Is your ETF dying?

When most of us think of ETFs (electronically traded funds), we typically think of the SPY, the DIA, and the QQQQ, those stalwart index tracking stocks that have been with us for more than a decade (seventeen years for SPY!). We’ve grown downright comfortable with them, as evidenced by their ever-swelling trading volumes, and most of us tacitly assume they’ll be around for as long as their underlying indexes are alive and kicking.

But that isn’t the case for some of the more recent additions to the ETF universe. Take for example the BEO, the Enhanced S&P 500 Covered Call Fund. This fund seeks leveraged returns based on the CBOE S&P 500 Buy-Write Index (index symbol: $BXM). All well and good, but what isn’t apparent is that this fund, along with some of its brethren, have short shelf lives. What does this mean?

It means that they’ll be expiring soon. According to a representative from the fund issuer, IQ Investment Advisors (now owned by Bank of America), the BEO was designed specifically to take advantage of increased market volatility and was never meant as a long-term investment vehicle.

According to the fine print on the fund’s fact sheet, the BEO is scheduled for termination in October. However, the customer service rep said that the fund’s board could opt for an earlier closure, most likely a month or two sooner.

So, what does this mean for those joes who are long BEO? It means that at fund termination, they will receive whatever the net asset value (NAV) of its holdings are at that time. If the fund’s recent precipitious price drop is any indication, it looks as if investors are already jumping ship.

Take a look at the BEO compared with its underlying index and you’ll see why I suspected something was afoot:

BEO Chart 1-19-10

$BXM Chart 1-19-10
Because of its enhanced nature, the BEO won’t perfectly track the $BXM. In fact, if you look at a daily chart of both you’ll see that the BEO spikes up right before its semi-annual distributions in mid-December and mid-June. It’s been paying $1.10 consistently ($2.20 annually) since 2005 inception but the customer service rep I spoke with said that because of falling market volatility, upcoming distributions on covered-call based funds will most likely be reduced giving investors another reason to head for the exits.

Other IQIA fund family expiration dates
Within this family of eight funds, the two other covered call based funds are also set to expire soon. The termination date of the S&P 500 Covered Call Fund (symbol: BEP) is 3/31/10 and that of the Small Cap Premium & Dividend Income Fund (symbol: RCC) is 7/23/10. The company’s rep said that these funds, too, could terminate earlier then their printed expiration dates. Just so you know.

As with most purchases, it’s caveat emptor and another good reason why it’s so important to read the fine print, especially for volatility-sensitive ETFs. If you’re unclear on how a fund operates, don’t hesitate to call the fund’s issuer or consult your investment advisor.

Final Note: Comparison of returns of BEO vs the S&P 500 tracking stock (SPY)
On a lark, I decided to look at the returns of the BEO since 1/3/2006 (I wanted to give the fund a few months to find its sea legs) and compare those with the performance of its underlying index, the $BXM, as well as the S&P 500 tracking stock, SPY.

BEO vs SPY Table 1-19-10

The table shows that the SPY out-performed the BEO on a price appreciation basis; adding in the dividends gave the edge to the BEO. But the surprising thing was that the $BXM out-performed both even with no help from dividends!

For further reference:
“An In-Depth Look at the New Covered Call ETFs,” Richard Shaw., 6/6/07.

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