QQQX's Distribution Could be Cut Following Rout in Tech Stocks

Rising interest rates are putting undue pressure on growth-oriented companies that are typically more reliant on debt financing.

Investor expectations for these growth companies have soured, as evidenced by the growth-tilted Nasdaq Index dropping about 30% this year compared to the blue-chip-oriented Dow Jones Industrial index's less than 10% decline.

The Nuveen Nasdaq 100 Dynamic Overwrite Fund (QQQX), which track's the largest 100 non-financial stocks listed on the Nasdaq stock exchange, has seen a similar nearly 30% drop in net assets (NAV) this year – despite the fund employing a call option strategy designed to limit the fund's downside risks.

This loss in assets makes the fund's distribution, which is funded primarily by capital appreciation, much more fragile.
Source: Simply Safe Dividends

QQQX historically distributed around 7% of NAV each year, a rate that was covered by investment returns for most of the past decade thanks to strong equity markets.

The pandemic-driven surge in growth stocks led management to raise QQQX's distribution by nearly 30% over the past two years. 

This increase maintained a NAV distribution rate of around 7% but represented remarkable growth; the fund had raised its distribution by just 11% over the prior six-year period.

With surging interest rates popping the growth stock bubble this year, QQQX's distribution raises look too aggressive in hindsight. 

The fund's NAV distribution rate has jumped to 9.3% following the rout in tech stocks, a level that future investment returns could struggle to cover.  

QQQX still has a reserve of unrealized gains to cover the distribution temporarily. But unless there is a strong market recovery, especially amongst tech firms which account for over half of the fund's assets, the payout looks unsustainable without further eroding NAV.

While your crystal ball is as good as ours, we wouldn't be betting on a return to the exuberant tech valuations seen in 2021 any time soon.

Technology firms continue to announce layoffs and other cost-cutting measures as they brace for a more challenging economic outlook. Higher interest rates and a weakening economy will curb growth initiatives and make it more unlikely for tech valuations to rocket back to recent highs that assumed perpetually low interest rates and near-limitless growth prospects.

As such, QQQX will likely need to either eat away at the fund's diminished NAV to support the distribution or reduce the payout to a more sustainable level. We estimate the fund would opt for a distribution cut of around 25%, which would return the NAV distribution rate to pre-pandemic levels.

Given the diminished distribution coverage and cloudy outlook, we are downgrading QQQX's Dividend Safety Score from Borderline Safe to Unsafe.

That said, despite the increased odds of a distribution cut, QQQX remains a decent fund with heavy exposure to industry titans well positioned to ride out an economic contraction, like Apple (15% of portfolio), Microsoft (12%), and Alphabet (8%) – the parent company of Google.

Even so, if we held shares of QQQX, we would consider reallocating those funds into a CEF with a safer distribution and less exposure to the pressures imposed by rising interest rates. Healthy alternatives include Cohen & Steers REIT and Preferred Income Fund (RNP) and Gabelli Dividend & Income Trust (GDV).

It's also worth noting that shares of QQQX trade at an unusually high premium to NAV, making for a potentially timely exit opportunity for investors interested in moving on to other ideas.
Source: Simply Safe Dividends

We will continue to monitor QQQX and provide updates as needed.

Trusted by thousands of dividend investors.

Track your portfolio now

Our tools and Dividend Safety Scores™ at your fingertips.

More in World of Dividends