High Income ETFs from NEOS Investments such as the NEOS S&P 500 High Income ETF (SPYI) aim to offer investors high monthly income, tax efficiency, and long-term capital appreciation.

When evaluating the tax efficiency of income-focused ETFs – particularly ones that utilize option writing – investors should understand the distinction between Return of Capital (ROC) and Return of Principal. While these terms may sound similar, their implications for investment performance and tax efficiency are vastly different.

Return of Capital (ROC): Aiming to offer a high degree of tax efficiency

While some mistakenly associate ROC with poor fund performance, in reality, it is a tax classification that may allow investors to defer tax liabilities on current income distributions:

• Tax Deferral: ROC distributions are not immediately taxable as income. Instead, they reduce the investor’s cost basis, deferring taxation until the investment is sold, potentially allowing for long-term capital gains tax treatment rather than ordinary income tax rates.
• Enhanced After-Tax Returns: Because ROC distributions lower taxable income in the short term, they provide investors with greater flexibility in managing tax liabilities while still seeking a steady income stream.

A critical takeaway is that ROC may not be an indication of poor fund performance, it is a tax designation. Many actively managed funds, like SPYI, aim to generate strong total returns while offering ROC distributions that enhance tax efficiency.

Let’s look at SPYI’s 2024 performance – both from a distribution and total return standpoint – where you’ll also see close to 94% of its income distributions were classified as a return of capital (not taxable until fund shares are sold).

SPYI Delivered Tax-Efficient Monthly Income and Price Appreciation in 2024

In 2024, SPYI generated a total return of 19.04%, significantly exceeding its trailing 12-month distribution rate of 11.76%. This demonstrates that in 2024 SPYI offered a tax-efficient income strategy as well as principal appreciation.

This material must be preceded or accompanied by a prospectus. Investors should carefully consider the investment objectives, risks, charges and expenses of Exchange Traded Funds (ETFs) before investing. To obtain an ETF’s prospectus containing this and other important information, please call (866) 498-5677 or view/download a prospectus here. Please read the prospectus carefully before you invest. SPYI expense ratio = 0.68%

There is no guarantee the NEOS ETFs will make monthly distributions, and the amounts may fluctuate from month to month. Distributions made by the Fund have been classified as a return of capital and may be comprised of option premiums, dividends, capital gains, and interest payments. Please see the 19a-1 notices for a more comprehensive breakdown of each month’s distributions.

Past performance is no guarantee of future results. The performance data quoted here represents past performance. Current performance may be lower or higher than the performance data quoted above. Investment return and principal value will fluctuate, so that shares, when redeemed, may be worth more or less than their original cost. For performance data current to the most recent month end, please call (866) 498-5677 or visit https://neosfunds.com/spyi.

All references to tax matters are provided for informational purposes only and should not be considered tax advice and cannot be used for the purpose of avoiding tax penalties. Investors seeking tax advice should consult an independent tax advisor.

Source: US Bank Fund Administrators, YCharts.

On the other hand, Return of Principal can have negative consequences…

Return of Principal occurs when a fund distributes more than its underlying investments generate in returns, effectively depleting investor capital. This can lead to:

• Erosion of Investment Value: When a fund continually returns principal rather than income, it may be an indication that the investment strategy is underperforming and unsustainable in the long run.
• Investor Confusion: Many investors mistakenly assume that all ROC distributions fall into this category. However, in the case of well-structured funds like SPYI, ROC can potentially be a tax efficiency tool rather than a sign of capital erosion.

The NEOS Advantage: Options-Based ETF Pioneers

What sets NEOS Investments apart from other ETF issuers is its leadership team’s unparalleled expertise in the options-based ETF space. Garrett Paolella and Troy Cates, the Co-Founders and Managing Partners of NEOS Investments, are pioneers in this segment, having previously created and managed some of the largest options-based ETFs still on the market today.

Unlike many ETF issuers that have only recently launched options-based funds to capitalize on a growing trend, the NEOS team has dedicated much of their careers to this highly specialized segment of the ETF market.

Conclusion

Understanding the difference between Return of Capital and Return of Principal is essential when evaluating income-focused ETFs, especially those utilizing options strategies.

In 2024, SPYI exemplified how a well-managed fund can generate strong total returns while offering tax-efficient income distributions classified as ROC – which is not an indication of capital depletion, but rather a tax efficient classification of income distributions.

With a leadership team that has been at the forefront of the options-based ETF market for years, we believe NEOS Investments stands out from competitors who have only recently entered this space.