Upstart exchange-traded fund company Neos just got a huge vote of confidence from Goldman Sachs.
Neos, which Goldman agreed to acquire for $2.25 billion this week, has fast become one of the ETF industry's leading players in covered-call funds, a popular strategy that promises investors a chance to generate fat yields, sometimes north of 10%, while also benefiting from stock market appreciation.
Along with so-called "buffer ETFs" -- Goldman acquired a buffer ETF company last year -- it's a group of funds that appeals to retirees, who are looking for yield products in a market when dividend payouts and interest rates remain historically low. It has earned the products the nickname "boomer candy."
Neos's roster of more than a dozen funds includes the $14 billion Neos Nasdaq 100 High Income ETF and the Neos S&P 500 High Income ETF. Both funds offer distribution rates of more than 12%.
The covered-call strategy can be appealing to investors looking to generate consistent income, without having to entirely exit the stock market. The Neos funds hold stocks in their respective benchmarks, similar to the way index funds do, but Neos portfolio managers also sell call options on the indexes to generate regular income for fundholders.
The strategy's sweet spot is a market where stock prices are rising steadily but not rocketing ahead. That allows fundholders to pocket the call premiums and enjoy gains from stock market appreciation. But there are risks. If the market rises too quickly, call options sold by the funds will be exercised, capping fundholders' gains. If the market plunges, covered call investors are still on the hook for stock market losses, making the strategy a risky alternative to owning bonds.
So far, Neos's most popular funds have delivered solid total returns, at least for funds designed to generate income rather than match the market. The Neos S&P 500 High Income ETF, which launched in 2022, has returned 16.7% a year on average over the past three years, compared with 21.% for the S&P 500. The Nasdaq 100 version, which made its debut in 2024, has returned 19.2% in the past year, compared with 26.8% for the index.
Neos designed the funds in a way that attempts to eliminate some of the frustrations investors have with the covered call strategy. One pain point is taxes. While distributions for covered-call funds are frequently taxed like income, Neos notes that it sells index options, which allow for more favorable tax treatment, with 60% of the income qualifying for long-term capital gains treatment.
In addition, while Neos acknowledges its funds will lag behind in big bull markets, its funds attempt to address this too. The firm says investors retain exposure to upside because it avoids selling call options on funds' entire portfolios and because it sometimes buys out-of-the-money call options that could pay off if the market surges to a certain level.
"We believe it's crucial to consider total return potential alongside income generation so investors have the opportunity to grow their capital over time," said Neos co-founders Garrett Paolella and Troy Cates in an email.
Should investors add Neos or other covered call funds to their portfolios?
CFRA analyst Aniket Ullal says the covered-call ETF category's popularity is impressive. He notes funds have been grabbing investment dollars even in years when the stock market has posted 20%-plus returns -- suggesting investors are hungry for income and don't mind missing out on some stock market gains.
Still, he suspects some of the money making their way into covered-call funds is coming from the roughly $3 trillion sitting in low-yielding retail money-market funds. Top retail money-market funds yield just 3.7%, according to Crane Data, a pittance compared with Neos 12%-plus payouts -- an enticing prospect for retirees in need of income.
"Demand is not driven by market dynamics, it's demographics," Ullal says.
If you are buying a covered-call fund because you are frustrated with stingy bond yields, that is probably the wrong reason. The funds offer a bit of downside protection -- income from writing calls should offset some price declines in a stock market sell off, just as dividend stocks' payouts do. But investors are ultimately still buying a basket of stocks, whose value will decline alongside the market's.
While covered-call funds can deliver investors extra income, they are no match for bonds' downside protection.
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