As I write this, Bankrate.com, a popular U.S. website that publishes national surveys of savings accounts and certificates of deposit (CDs), shows that the annual percentage yield of the average U.S. savings account is 0.58%. By comparison, their top savings account partners offer a substantially higher yield of 4.69%.

But if you put your money into a savings account today, even at these top partners, are you guaranteed to get 4.69% interest in a year’s time? The answer is: probably not. The quoted annual percentage yield is the annualized rate that a bank currently pays out, assuming no other actors change in the next year. As most savvy investors know, the only constant in the financial markets is that financial markets and conditions are never constant. Variables continuously shift based on endogenous and exogenous forces.

For example, the market currently believes that economic conditions will tighten, resulting in rate cuts from the Fed starting in June. If this market expectation were realized, lower Fed Funds Rate would likely lead to lower savings rates. Savers will likely be unable to achieve the currently quoted 4.69% yield.

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So why is this seemingly non-accurate, potentially deceptive annualized yield methodology used for most retail/consumer financial products? Yield annualization provides standardization that allows consumers and professionals to compare a single number across different financial products. A higher yield should imply that an investor is being compensated for a higher level of risk in the product than a product with a lower yield. The measure may be useful for products with low yield volatility and less accurate with higher yield volatility. Again, the standardization is great, but users should not forget that the annualization process assumes that the rate you get now is the rate you will continue to get over the next year, whether true or not.

In Jason Zweig’s The Intelligent Investor, published on February 16, 2024, titled “A Fund With a 94.9% Yield? You Guessed it, There is a Catch”, he warns his readers that the distribution yield from covered call ETFs, though acknowledged to be published in line with required FINRA and SEC regulations, may be misleading from a return perspective.

And you might be surprised to know that we at Kurv AGREE! However, our reasons are more nuanced and detailed.

First, let’s establish facts. Using our Kurv Yield Premium Strategy Tesla (TSLA) ETF (ticker: TSLP) as an example, we declared and distributed $0.5555 per share from the fund (shown in the bottom table on our website: https://www.kurvinvest.com/etf/tslp). This is a realized yield of 2.59%, which is the distribution-per-share divided by the NAV of the fund (0.5555/21.45). We opt to show this number because we believe it is a more accurate representation of what an investor actually received in January.

Income-focused investors who use covered call ETFs are generally focused on the monthly dividend amount they receive. They will ask ETF issuers to publish a distribution yield number so they can compare the yield received from other investments in their portfolio. Per FINRA rules, any published yield numbers must be accompanied by the 30-day SEC yield. The 30-day SEC yield is an annualized number. So, to provide an apples-to-apples (annualized to annualized) comparison, managers must show the annualized version of the distribution yield, which is 30.49% (Formula: (Distribution per share / NAV) * [annualization factor = 365 / (number of days in the month]) or 2.59% * [365 / 31]). As mentioned before, annualizing a yield number implicitly bakes into the assumption that this is the yield you may expect to receive on a forward-looking basis for the next 12 months.

Managers who give the false impression that the distribution yield can remain constant and actively market it that way are doing a disservice to their investors. At Kurv, we don’t do that. We look to distribute, at most, only the premiums that can be harvested from the market, which may change month-to-month as we write the covered calls. Tying a fund to a distribution rate will most likely lead to overdistribution.

As an aside, it is also important to note that the distribution yield and the 30-SEC yield are calculated by an independent third party, our custodian and books of record, U.S. Bank. The same calculation is used for all of their investment management clients.

So what is an investor to do?

At Kurv, we believe our investors should look at two measures without baked-in assumptions.

Monthly distribution-per-share: As mentioned, these are realized distributions and do not have any forward-looking implications. By dividing the distribution by NAV, you get the current realized monthly yield of the investment.

Total Return attribution: A more accurate representation of distribution is via the decomposition of total return. For example, Kurv Yield Premium Strategy Microsoft (MSFT) ETF’s total return (ticker: MSFY) for January is 5.37%, of which 4.39% is price return and the remaining 0.98% is income return. There are no embedded assumptions in these numbers.

Any annualized yield will have baked-in, forward-looking assumptions. This problem will worsen in a higher base-rate environment. For decades, we got used to a zero-interest rate environment. Annualizing a yield number of zero or close to zero will still produce a yield number that is zero or close to zero. The higher the rate environment, annualization will exaggerate the difference in yield in different financial products. So buyers need to be savvy not only in the investments they put their money into but also in the tools or indicators they use to compare their investments.

With the run up in equity markets this year and tightening of high yield spreads, investors should reassess the upside return potential for each stock exposure and high yield bond allocation in their portfolio. If the expected returns are limited from capital appreciation, enhancing income generated from our Yield Premium Strategy ETF could be an attractive engine for additional portfolio returns.

For any questions or comments, please reach out to us at info@kurvinvest.com or visit us at kurvinvest.com.

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