NAV erosion: when high-income funds pay you your own money

How these funds pay so much

Closed-end funds (CEFs), business development companies (BDCs) and option-income ETFs promise high, often monthly, payouts. The money can come from three places: net investment income (interest and dividends minus costs), realised gains, or the fund's own capital. When payouts exceed the first two for a long time, the difference comes out of net asset value, the value of the holdings behind each share.

Leverage and fees amplify the effect. Combined fees of BDCs often run at 2–4 % of NAV a year, and one popular BDC ETF reports total costs of almost 13 % when the fees of the funds it holds are included.

Option-income ETFs

Funds that sell call options on a single stock collect option premiums and pay them out. Israelov and Nielsen describe a covered call as passive stock exposure plus a short volatility position plus a bet that the stock will not rally, and the last part is not rewarded on average. You keep most of the downside but give up much of the upside.

In practice, a Barchart review found that of 24 single-stock option-income ETFs only 2 slightly beat their underlying stock on total return; a well-known fund on Nvidia returned about 187 % since May 2023 against about 372 % for the stock. Another fund on Tesla showed a total return of +7.8 % from launch to January 2025 while its price fell 67 %, and one of its recent distributions was about 93 % return of capital.

How to read the numbers

Our NAV erosion and structural NAV erosion red flags fire on these patterns and cap the Smart Score at 3.

• NAV per share over three to five years: a steady decline is the clearest warning.
• Distribution coverage: net investment income divided by the payout; below 100 % for many quarters means erosion.
• The share of return of capital in the fund's distribution notices.
• Discount or premium to NAV: buying at a premium adds risk.
• Reverse splits: they hide a falling price, they do not fix it.

Is there a place for them?

Selected BDCs and CEFs with covered payouts, bought at a discount, have delivered reasonable returns in some periods. The evidence does not support using them as the core of an income plan. Research-based allocations usually keep such funds to a small satellite, around 10 % of the portfolio in total and a few percent per fund, and measure them by NAV total return rather than by the yield on the screen.