For income-focused investors, Roundhill Investments has an exciting lineup of exchange-traded funds. They have been innovators in cryptocurrency covered call ETFs, zero-days-to-expiration (0DTE) ETFs, and their high-yield WeeklyPay ETFs, which use swap contracts. However, Roundhill also has a pair of ETFs that I believe are intended for a specific use and are not appropriate for most investors.
The two ETFs are the Roundhill S&P 500 Target 20 Managed Distribution ETF (XPAY) and the Roundhill S&P 500 Target 10 Managed Distribution ETF (TPAY). As the names indicate, the two ETFs pay distribution yields of 20% and 10%, respectively.
These funds do not use any options or alternative securities trading to generate cash to pay the distributions.
The ETFs hold options contracts to produce a synthetic long position in the S&P 500. Buying calls and selling puts with the same expiration dates and strike prices creates a position that mirrors the returns of the underlying asset. A synthetic long position can be more capital-efficient but does not offer any performance advantage over the underlying asset, which, in the case of these ETFs, is the S&P 500.
XPAY and TPAY will neither outperform nor underperform the S&P 500 (minus expenses). What these funds offer is a tax-advantaged distribution policy with monthly dividends.
These ETFs pay out a return of capital (ROC) equal to the target distribution rate. The distributions are, in effect, a return of the investor’s principal with no added value.
For example, if the S&P 500 gains 12% over the year, an investor would receive roughly 10% in distributions, and the investment would be up about 2% at the end of the year.
While I don’t think these ETFs are good choices for the everyday investor, I can imagine some uses for tax and estate planning.
If you put $1 million into TPAY, it would throw off $100,000 per year in non-taxable dividends. ROC distributions reduce the cost basis, so the taxes eventually become due. However, your heirs would receive a step-up in basis, allowing them to avoid taxes on the ROC-depleted basis.
Consider an assisted-living or nursing-home setting where costs are high, but life expectancy is limited. Using XPAY or TPAY to generate tax advantaged income, rather than paying capital gains taxes, could make sense.
TPAY could throw off non-taxable distributions for up to a decade. XPAY would do this for a shorter amount of time, but at double the payout rate.
I want to reiterate that XPAY and TPAY are probably not great investments for those looking to generate high income with stable principal. If you are looking for those types of high-yield opportunities, check out our ETF Income Edge newsletter, the MSIF share price will climb to a premium to the current NAV of $15.55.
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