let's say I own a stock and the market value is $20 today.
I can sell you, Ben, a call option. You would pay me a premium for the right to purchase that stock at, let's say, $22. That's called the strike price.
The market price is 20, the strike price is 22. As long as that stock doesn't get to $22, I continue to hold it and I keep that premium. If the stock goes up in value and in a few days it's $23, you are going to exercise that option and you're going to buy that stock from me at $22.
Now, you own the stock that you paid $22 for and now it's worth some amount more than 22. What that means is my upside on the stock is capped at $22. There's no scenario there where that stock can go above 22 and I still own it.
As soon as it hits there, I have to sell it. That's how the upside is capped when you sell it. Now, on the other side of it, I'm collecting a premium.
You're paying me for that option. I am getting something in addition to the stock, but I also know that I will never own that stock for more than $22. However, if the stock goes down to $18, yeah, I collected the premium but I still have a stock that's down $2 now.
I lost a little bit less than I would have had I not sold you the option. Otherwise, I've pretty much enjoyed all of the downside of that stock. The premium that you pay to me to buy that call option is the income that we're talking about here.
This is the income that is sent to investors of covered call ETFs. I think that's a basic idea but that capped upside is a huge thing to give up based on the premium you're collecting.
Ben Felix: Great explanation. Somewhat to reiterate what you said but I think now that you've explained it the way that you just did, it gives listeners a much better background for what I'm about to say. Selling a call option on an equity that you own, that's a covered call, on an equity that you own generates income, that's the premium that you collect, and creates a liability that empirically more than offsets the income received.
The liability is the potential need to sell the stock if it rises above the strike price. That right there is why the distribution yield on covered call funds is an extremely misleading metric. Selling a call option means selling the right to buy the underlying stock at a predetermined price, that's the strike price as you mentioned, in exchange for a premium.
An equity covered call strategy invests in stocks and then sells options on those stocks. A fund using the strategy or even just an investor using the strategy is going to distribute income. It's going to create these income distributions from selling the calls as cash to investors.
That is why a covered call fund has high distribution yields. It's collecting option premiums and distributing those to their investors. Now, those distributions feel like investment returns, and they kind of are in isolation, but they don't exist in isolation.
Selling the call is the first step in the trade. It's not the whole trade. The fund has sold the right to buy the underlying stock at the strike price.
As your example explained so well, Dan, if the price of the underlying asset rises above the strike price, the option holder, whoever the fund sold the option to, me in your example, will exercise their call option and the fund will have to sell the stock at a price below its market value, putting a cap on upside returns.
Dan Bortolotti: That's right. If you think about this, if the stock price goes nowhere, if the stock is worth $20 today and it's worth $20 two years from now, I'm probably collecting a dividend from the stock and I've collected the premium. Yeah, I'm ahead versus if I had just bought the stock and not sold the option.
That's the theory and I think that's where people sort of think, I'm getting this little bonus. What they're leaving out is the fact that as you said, by collecting that premium, it's not a bonus. You have basically acquired a liability and that part has to be factored into the story here or you're not getting the whole picture.
Ben Felix: You just think about simple logic that the distribution of stock returns, that upside piece is really, really important and so is the downside. What tends to happen is that stock returns are typically positive and occasionally extremely negative. You're giving up a big chunk of that typically positive and you're eating all of the occasionally really negative.
The other important characteristic of stock returns is that after they've been really negative, they tend to be a little bit more positive than normal and you're giving up a big chunk of that little bit more positive than normal, which really messes things up. I want to talk a little bit about the expected return mechanics. What is happening that's making your expected return decrease with these strategies?
Call options are positively exposed to their underlying equity and that's measured by a term called delta for what it's worth. In your example Dan, I bought a call option from you and if the stock went up, I participated in that upside. I had positive exposure to the stock through the call option that you sold me.
When you sell a call on an asset that you own, so that's the covered call that we're talking about, that for the same reason, it reduces your exposure to the underlying asset. You're effectively shorting exposure to the underlying equity by selling the call option. If we hold option maturity constant, call option prices and deltas, so exposure to the underlying, monotonically increase in a decreasing strike price.
As the strike price gets closer to the actual price of the underlying, the call option prices and deltas are going to increase. If you're running a covered call strategy and you want higher income, you can sell options with lower strike prices, which is going to give you a higher income and higher short delta because you're selling the options. That piece is really important in understanding how yields are related to expected returns.
Dan Bortolotti: Just to return to that initial example we gave. If you have a stock that the market price today is $20 and I sell you a call option with a strike price of $22, it's going to be some price that's determined by a complicated formula. If I sell you a call option and the strike price is $23, I'm going to collect a lower premium.
If I sell you a call option and the strike price is $21, I'm going to collect a higher premium. That's the concept here.
Ben Felix: Correct. If you just think about the amount of upside that you're capping is greater.
Dan Bortolotti: If I sell you one with a strike price of $23, I can enjoy that full $3 appreciation in the share price. At 21, as soon as it goes up a buck, I don't own that stock anymore.
Ben Felix:
Exactly. If you sell it at the market price, any upward movement, you don't get to keep, which some funds are doing to get those really high yields. In simple terms, higher yield mechanically means lower exposure to the underlying asset by being short a higher delta option.
It correspondingly means lower expected returns and higher option premiums, but still lower expected returns. When you sell the call option, you're receiving that option premium that does feel like income and it's packaged up and distributed and marketed by covered call funds as income. As we said before, the fund now has a liability, the potential need to sell the underlying shares below their market value if the price rises above the strike price.
That liability exists until the position is sold or the option expires. Just to reiterate, the expected return of the short call, of the call that you're selling, is increasingly negative with an increasing derivative yield. If you want a 14% yield, that you're getting a lower expected return than if you want a 6% yield.
Why this matters is that over the full life cycle of this type of trade, the outcome is generally worse than simply having held the underlying equity. Part of the reason is a lower equity beta, so you've got less exposure to the equity risk premium. That's a big part of it.
Now, another interesting point is that that's something, if you wanted a lower equity beta, you could accomplish that by reducing your exposure to the stock and holding cash. The thing that really bothers me about covered calls is that you're not just reducing your equity beta, it's also an asymmetric reduction to the exposure. You're keeping all that downside while capping your upside.
Markets are volatile, always. Through any periods of market volatility, which are going to happen, like it or not. Anyone tells me that there's a flat market that you're going to make money with a strategy and it just doesn't exist.
Markets are volatile and you eat most of the downside and don't participate in a large portion of the upside. With the strategy, systematically missing out on recoveries, which are common after major downturns, like we mentioned earlier, is just very expensive on expectation. There is one potential saving grace for covered calls, the volatility risk premium.
This is a little bit complicated, but equity options tend to be priced with an implied volatility. Like you mentioned, the complicated formula to price options, volatility is one of the inputs there. The implied volatility, the volatility implied by option prices tends to be higher than realized volatility.
That theoretically creates the opportunity for option sellers to earn an expected risk premium for enduring the risk of an extreme event where realized volatility actually exceeds implied volatility. That's a little complicated, but this is one of the things that more technical people who promote these strategies or who believe in them will say, well, I'm getting access to volatility risk premium. That is not how these products are marketed by the company selling them.
Dan Bortolotti: I was going to say, I don't think there are any retail investors out there who buy covered call ETFs because they want to exploit greater volatility. It's the opposite. They think that they're exposed to less volatility by capping the upside and accepting a steady premium income in return, but it's an illusion.
Ben Felix: I've only ever seen these covered call strategies marketed on their income, not on their exposure to the volatility risk premium, which again, most retail investors would not know what that means. Now, an interesting thing that I learned in the devil's bargain paper is that in back tests going back before 2011, covered call strategies look really good because the volatility risk premium was positive. In recent history, since about 2011, the volatility risk premium has not been anywhere near sufficient to offset the reduction in equity exposure from selling the options.
Since about 2011, the performance of these strategies has been quite poor, which is interesting. Now, why would that happen? One idea could be that when a trade becomes too crowded by something like the proliferation of retail funds chasing the strategy or institutional investors chasing the strategy, that could mess up the option pricing to the point where that risk premium gets squished down.
That's, I think, a reasonable explanation for why that's gone away, but the empirical reality is that since about 2011, the volatility risk premium has been not so useful to covered call strategies. Maybe it comes back. Maybe it's positive at some point in the future.
I don't know, but the challenge is if you look at a long-term back test, these strategies can look quite good on risk and return metrics, but since about 2011, that has not been the case.
Dan Bortolotti: Interestingly, that's right around the time when these products started to hit the market.
Ben Felix: That is interesting. I do think it's a reasonable explanation that maybe there was something cool there and a lot of people chased it and now it's gone. I want to make sure it's really clear that the point about asymmetry is really important for long-term investors who have historically benefited from a little bit of mean reversion in stocks.
To the extent that we can expect that to continue in the future, that makes stocks a little bit less risky at long horizons than they would be if returns were completely random. If after a really good return, stocks don't tend to do as well and after really bad returns, they tend to do a little bit better, that makes stocks less risky in the long run than if returns from one period to the next were completely random. That's for what it's worth the opposite basically of what happens with bonds.
Bonds tend to continue having poor performance after having poor performance.
Dan Bortolotti: That doesn't bode well for bond investors after a couple of bad years. We saw a bit of a rebound this time around. It was 2021 and 2022 that were terrible years for bonds, but you're right, they haven't exactly shot out the lights over the last three years since then.
Ben Felix: That's in nominal terms. If you look in real terms, it gets ugly fast for bonds. The bond drawdown that we saw in those years, in real terms, was wild.
Dan Bortolotti: Because inflation was so high, it's true.
Ben Felix: And bonds don't tend to recover from that very well, whereas stocks do. Based on that, those characteristics of stock and bond returns for long-term investors, Scott Cederberg's research that listeners are probably familiar with, and if they're not, they can go listen to his episodes we've done with him.
His research with his co-authors suggests that the higher expected returns and mean reverting tendencies of stocks make them less risky than bonds, or than even including an allocation to bonds in a portfolio for a long-term investor. That includes long-term investors who need to live off of their investments. Obviously, that finding is debatable, but I think directionally, the idea that stocks are probably a little bit less risky than we typically think, and nominal bonds are a little bit riskier than we typically think for long-term investors, is important.
It all comes back to their relative expected returns, whether their returns are mean reverting or mean averting. That is just an important setup, because when you sell calls on your equity position, you're doing two things. You're lowering expected returns.
There's one of the good things about stocks for long-term investors is now gone, and you're eliminating the mean reverting tendency of stocks by capping the upside, while only slightly improving the downside by the amount of the option premium. Those two really attractive characteristics of stocks for long-term investors are being completely eliminated, or mostly eliminated by a covered call strategy.
Dan Bortolotti: How does this work? I mean, because I've seen that there are a few covered call ETFs in Canada that sell options on bonds rather than stocks. I'm trying to get my head around whether the fact that bonds don't tend to mean revert is better or worse in this context.
Overall, it seems to me, you're going to sell call options on bonds that have a 3% yield, and the ETF has a 12% distribution, which some of these do. There's got to be some risk in there, or some mechanism that makes no sense that most people don't understand, and they're just focused on, I'm getting 12% from my bonds, which is obviously not true.
Ben Felix: I need to dig into what's going on there. I haven't looked at the fixed income products. It's really, really interesting to compare.
One of the things that I'm going to do in a couple minutes here is compare the historical returns of covered call funds to the historical returns of the underlying assets that those funds invest in. When you look at that for equities, which is all I looked at for this episode, you can really see all the stuff that we've been talking about where they both go down a lot when the equities go down, but the covered calls just don't recover in the same way. Over time, that becomes increasingly damaging for the covered call strategy.
Bonds being less volatile, I'd have to look at some of their past returns for live funds to see what they look like.
Dan Bortolotti: I don't know how much live history these ETFs have, but it will be interesting.
Ben Felix: It'd be interesting to look at as a follow up. One of the interesting things that you do see, particularly with the higher distribution yield funds, is that their net asset values decrease over time. In the fixed income example, when they have a lower expected return already, and if they have a really high yield, like if it's a 14% yield or whatever it is, I would expect to see the net asset value or the price only value, not the total return, declining over time.
Anyway, it'd be an interesting thing to look up for a follow up episode. Selling calls in your equity positions, it lowers the expected returns, eliminates the mean reverting tendency of stocks by capping the upside. Really just not good for long term investors.
I would argue it makes covered calls quite risky for long term investors. For the same reason that the higher expected returns and mean reversion in stocks makes it a little bit safer for long term investors. I think eliminating those things makes a covered call strategy quite risky for long term investors.
That might be hard to believe given the large distribution yields, like the Twitter DM question about how can a 14% yield be bad, but it is absolutely crucial to remember that these distributions are not income. The way that bond interest is presenting it this way, which at least one of the funds that we'll talk about later on the fund website does present it this way. They show the yield of the fund next to the yield of a REIT fund, the yield of a T-bill, actual yields compared to covered call yields, which are just not the same thing.
Those option premiums, like we've said, they come with the associated liability and the lower expected returns, and they have a much less favorable shape of the distribution of returns for long term investors.
Dan Bortolotti: It sounds like it's a similar thing with those classic income funds that a lot of the distribution is return of capital. The mechanism is obviously different, but there too are often marketed with these eight, nine, 10% yields, quote unquote, but it's not income if it's just money being returned to you. To come back to that original question, how can it be a bad investment to buy something with a 14% yield?
Because if you buy something with a 14% yield and it falls in price 16%, then your total return is minus two, not 14. There's various reasons why that can happen, but we always have to look at those two sides of the return, the net asset value and the income.
Ben Felix: We'll talk about the total returns in a second. It's super interesting to see the actual historical total returns of a covered call strategy versus its underlying. One of the biggest problems I see for these funds, and it's interesting when you look at discussions online, I mostly look at discussions on Reddit because it's just such a rich place for random people to discuss things, but random people have interesting thoughts even if they're not correct.
Interesting to see how some people do go into income investing or fire financial independence retire early subreddits to ask about covered call strategies and they get a mixed bag of answers, but some people do get it. I did see some posts where people came in with some crazy idea about covered calls and were off of that ledge by some sensible comments. It is interesting to see the diversity of opinions and discussions online.
That being said, there still are discussions online in those fire communities and income investing communities that refer to the distributions from covered call funds as if they're income, as if they're perpetually sustainable, which as we've talked about, they're not. I saw one post where somebody was asking, and I think this is one of the ones where they were talked away from the idea by some sensible commenters, but they were asking about why wouldn't I borrow money at 5% from my line of credit and invest in covered call funds with a 14% distribution yield? Which if you think that those things are the same, then that does make a lot of sense, but when you realize that the 14% distribution yield is not a return and is in fact an indication of a lower expected return than the underlying equities, you realize it doesn't make a whole lot of sense.
Dan Bortolotti: Yeah, I'm pretty sure if that was possible, somebody would have already be doing it.
Ben Felix: That's a pretty sweet arbitrage, yeah.
Dan Bortolotti: We're laughing, but I mean, it's not a terrible question in the sense that if you're not a sophisticated investor, it's easy to be seduced by things like that. As we said at the top, fund companies know that and they prey on the lack of sophistication when they create these products and market these huge yields.
Ben Felix: Totally. The combination of high distribution yields, lower expected returns, an uncapped downside and a capped upside means that someone who's spending the distributions, especially if they're really high kind of distributions, I think would be expected to deplete their capital fairly quickly. That's another reason why calling these distributions passive income or income is financial BS.
One interesting point, and this is from an old academic paper from, I can't remember who, but one of the behavioral finance OGs that basically says that covered calls could be used as a psychological trick, basically. If you are aware of what you're doing and what the trade-offs are, this could be a way to help you spend down your capital using covered calls because that's effectively what they're doing. If you want to reduce your beta and you want to spend down some of your capital, maybe doing covered calls is not such a bad idea as long as you understand the trade-offs that you're making.
If you couldn't psychologically bury yourself to spend from capital otherwise.
Dan Bortolotti: This would be, for example, if you were drawing down your portfolio at a 4% or 5% clip, but the actual securities in the portfolio only pay like a 2% or 3% yield, this would allow you to spend a little bit more. For sure, it would draw down your capital, but that's the point. It would draw it down over time, not in five or six years.
It would be over your retirement. It seems reasonable enough.
Ben Felix: Yeah, and it depends on the underlying too. One of the examples I'll give in a second is a Canadian bank ETF. Canadian banks have done so well even with the capped upside with a relatively modest distribution yield on the covered call strategy.
The net asset value in that case has not declined over the life of the fund. That's a combination of good underlying performance and a modest yield. I think it is about 6% like in your example just now.
I talked to somebody recently who's very well versed in ETFs and covered calls and they were talking about how their dad uses a covered call with whatever 6% yield basically for that reason because they really like the income. If that's what's important to you, then maybe it's not so bad. I just think you have to go into it understanding what it is that you're buying and what the effect is on expected returns.
Dan Bortolotti: It's worth a quick pause here I think to ask, how is that income taxed?
Ben Felix: It depends where you are. In Canada, I believe it's typically going to be taxed as a capital gain distribution. In the US, it's derivative income.
I think it does depend on where you are.
Dan Bortolotti: That makes a huge difference.
Ben Felix: It does.
Not nearly as punitive as it is in the US. We don't use covered call funds. I haven't looked at a whole lot of tax receipts for covered call funds.
That's something people should be sure of before they use these strategies and get their own tax advice, but I'm pretty sure that's how it's taxed in Canada. That's the theoretical piece. We talked about what's going on under the hood.
While we don't really like the shape of the distribution from these products, it's really interesting to look at live funds. What I look for is cases where we have a live product with a decent history to examine that also has an identically matched. Well, there's one where I didn't have an identical match, but mostly I had an identically matched underlying ETF.
We have the covered call ETF and then we have an ETF that's just a long only fund that owns the exact same underlying equities, but does not write any options. BMO has a couple that launched in 2011, so it's a pretty good history to look at. The BMO covered call utilities ETF launched in October 2011.
It's distribution yield is 7.37% compared to 3.43% for the underlying, so it is a decent chunk higher, but not crazy. Not as crazy as some of the ones. More than double.
Double, but it's not 14%.
Dan Bortolotti: Yeah, that's right.
Ben Felix: Now, if you look at the performance chart, there have been some periods where the underlying equities don't perform so well, like when you talked to the example earlier, Dan.
The covered call fund has been able to outperform those periods because of those option premiums, but those periods tend to be really brief. In the long run, they're far outweighed by the capped upside. Over the full period since inception, the covered call ETF has trailed the underlying by an annualized 2.6 percentage points. It's interesting, right? We see that higher yield, 3.43% on the underlying versus 7.37% for the covered call strategy, but it's trailed in terms of total returns by 2.6 percentage points over the full period. Then I also looked at rolling periods, so it's trailed the underlying in more than 70% of three year rolling periods with a one month step.
If I increase that window to four year periods, the covered call fund has underperformed in 85% or just below 85% of rolling four year windows.
Dan Bortolotti: That's pretty telling. That's these sideways markets or prices don't increase, but I'm getting income in the meantime. Yes, those periods exist, but not very frequently.
Ben Felix: Yeah, exactly. You're much more likely to underperform than outperform by doing this.
Dan Bortolotti: Yeah, over four years, seven times more likely.
Ben Felix: Exactly. That underperformance is particularly pronounced. You can see it in the chart if we have it up in the video when the underlying equities drop dramatically and then recover, as we've been talking about, which as we've already mentioned is a pretty typical characteristic of equity returns.
I mentioned earlier that reducing equity beta by holding cash can get you to a similar place, at least from a beta perspective as a covered call. For this one fund, I ran a portfolio of 60% BMO equal weight utilities and 40% high interest savings account using a high interest savings ETF from October 2013, which is constrained by the ICETF through August 25th, 2025. If you can see the image in the video, they track pretty closely most of the time, except that the covered call fund gives up extreme upside events and eats the whole meal on the downside.
Dan Bortolotti: It's a pretty bad combination.
Ben Felix: If you want lower beta, it seems like holding cash and equity is a better deal than this.
Dan Bortolotti: This is, to me, such an important point because there are so many products out there that purport to deliver equity-like returns without equity-like risk. Our phrase like this, well, we cap some of the upside, but in exchange, you get this benefit of income or lower volatility or whatever it is. Well, I was going to say it's not that it's totally wrong.
In this case, it is totally wrong. In some other cases, it's just a different way of framing a classic balanced portfolio. If you don't want all of the volatility of an equity portfolio, add some fixed income.
In this case, I thought you were going to say that you ran the covered call ETF with like 10% or 20% cash, but you ran it with 40% cash, which is a huge drag on an equity portfolio. Yet, that was actually what matched up with the total returns of these covered call ETFs. That to me, I don't know, taking 60% equity risk or 70% equity risk and then putting the rest in cash, bonds, GICs, whatever your choice is, just seems to me to be a much better trade-off in the long run.
Ben Felix: I agree. I think you get a better outcome, which is what I found in my quick little model. I'm not going to do that cash allocation for the rest of my examples, but I did happen to see that Jeff Tack from Morningstar, he's managing director for Morningstar Research Services.
He did a post in his sub stack where he looked at a sample of 22 single stock covered call ETFs. This is where I got the idea to do this actually. He showed that a combination of cash and the underlying stock outperformed most of the funds, had lower volatility than all of the funds and had a higher sharp ratio than most of the funds.
If you want a lower beta, covered calls are maybe not the best way to do it.
Dan Bortolotti: Do we know what proportion of cash or did he try that data with different allocations of cash?
Ben Felix: I'd have to look at his post. We will have in the video an image with his headline results, but let me see if I can find it.
Dan Bortolotti: I thought the 40% was a lot higher than I would have expected.
Ben Felix: Yeah. His were all in that range, but let me just see if he shows that in his table here. No, he just says plus cash.
He doesn't say what proportion of cash, but if I remember from reading his post, it was a similar level to what I found. Yeah, I was honestly surprised by that too. I had the same thought as you Dan.
I just did this pretty casually. I just did cash allocations until the return profiles matched up somewhat. I started at 90% equity and 10% cash.
I was like, that seems pretty reasonable because this isn't a super high yield fund. Nope, 70, no and just keep going down.
Dan Bortolotti: 70, 80 would have dramatically outperformed.
Ben Felix: Yeah, 60 where it was like, oh, these are pretty close at this point. Similar results to what Jeff from Morningstar found. Again, I'm not going to do that cash allocation thing for the rest of these examples.
It was just analysis that I added later on after I'd already written most of this. I just did it for the one fund and then referenced Jeff's post, but you kind of get the idea, I think. There's another BMO fund that launched in January 2011.
It's a cover called Canadian Banks Fund. It's the one I referred to earlier. It's got a current distribution yield of 6.13% compared to 3.61% for an ETF of the underlying equity. It's an equal weight banks underlying fund. The covered call fund has underperformed by an annualized 2.71 percentage points since inception and has outperformed in less than 1% of rolling three-year periods since inception. I didn't even do the four-year periods for this one because I don't know, I think it would have been zero.
Dan Bortolotti: Would have been zero, yeah.
Ben Felix: That's banks. There's a Global X S&P TSX 60 covered call ETF.
That one launched in March 2011. It's got a distribution yield currently of 7.67% or at least when I pulled the data, it might be different today. It's trailed the iShares S&P TSX 60 ETF by 3.65 percentage points since inception and it has trailed in 92% of three-year rolling periods since inception. We could go on through these examples, but I think you kind of get the idea. Covered calls are not good for long-term investors, particularly to be fair in cases where the underlying equities have gone up, which all these cases are. If you're going to invest in underlying equities that you don't think are going to go up, maybe you just shouldn't invest in them at all.
I think it's pretty hard to predict that these underlying equities are going to perform just right so that my covered call strategy is going to outperform the underlying. But if that's true, it's probably going to perform worse than some other equities that would have performed better.
Dan Bortolotti: It's just a bizarre expectation. I think if you scratch the surface of people who buy these ETFs, they would not say that that was their goal. I'm intentionally going to buy stocks that I expect will go nowhere because that's the ultimate or optimal condition for covered calls outperforming buy and hold.
If we all agree that we start by buying stocks and then we decide whether to layer on the covered calls, how about if we start with stocks we think are going to go up or at least a diversified portfolio that we expect in aggregate will go up, then it's pretty hard to argue why you would want to layer on the calls because as you've just spent a lot of time showing, that is likely to reduce your return in 80% to 90% of three and four year periods, at least based on this sample.
This might not apply everywhere, but it's a bizarre strategy when you think it through.
Ben Felix: Those ones are pretty tame. Distribution yields in the 6% to 7% range. Someone told me that their father is using these as part of his retirement plan.
I'm like, if he likes and it feels comfortable, that's great. I think where these really go off the rails is when they start pushing for higher yields. If you remember from earlier, if you want higher income on your covered call strategy, you can sell options with lower strike prices, resulting in higher income and higher short delta.
In other words, targeting a higher income exacerbates all of the issues that we've talked about with covered calls. The lower strike price can give you higher distribution yields, but you also get less exposure to the underlying, a tighter cap on upside performance, which as we've described in lots of detail is not great.
Dan Bortolotti: Almost inevitably, you are ensuring that the net asset value of your fund is going to decline.
Ben Felix: For sure. When you start pushing for these crazy yields, I think that's exactly what you would expect, which if you want that, great, but that's the expectation you should be setting for yourself, not that you're getting a 12% or whatever, 14% income.
Dan Bortolotti: Or 12% return, because it certainly is not a return.
Ben Felix: The Hamilton ETFs yield maximizer ETF series, they target yields well over 10% by selling at the money call options. Again, we're getting really tight to the price underlying, which is going to give you lots of income, but it's also really going to mess up the distribution of returns and really reduce your expected returns. I didn't look at a ton of their funds, I just looked at one.
I looked at the US equity yield maximizer ETF as an example. It targets a distribution yield of 12% and it has underperformed an S&P 500 ETF by an annualized 4.48 percentage points over its relatively short history, to be fair. I do also want to address JEPI specifically.
This is an important one in the covered call world. It's the JP Morgan equity premium income ETF. This is a fund that really gained a cult-like following around 2022.
In that year, it outperformed the S&P 500 by around 15 percentage points. Serious outperformance. Which just means it lost less probably.
That's correct, yeah. Slightly negative return while the S&P 500 was very negative. I think that outperformance in that year combined with its prominently marketed high distribution yield, and this is the offender that shows on the fund website.
This chart, we can show it in the video, that ranks all these different sources of yield and JEPI is the highest yield source. It's compared to all of these other assets where the yields are actually more closely related to their expected returns. Then this guy's sitting out there, look at my yield, which is in fact negatively related to its expected return, which to me is just egregious.
That combination had a really big year and it's marketed on this really high yield. It's a fund that has its own subreddit. I always think those are especially interesting funds when there's a culture around an ETF.
The problem though is that like other covered call strategy we've talked about, it has underperformed an S&P 500 ETF. In this case, by 5.92 percentage points since inception in May 2020. This one's not a perfect comparison.
This is the one I mentioned that I didn't have a great underlying comparison. The S&P 500 isn't quite right because JEPI's underlying equity portfolio is actually actively managed. Now, I don't know if blaming the underperformance on active management or uncovered calls is worse, but in either case, we know that these things don't generally play out well for investors in the long run.
Dan Bortolotti: They compound each other. You take a strategy that seems almost guaranteed to underperform and layer on the risks of active management. It's not a great combination.
Ben Felix: I can just hear people saying, you can't compare that to the S&P 500. It's actively managed. Okay, so we want to blame it on active management instead of covered calls?
Okay. I think that's funny. I laughed about that one when I wrote it.
The most recent development, and it's not that recent, it's like I think around the last couple of years, they've started popping up in meaningful numbers is single stock covered call ETFs. It's exactly what it sounds like, covered calls on single stocks in an ETF wrapper. Honestly, kind of cool that this relatively advanced investment strategy that you don't have to go and do it yourself.
You can just buy an ETF. It's kind of cool. It comes back to the question of who does a financial innovation benefit, and it doesn't typically benefit end investors.
It is still cool to see this type of financial engineering in a product. I always think that's fun. Even if I think that they're silly and detrimental to investors, it's still cool to see.
Dan Bortolotti: If your goal was to buy a stock and then sell calls on it, there's tons of evidence on this. Retail investors are absolutely clueless when it comes to using options. If you know what you're getting into, at least you have some professional actually buying those options for you.
Ben Felix: Robert Merton talked about this when he was on Rational Reminder in a completely different context, but he was talking about how leverage can be a good thing for long-term investors, and maybe a good way to get access to leverage is through options. He does not expect retail investors to be using options in their portfolios. He thinks that products should be created.
That's an example where maybe you could create a leveraged equity product that uses options to get that exposure. That would be cool. It's not what we're seeing here.
The concept that you can productize complex strategies, I think is kind of neat. Even if it's usually not good for investors, you can't say it's not interesting. We've got these single stock covered call ETFs.
Some of their distribution yields are absolutely astronomical, but as you might expect by now, so is their underperformance. It is actually interesting, Dan. You mentioned return of capital earlier with other types of funds.
For the final notes that I put together here, I only looked at one single stock covered call ETFs, but I looked at a bunch as I was browsing through examples, and a lot of them actually have significant return of capital in their distributions. I guess they must be targeting yields regardless of the source. They're just saying, we're going to give you a really high yield, even if we're giving you your own money back, which is itself interesting.
Dan Bortolotti: It's hard to imagine these huge yields, and you've got an example or two here, but how you could possibly pay out those kinds of distributions just with premium options or option premiums?
Ben Felix: I don't know. They all have disclosures on the fund website that says, here's what the distribution was, this much of it was return of capital. Just to make it a relatively pure example, I chose one specifically that did not have return of capital, at least for this distribution.
TSLY is the one I looked at. It writes covered calls on Tesla shares. Its distribution rate at the time when I wrote this is 48.59% or was 48.59%, which is crazy, but since inception in November 2022, it has underperformed Tesla, which is the underlying equity by more than 20 percentage points annualized. Ridiculous. Those numbers are crazy.
Dan Bortolotti: I don't know how you call that even an investment product. I mean, that's a speculative tool. Buying the individual stock is risky enough, but this, as we've been talking about, just exposes you to a whole lot of risk and doesn't even really give you any upside.
The premium income is the only upside you're going to get if you're selling options at the money. You're not going to get any appreciation.
Ben Felix: Which is counterintuitively actually downside, not upside, at least on expectation. I'd love to hear from someone who's using these products, what their thought process is. I'd be surprised if listeners are using them, but if anyone listening is using a single stock covered call ETF, I'd love to hear from you about what the motivation is, what you're getting from it, what we're missing.
I personally just can't rationalize why you'd invest in that product. If you want exposure to Tesla, why would you buy TSLY? I don't get it.
You're capping your upside, you're keeping all the downside, you're getting premium income, but that premium income is more than offset by the upside that you're losing.
Dan Bortolotti: In theory, I suppose you're getting that really large premium income and if the stock stays the same or goes up just a tiny bit or down a tiny bit, you're ahead.
Ben Felix: It's speculating on a specific movement pattern of the underlying stock.
Dan Bortolotti: Which is you're specifically speculating on something that is completely random and unpredictable. There's a word for that and it's not investing.
Ben Felix: Yeah. The numbers on these single stock ETFs are just ridiculous, but I think they do highlight the previously mentioned relationship between high derivative income yields and lower expected returns. You got that massive yield, but you trailed by 20 percentage points annualized.
Crazy numbers. The last point that's worth mentioning is that covered call funds will tend to have higher fees and transaction costs and funds holding their underlying equities. For the sample of funds that I mentioned in this episode, excluding the single stock fund, and one note on this, it's in the weeds I guess, but JEPI is a US listed fund.
It does have a Canadian listed equivalent. In Canada, funds are required to report on their management expense ratio, which is their management fee and some other costs, and their trading expense ratio. US funds don't report the same way, but their trading expense ratio, so it's not as easy to figure out what their explicit trading costs are.
For this comparison, I used the Canadian listed version of JEPI. The MER and trading expense ratio for that fund in this little sample that I'm going to talk about in a second here is the Canadian listed version of JEPI. Probably unnecessary to explain that, but did it anyway.
For this sample fund, so the BMO funds, the Global X fund, and the Canadian version of JEPI, and excluding the single stock fund. The average management expense ratio of the covered call funds was 0.63% and the average trading expense ratio, the TER, which is something that you can find. All funds are required to file an MRFP, manager report of fund performance, twice a year.
They contain all kinds of cool details, but they are required to report on the management expense ratio and the trading expense ratio. For any fund, you can go and look this up. Any Canadian fund.
The trading expense ratio for my little sample here, just equal weighted, was 0.16%. That's 0.63% for the management expense ratio, 0.16% for the trading expense ratio. The funds in the comparison that I used just for the underlying equities, so the long only underlying portfolios, they have an average management expense ratio of 0.25%. A little higher because we have the JEPI thing in there, which has a bit of a higher fee and the banks and utilities, those are more specialized ETFs. But still, 0.25% is the average MER compared to 0.63 for the covered call funds. Average trading expense ratio for the underlying equity ETFs was 0 on average. Trading at stocks is cheap, trading options is, I guess, more expensive.
Dan Bortolotti: I'm actually a little bit surprised that the trading expense ratio on the covered call ETFs wasn't higher. I'm assuming that there's a lot of, well, especially if you're buying them at the money, you're buying and exercising them in rapid succession and presumably there's some cost to that. But if it's what you do and you're doing it at scale, you can keep those costs at least reasonable.
16 basis points is not enormous.
Ben Felix: It's not enormous, I agree, but it's high. You can find actively managed funds that have trading expense ratios in that range or higher, but that's high for any fund. You can find higher, but if you show me a trading expense ratio on a fund of 16 basis points, I'm like, well, geez, what's going on there?
Dan Bortolotti: Maybe they're doing all their trades at online brokerages and paying 9.99. That would make sense.
Ben Felix: That last point is just to show that you're paying a pretty significant premium to access all of the downsides of covered calls. Those high income distributions have to be really, really psychologically important to you for this to make sense or you have to be a sophisticated investor who believes they can harvest the volatility risk premium using these ETFs, which my understanding from people who actually pursue that risk premium would say that ETFs are one of the worst ways to do it because that's not what they're targeting. They're really designed for yield.
I do want to say that some investment managers may successfully use covered calls or similar strategies to access a volatility risk premium. It's a pretty esoteric risk premium and it's probably not required for the typical household saving for or living in retirement. You mentioned this in a blog post Dan from years ago that I loved where you said, I don't remember what the example was, but nobody failed to meet their retirement goals because of whatever, I can't remember what it was, small cap value stocks or something like that.
Dan Bortolotti: Fill in the blank there. Nobody really needs to engage in these strategies. It doesn't mean they're completely worthless.
It just means why are you wasting your time with them unless you have a very high confidence level that they're going to improve your returns and by extension, improve your financial well-being. Boy, it's hard to make that argument here.
Ben Felix: I agree. Unless it really makes you feel good. I did find it interesting that this very educated finance person that I talked to recently was more than happy to have their father using covered calls for their retirement portfolios.
Fair enough. If it makes you feel good and it helps you spend in a way that is fairly reasonable and who am I to say that you're doing it wrong. We already mentioned this earlier, but I think one of the big issues with the volatility risk premium angle is that even if it is there, even if it was worth pursuing, these funds are not marketed to retail investors that way.
They're marketed on their distribution yields, not on their exposure to the volatility risk premium, which most people would have no idea what it meant. They understand income, volatility risk premium, probably not so much. I've already said this, but I'm going to say it again.
In my opinion, selling these products on their yield, marketing them on their yield, which as we've mentioned in the case of covered calls, is inversely related to the strategy's expected returns, shows indifference to the truth. I'll say the word for real this time, it is bullshit. Especially when it's held up to things like treasury bill yields or other yields that are better approximations of expected returns.
Dan Bortolotti: It's hard to imagine that regulators allow those kinds of comparisons. There are some pretty good regulations in effect that people cannot market bullshit. I don't have any specific examples here of fund companies doing that, but it certainly makes investors vulnerable if that's the only metric they're looking at.
Ben Felix: Totally. I guess they're in some ways comparable because they're packaging out relatively complex strategies. If you look at structured products, they do the same kind of thing where they market headline rates of return.
They basically market the best possible outcome that you could get if this thing pays off in the best way possible. If you get the exact specific return scenario that makes this thing give you the highest return, they'll be marketed on that, which is similarly a ridiculous thing for investors to buy when the actual underlying expected return profile of the asset is really quite unattractive. Taken together, all that information, I really don't think covered calls have anything special to offer.
They get you to a place similar to holding a bunch of cash, except that your upside is limited and your downside is unlimited. They're more likely to be detrimental to most investors' expected outcomes than to improve them. Their high yields come at the expense of lower expected returns and historically lower realized returns in live products.
The volatility risk premium, which could theoretically help covered calls recoup their lower expected returns has not been anywhere near sufficient to offset the reduction in expected returns since around 2011, as you mentioned Dan, when these products started to become really popular. All of these downsides are not just theoretical, they show up very clearly in the terrible performance of live covered call strategies when those strategies are measured properly by their total returns, not by their yields.
Dan Bortolotti: It seems like a pretty slam dunk on these products. They have such superficial appeal, but like so many other financial products, you really do have to understand at least a little bit about how they work. I don't think either of us is pretending we have a super crystal clear understanding of exactly what the mechanism of all these products are, but it really comes down to that old maxim, if it sounds too good to be true, it is and nowhere is that more true than with financial products.
Ben Felix: 100%. I'll be interested in the feedback on this episode. I did a video a while ago on why trading options is generally a losing prospect for retail investors. I just talked about trading options in general, but the most common comment that I get on that video is, what about selling covered calls?
Hopefully this helps to address that what about. They are terrible too, just for different reasons than other forms of option trading. Not terrible, that's not fair.
They have trade offs that I don't find particularly attractive. Maybe somebody else really likes them. That sounds more generous than bullshit.
I already called it that twice, so I'm stuck on that one.
Dan Bortolotti: You even made me say it twice now.
Ben Felix: I'm sorry, Dan.
Dan Bortolotti: I'm going to have to wash my mouth out with soap.
Ben Felix: Cameron's not going to be impressed. We do have one review. I'll read the disclaimer.
You can read the review and then I got some comments based on the review. We have a review from Apple podcasts to read the under SEC regulations, we are required to disclose whether a review, which may be interpreted as a testimonial, was left by a client, whether any direct or indirect compensation was paid for the review, or whether there are any conflicts of interest related to the review. As reviews are generally anonymous on Apple podcasts, we are unable to identify if the reviewer is a client or disclose any such conflicts of interest, which wouldn't exist anyway because we don't pay for reviews because that'd be super weird.
That's not part of the disclaimer, but I think it's important.
Dan Bortolotti: That would be inappropriate. Yes. Here's one review that we did not pay for from Daniel R.
from the US. He says, hello from down south. Thanks to Ben, Dan, Cameron, and everyone behind the scenes.
This podcast has become my top recommendation for friends and family looking to improve their financial literacy. As a listener, I appreciate the depth and breadth of topics covered. Special shout out to episode 372.
I had been procrastinating doing research on effective charities. Thanks in part to this episode, GiveWell will be receiving a monthly donation from my family.
Ben Felix: That's very nice. It made me want to mention something though, that also came up in a previous review. I don't remember the details exactly.
This reviewer did say, thanks in part to this episode, which gives me some reassurance, but I think it's great that people trust the information that comes from this podcast. I'm grateful that we're considered a useful, credible resource for people to make decisions based on. I do hope that people are not making final decisions about important things based on a single podcast episode.
A previous review mentioned going all in on 100% equity portfolio after listening to Scott Cederberg. I get it. That was a compelling episode.
I was already in 100% equity portfolio, so whatever. I can't really throw any shade on someone deciding to go 100% equities, but it does make me a little bit nervous that listeners may hear things in the podcast and immediately go and act on them without doing their own research. I'm not saying that I think listeners are doing that.
I'm sure we have lots of very responsible, thoughtful listeners. I'm just saying I hope that they're not doing that. Someone posted in the Rational Reminder community a while ago.
I can't remember what it was, but it was some rule of thumb that they follow where anytime they're going to make a major change to their portfolio, I don't even remember what the timeframe was, but they'll sit on it for 60 days. Thinking about going 100% stocks because they heard Scott Cederberg, they're not going to do that for 60 days. They're going to sit on it, simmer, maybe take in more information, see how they feel 60 days later.
Maybe it was 30 days. I don't know. Whatever.
Some separation of time. Same for the GiveWell thing. Instead of going and giving them all the money that you're planning on donating this year, you hear the episode, maybe you wait 30 days, look for other information, look for conflicting information.
Anyway, I just wanted to say that. It makes me a little nervous. Maybe someone listens to this episode on covered calls and they're using a covered call fund and they hear this episode and they go and immediately sell it and invest in something else.
I don't know. I think we are doing our best to give useful, credible information, but it makes me a little uncomfortable being the final source of, I'm going to go and act on this now. Just a thought that I had.
Dan Bortolotti: Yeah. Especially a decision like going 100% equities. The issue is not, well, you're going to do your own research and find out that Scott Cederberg was wrong.
That's not the point. The point is, he's right, but that doesn't mean that 100% equities is appropriate to everybody's risk tolerance. There's theoretically correct and then there's correct for you in practice.
I think you're right. You don't always have the wisdom to tell that difference until you're a very experienced investor. Before you jump into 100% equities, make sure you understand the risk.
Ben Felix: For anything that we talk about in the podcast, giving yourself time space, I think it makes sense. Discussing stuff in the Rational Reminder community could be another approach. If you hear something, you're like, oh, I really want to do that.
Going and seeing what other people said in the Rational Reminder community, which is a place that a lot of really, really smart people participate in discussions. Hearing different points of view, why something might or might not make sense for one person. GiveWell is a good example where there's quite a lively debate about whether what they're doing does actually make sense or whether there are better ways to approach giving.
That could be a good rule of thumb. Before making a decision based on an episode, go and see what the community discussion looks like. Actually, the asset allocation discussion led by Louis, that included lots of comments from you Dan and from Ben Wilson.
That episode sparked a pretty substantial discussion in the community. A lot of it ended up being about, there's a bunch of discussion about asset allocation, about stocks and bonds. There's some interesting comments about whether stocks and bonds are the only things you should be talking about in asset allocation, which is a valid point that I thought about as Louis was talking.
I think from a general perspective, thinking about riskier assets and less risky assets just to make the discussion more straightforward is fine. It is a valid point that asset allocation is not just about stocks and bonds. Then a lot of the discussion in the community ended up being about whether it makes sense to pay off a mortgage or invest.
That was interesting. Interesting comments about behavioral loss tolerance, whether that actually matters. Really interesting discussion about advisors and what effect advisors have on investors' portfolios.
We talked about advisor fixed effects during that episode, but based on I think your comments and Ben Wilson's comments, a lot of people were saying that it sounds like we push people into more conservative portfolios than they would be otherwise, when it's maybe better for people to be in more aggressive portfolios than they would be otherwise if they have an advisor. It was just lots of really interesting perspectives on asset allocation, which is a very personal topic, which is I think why it sparks such lively discussion.
Dan Bortolotti: I find the advisor question a really interesting one actually. I would love to dive into that one a little more deeply by talking with other advisors because my sense is talking with other advisors that I've certainly met people who are much more aggressive than I am personally. My guess is the average equity allocation of their clients is also higher, even though you assume a large enough sample size, that's all going to even out.
Then the second part of that is, is that a good or a bad thing? Is our job as an advisor to encourage people to take as much risk as they possibly can or is it to encourage them to maybe be a little more conservative under the assumption that they don't always appreciate how volatile stocks can be and or they don't need a 7% or 8% expected return in order to reach their goals? These are all really good, really compelling questions and I think you could make good arguments on both sides.
That's one I would love to explore in the future.
Ben Felix: More generally, what I would love to start doing as PWL continues to get larger and larger and we have a larger number of clients, we have really interesting data. It's just what do we do with it? One thing that I would love to do is start collecting information on clients' asset allocations before and after they become a client.
Typically, someone comes to us and whether they're a DIY investor or they're with another advisor, they have a portfolio. It'd be very interesting to see on average, how does someone's portfolio change from when they're onboarded to when they're whatever a year into becoming a client or even just from what their portfolio is when we meet them versus what is their investment policy statement when they're onboarded with PWL. I think that would be an absolutely fascinating data point to explore.
Dan Bortolotti: The challenge there of course is getting the data on the way in because so many meatloaf portfolios that we see from new clients, the asset allocation isn't even clear. It's very hard to tease out. It's not like people are buying products like we use that have well-known asset mixes, ETFs or funds that only hold Canadian stocks or only hold international stocks.
They're thrown into these kind of mishmash funds and we don't even really know what's in there. At least overall, probably stocks and fixed income, you could probably tease out for most people with pretty good clarity.
Ben Felix: I have a tool in white charts now. I just did this for an advisor recently where there was exactly what you just described. They had a client they were onboarding and their current portfolio was a mess.
A ton of different holdings, individual securities, funds, you couldn't understand what was happening. White charts has a feature where you can upload PDF statements and it will extract all of the holdings and then you can analyze it like you would any other fund in white charts. You can look at asset allocation, number of holdings, past returns, all that kind of stuff.
It's possible. The challenge is, how do we systematize that? Anyway, it probably takes honestly somebody dedicated to doing that type of work with PWL's data, but I think we could probably start gaining a lot of really interesting research insights.
Dan Bortolotti:
Even if we only looked at the asset allocations here, post move to PWL, and so look at each advisors here. What's the average age of your clients and what is the average equity allocation? Because older advisors are likely to have older clients, for example, and make sense that they might be more conservative, but to just adjust for age and then say, this advisor, his average client is 80% equities and this other one, her average allocation is 50 or 60.
That's probably the advisor's own bias creeping in there for better or worse.
Ben Felix: That advisor fixed effects paper, that's what they did. They controlled for a bunch of variables that you would expect to be the main determinants of someone's asset allocation and they found that the advisor fixed effects were dominant over all those other variables. I agree.
You could do employment status and age and maybe a couple other straightforward variables and then see how impactful relative to those things the advisor is. I'm just dreaming here about cool stuff we could do in the future. Based on the community discussion on the asset allocation episode, I think it would be cool for us, Dan, to do an episode either on investing versus paying down debt because I think that's an interesting topic or, and maybe it's a separate topic, maybe it's the same one, should you pay off your house?
Because I think that alone is a really interesting topic.
Dan Bortolotti: This came up on the rent versus buy episode and you had said something to the effect that really jumped out at me, which was the advantage of being a homeowner is even lower once you've paid off your mortgage. I was like, whoa, that's really counterintuitive. When you think it through, if you assume that leverage is one of the advantages of home ownership, then it must also be true that when the leverage is gone, that advantage is diminished.
A fascinating way to approach the problem that I think most people have not thought about.
Ben Felix: It's like the 100% equities thing. If you're a robot and your goal is to maximize your returns, you should never pay off your mortgage. You should borrow as much as you can against your house to invest in stocks.
Personally, I will probably pay off my mortgage soon and not borrow against my house.
Dan Bortolotti: Me too. Obviously, we don't want to do the episode now, but I think it raises a lot of fascinating questions that I'd love to explore.
Ben Felix: Maybe I'll try and do that for the next, unless we do an AMA. Anyway, we'll work on that one. I think it'd be a really interesting discussion.
Based on the large number of comments in the community on that specific question, I think a lot of people would get value from it. It's actually interesting. A few people said things like, because I had said that in the community, that I would pay off my mortgage as soon as possible.
People said that it was really good for them to read that because they had assumed that I would say that paying off your mortgage is a really bad idea because of how expensive it is to have all equity. They're like, wow, I really wanted to pay off my mortgage, but thought it was a terrible decision. Now, I feel better about actually doing it.
It could be a valuable discussion for people to hear. By the time this episode is out, we will have had our meetups in Victoria and Vancouver. We're recording this on the 10th of September.
That's Wednesday. On the Monday of the week that this episode comes out, I will have headed to Vancouver and Victoria with Cameron. We will have had our Rational Reminder meetups over there.
Hopefully, in our next episode, we can report on how those went. Cameron and Ben Wilson, who listeners now know from the recent episode, were in LA recently at Future Proof, big conference for financial advisors. We may get some interesting insights from Ben and or Cameron on that conference when they come back as well.
I think that's all I got. Anything else?
Dan Bortolotti: No. I think that was a great episode. Thanks for all your work on it.
Ben Felix: Well, thanks for your contributions.
Your concise, plain English explanations are so powerful.
Dan Bortolotti: It's just how my mind works.
Ben Felix: I love it.
I think it adds a ton of value to the podcast. All right. Well, thanks everyone for listening.
Disclosure:
Portfolio management and brokerage services in Canada are offered exclusively by PWL Capital, Inc. (“PWL Capital”) which is regulated by the Canadian Investment Regulatory Organization (CIRO) and is a member of the Canadian Investor Protection Fund (CIPF). Investment advisory services in the United States of America are offered exclusively by OneDigital Investment Advisors LLC (“OneDigital”). OneDigital and PWL Capital are affiliated entities, however, each company has financial responsibility for only its own products and services.
Nothing herein constitutes an offer or solicitation to buy or sell any security. This communication is distributed for informational purposes only; the information contained herein has been derived from sources believed to be accurate, but no guarantee as to its accuracy or completeness can be made. Furthermore, nothing herein should be construed as investment, tax or legal advice and/or used to make any investment decisions. Different types of investments and investment strategies have varying degrees of risk and are not suitable for all investors. You should consult with a professional adviser to see how the information contained herein may apply to your individual circumstances. All market indices discussed are unmanaged, do not incur management fees, and cannot be invested in directly. All investing involves risk of loss and nothing herein should be construed as a guarantee of any specific outcome or profit. Past performance is not indicative of or a guarantee of future results. All statements and opinions presented herein are those of the individual hosts and/or guests, are current only as of this communication’s original publication date and are subject to change without notice. Neither OneDigital nor PWL Capital has any obligation to provide revised statements and/or opinions in the event of changed circumstances.
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Links From Today’s Episode:
Stay Safe From Scams - https://pwlcapital.com/stay-safe-online/
Meet with PWL Capital: https://calendly.com/d/3vm-t2j-h3p
Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
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Benjamin Felix — https://pwlcapital.com/our-team/
Benjamin on X — https://x.com/benjaminwfelix
Benjamin on LinkedIn — https://www.linkedin.com/in/benjaminwfelix/
Dan Bortolotti — https://pwlcapital.com/our-team/
Dan Bortolotti on LinkedIn — https://ca.linkedin.com/in/dan-bortolotti-8a482310