The Dividend & Covered Call Trap: Why VEQT Beats "Income" ETFs

Canada's ETF industry has exploded with "income" products: covered call ETFs from BMO (ZWB, ZWC, ZWK), Hamilton (HDIV), Global X (HYLD), and a growing swarm of single-stock covered call ETFs promising eye-popping distribution yields. Meanwhile, classic dividend ETFs like XDV, VDY, and CDZ continue to attract investors who believe "getting paid to hold" is a superior strategy.

The data says otherwise. Every single one of these approaches has historically underperformed simply holding a globally diversified index fund like VEQT. Let's break down exactly why.

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The Covered Call Illusion

How Covered Calls Actually Work

A covered call strategy involves holding a stock (or index) and selling call options on it. The option premium you collect becomes the "distribution" — the yield that gets marketed so aggressively.

Here's what the marketing doesn't tell you: that premium is not free money. By selling a call option, you are selling your right to participate in any price appreciation above the strike price. You're capping your upside in exchange for a small payment today.

Think of it this way: if you owned a house that appreciates 15% this year, a covered call strategy is like accepting a $2,000 payment from your neighbour in exchange for a promise that if the house goes above a certain price, the gains are theirs. You get the $2,000 either way — but in most scenarios, you lose far more than you gained.

What Ben Felix's Research Shows

Ben Felix, CIO at PWL Capital and host of the Rational Reminder podcast and Common Sense Investing YouTube channel, has done extensive research on this topic. In Rational Reminder Episode 375, titled "Covered Calls: A Devil's Bargain" (September 2025), he analyzed the performance of covered call funds with at least 10 years of history.

The result: every single covered call fund underperformed its underlying index over 10 years.

Drawing on a paper by Roni Israelov and David Dong published in the Journal of Alternative Investments, Felix demonstrated that holding a covered call ETF produces a return profile nearly identical to holding roughly 60-75% equities and 25-40% cash. In other words, that flashy 14% yield isn't generating extra return — it's just returning your own capital to you while reducing your equity exposure.

In a December 2025 interview with Advisor.ca, Felix called the proliferation of these products — particularly single-stock covered call ETFs and single-stock leveraged ETFs — "ETF slop": products that are highly profitable for issuers but not in the best interests of investors.

The Withdrawal Test

One common argument is: "But I need income! I can just spend the distributions without selling shares."

Felix tested this too. He compared two scenarios:

1. Spending the distributions from a covered call fund
2. Holding the underlying equity and selling the exact same dollar amount

In every case, the equity holder ended up with more money, even after the withdrawals. The covered call distributions aren't magical income — they're a less efficient way to generate cash flow than simply selling a small percentage of a better-performing asset.

This is the critical insight: there is no financial difference between receiving a $500 distribution and selling $500 worth of shares — except that the distribution forces the timing and triggers tax consequences you may not want.

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The Dividend Investing Trap

Covered call ETFs sit on the extreme end of the income-chasing spectrum. But even the less aggressive version — dividend-focused investing — introduces unnecessary costs and risks.

Why Dividends Aren't "Free Money"

When a company pays a dividend, its stock price drops by approximately the dividend amount on the ex-dividend date. You aren't receiving bonus cash — you're receiving a forced return of capital. Whether your $100 stock pays a $2 dividend (becoming a $98 stock + $2 cash) or simply stays at $100, your total wealth is identical.

The difference? The dividend triggers a taxable event. In a non-registered account, you're forced to pay tax on income you may not have needed yet — and while the Canadian dividend tax credit softens this for eligible Canadian dividends, it doesn't eliminate the drag entirely, and it does nothing for foreign dividends.

Concentration Risk

Canada's dividend ETFs are overwhelmingly concentrated in financials and energy — the two sectors that dominate Canadian dividend payers. XDV, for example, holds roughly 50%+ in financial stocks. You're getting "income" at the cost of massive sector concentration.

VEQT, by contrast, holds 13,000+ stocks across 50+ countries, including every sector. You own the dividend payers and the growth companies and everything in between.

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VEQT: The Boring Strategy That Wins

VEQT doesn't promise a 14% yield. It doesn't pay a flashy monthly distribution. It's a single ETF that holds virtually every investable stock on the planet at a management fee of 0.17% (MER ~0.20%*).

What it does deliver:

• Full participation in global equity returns — no upside caps, no sector bets
• Automatic diversification across ~13,000 stocks in 50+ countries
• Automatic rebalancing across four underlying Vanguard index funds
• Tax efficiency — you control when you realize gains
• Simplicity — one ticker, one purchase, done

0.17% management fee; official MER ~0.24% pending recalculation after November 2025 fee cut. Effective MER expected ~0.19-0.20%.

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Who Are These Products Actually For?

To be fair, there are narrow edge cases where income-generating products make sense — a retiree with a low marginal tax rate who genuinely benefits from the Canadian dividend tax credit in a non-registered account, for instance. But even then, you could replicate the cash flow by selling shares of VEQT, and you'd likely end up with more money over time.

The uncomfortable truth is that these products exist because they sell. Fund companies know that investors have a psychological preference for "income" — for receiving cash in their account without having to sell anything. That preference is exploited through marketing that emphasizes yield while obscuring total return.

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The Bottom Line

If you're holding VEQT, you already own every dividend-paying stock worth owning — plus thousands more. You participate fully in market recoveries. You pay rock-bottom fees. You don't give away upside to collect a "yield" that's really just your own capital being returned to you.

The most powerful income strategy is simple: own everything, let it compound, and sell what you need when you need it.

Don't trade the full power of global equity returns for the comfort of a monthly distribution number.

Sources & Further Reading

• Ben Felix, "Covered Calls: A Devil's Bargain" — Rational Reminder Podcast, Episode 375 (September 2025)
• Ben Felix & Dan Bortolotti, AMA #9 — Rational Reminder Podcast, Episode 379 (October 2025)
• Ben Felix on The Canadian Investor Podcast (October 2025)
• Roni Israelov & David Dong, "A Devil's Bargain: When Generating Income Undermines Investment Returns" — Journal of Alternative Investments
• Ben Felix interview, Advisor.ca (December 2025)
• Vanguard VEQT Fund Facts: vanguard.ca

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This article is for informational purposes only and is not financial advice. Consider your personal situation and consult a financial advisor if needed.