Derivative Income Can Be Costly
Derivative income funds offer high yields but lag returns and tax efficiency, with only 65% of returns preserved after taxes vs. 85% for large blend funds.
Investors seeking high yields in their stock allocations have been flocking to the category known as derivative income funds. This breed of products combines equity index exposure with options to generate income, producing higher-than-bond yields. In the first half of 2025 alone, 36 new derivative income funds were launched, and more than $30 billion in net flows were directed to the category.
Higher yields don’t always equate to higher returns. Over the past 10 years, the net return to the derivative income fund category was 7.12%, compared to 12.05% for large blend funds.
But some investors prefer their total return to be disproportionately composed of income. These investors should be aware that the income generated by options in derivative income funds is often treated as ordinary income for tax purposes, and that may drive up an investor’s tax bill.
This is apparent in the stark effect on returns that are preserved after taxes. Over the 10-year period ending June 30, 2025, only about 65% of returns survived taxes for the derivative income fund category, compared to 85% for large blend funds.
EXHIBIT 1
Tax Efficiency for the 10-Year Period Ending June 30, 2025
Disclosures
The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable, and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmission of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing, or other such legal requirements within the jurisdiction.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
CANADA
These materials have been prepared by Dimensional Fund Advisors Canada ULC. The other Dimensional entities referenced herein are not registered resident investment fund managers or portfolio managers in Canada.
This material is not intended for Quebec residents.
Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Unless otherwise noted, any indicated total rates of return reflect the historical annual compounded total returns, including changes in share or unit value and reinvestment of all dividends or other distributions, and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
Resources
