XEQT vs Covered Call ETFs in Canada: Why Chasing Yield Can Cost You

I’ll never forget the first time I saw a covered call ETF on my Wealthsimple watchlist. It was late 2022, the market had been grinding sideways for months, and there it was – HDIV, flashing a distribution yield north of 10%. Ten percent. Monthly income. I did the napkin math in my head: if I threw $100,000 at this thing, that’s $10,000 a year in cash hitting my account. I could practically taste the passive income.

I almost pulled the trigger. Like, I had the buy screen open. And I’m glad I didn’t, because what I’ve learned since then about covered call ETFs has completely changed how I think about yield, income, and what “returns” actually mean. Let me be honest – the allure of high monthly distributions is one of the most powerful forces in Canadian retail investing right now, and it’s leading a lot of well-intentioned people down a path that will cost them serious money over the long run.

Here’s the thing: a big distribution yield is not the same as a big return. And once you understand why, you’ll see exactly why XEQT – boring, unsexy, 2%-yielding XEQT – is the better choice for most Canadian investors who are still in the wealth-building phase of their lives.

1. What Are Covered Call ETFs and How Do They Work?

Before we compare anything, let’s make sure we’re on the same page about what covered call ETFs actually do. Because the strategy sounds clever until you understand the trade-off baked into it.

A covered call ETF holds a portfolio of stocks (or other ETFs) and then sells call options on those holdings to generate extra income. Here’s the simplified version:

• The ETF owns shares of, say, Royal Bank or Apple.
• It then sells someone else the right to buy those shares at a specific price (the “strike price”) by a specific date.
• In exchange for selling that right, the ETF collects a premium – cash that gets passed along to you as part of the distribution.

Sounds like free money, right? Here’s the catch: if the stock price rises above the strike price, the ETF has to sell at that capped price. It misses out on the gains above the strike. You collect the option premium, but you forfeit the upside.

Think of it like this: you own a house worth $500,000. Someone pays you $5,000 for the right to buy it at $520,000 anytime in the next month. If the market stays flat, you pocket the $5,000. But if your house jumps to $600,000? You still have to sell at $520,000. You got your $5,000 premium but lost $80,000 in appreciation.

That’s the fundamental trade-off of covered calls: income today in exchange for capped growth tomorrow. In a sideways market, this works fine. But in a bull market – which is what equities deliver more often than not over long horizons – you’re systematically giving away the best part of your returns.

2. The Major Covered Call ETFs in Canada

The Canadian ETF market has exploded with covered call products over the past few years. Here are the biggest names you’ll see on Reddit, YouTube, and every “passive income” blog:

ZWC – BMO Canadian High Dividend Covered Call ETF

• Holds a portfolio of high-dividend Canadian stocks (banks, telecoms, energy) and writes covered calls on them
• One of the oldest and most popular covered call ETFs in Canada
• Distribution yield of roughly 7-8%
• MER of approximately 0.72%

HDIV – Hamilton Enhanced Multi-Sector Covered Call ETF

• A “fund of funds” that holds other Hamilton covered call ETFs across multiple sectors (financials, utilities, tech, healthcare, energy)
• Uses modest leverage (approximately 25%) to amplify returns and distributions
• Distribution yield of roughly 10-11%
• MER of approximately 1.30% (including underlying fund fees)

HYLD – Hamilton Enhanced U.S. Covered Call ETF

• Similar to HDIV but focused on U.S. equities
• Also uses leverage to enhance distributions
• Distribution yield of roughly 10-12%
• MER of approximately 1.35% (including underlying fund fees)

CALL – Evolve Canadian Covered Call ETF

• Writes covered calls on a portfolio of Canadian large-cap stocks
• Distribution yield of roughly 7-9%
• MER of approximately 0.65%

There are plenty more – TXF, ZWB, ZWK, HMAX, UMAX, and a growing list of single-stock covered call ETFs. The industry has been cranking these out because they sell. Nothing attracts retail investor attention like a double-digit yield.

I get it – when you see these yields alongside XEQT’s modest ~2% distribution, the covered call ETFs look like they’re in a completely different league. But the headline yield is doing an enormous amount of heavy lifting in the marketing, and it’s hiding some uncomfortable realities.

3. XEQT vs Covered Call ETFs: Head-to-Head Comparison

Let’s put the numbers side by side. This is where the picture starts to get interesting.

A few things stand out immediately.

First, the MER gap is enormous. XEQT costs 0.20%. HDIV and HYLD cost roughly 1.30-1.35% when you include the fees of the underlying funds. That’s more than six times the cost. Over a 25-year investing career, that fee drag compounds into tens of thousands of dollars in lost wealth.

Second, total returns tell a very different story than distribution yields. ZWC might yield 7-8%, but its total return (price appreciation plus distributions) has historically lagged XEQT. The high yield obscures the fact that the share price is either flat or slowly eroding over time. HDIV and HYLD look closer to XEQT on total return in some periods, but that’s partly because of the leverage – and leverage cuts both ways in a downturn.

Third, the diversification is incomparable. XEQT holds 9,000+ stocks across the entire global economy. ZWC holds a concentrated basket of 40-60 Canadian large caps. You’re comparing a globally diversified investment to a sector bet on Canadian banks, pipelines, and telecoms.

4. The Yield Trap: Why High Distributions Do Not Mean High Returns

This is the single most important concept in this entire article, and it’s the one that trips up the most people. So let me spell it out clearly.

A high distribution yield does not mean you are earning a high return on your investment.

Here’s why:

Return of Capital (ROC)

Many covered call ETFs pay distributions that include a significant component of return of capital. This means the ETF is literally handing you back your own money and calling it a “distribution.” It’s like putting $100 in your left pocket, pulling $10 out, putting it in your right pocket, and telling everyone you earned a 10% yield.

Return of capital is not income. It’s not a gain. It’s your own money coming back to you, and it reduces your adjusted cost base. It makes the distribution look larger than what the fund actually earned.

NAV Erosion

When a covered call ETF distributes more than it earns, its net asset value (NAV) declines over time. This is the share price slowly grinding lower. You see it clearly if you look at the long-term price charts of many covered call ETFs – the distributions keep coming, but the share price keeps falling.

Consider this scenario:

• You buy 1,000 units of a covered call ETF at $20 each = $20,000
• Over 5 years, you collect $8,000 in distributions (roughly 8% per year)
• But the unit price drops to $16 = your holdings are now worth $16,000
• Your total value: $16,000 + $8,000 = $24,000 – a total return of 20% over 5 years, or about 3.7% annualized

Now compare that to XEQT:

• You buy $20,000 of XEQT
• Over 5 years, the unit price grows to $28 (reflecting roughly 8-9% annual total return)
• You collect about $2,000 in dividends along the way
• Your total value: $28,000 + $2,000 = $30,000 – a total return of 50%, or about 8.4% annualized

The covered call ETF felt more rewarding because cash was flowing into your account every month. But the XEQT investor ended up with $6,000 more. That’s the yield trap in action.

Capped Upside in Bull Markets

Remember the core trade-off of covered calls: you sell future upside for current income. In the years when markets surge – and historically, markets have positive years roughly 70-75% of the time – covered call ETFs systematically underperform because the call options get exercised, and the fund misses the bulk of the rally.

Over a 10-year or 20-year horizon, those missed rallies compound into an enormous gap. A few strong bull years are responsible for a disproportionate share of long-term equity returns, and covered call strategies cap your participation in exactly those years.

Let me put it bluntly: if markets return 15% in a given year, a covered call fund might capture 6-8% of that. If markets return -10%, the covered call fund might lose -7% (the premium provides a small cushion). The asymmetry is terrible for long-term wealth building – you give up most of the good years and only get modest protection in the bad years.

5. Tax Implications: The Hidden Mess

Here’s where covered call ETFs get even less attractive for many Canadian investors: the tax treatment is complicated and often unfavourable.

XEQT’s distributions break down into a relatively clean mix:

• Canadian eligible dividends – taxed at a favourable rate thanks to the dividend tax credit
• Foreign income – taxed at your marginal rate
• Capital gains – only 50% taxable (or 66.7% at higher thresholds under current rules)
• Return of capital – tax-deferred (reduces ACB)

Covered call ETF distributions are a messy blend of:

• Option premium income – typically classified as ordinary income and taxed at your full marginal rate
• Canadian eligible dividends – tax-efficient
• Capital gains – partially tax-efficient
• Return of capital – tax-deferred but reduces ACB, creating a larger capital gain when you sell
• Foreign income – taxed at your marginal rate

The problem is that a large portion of covered call ETF distributions comes from option premiums, which are taxed as regular income – the least favourable tax treatment possible. That 10% yield from HDIV looks a lot less impressive when a significant chunk of it is being taxed at your full marginal rate of 40-50%+.

In a TFSA or RRSP, tax treatment of distributions is irrelevant – everything is sheltered. But you still want the highest total return possible inside these accounts, and covered call ETFs are unlikely to deliver that over a multi-decade horizon. You’re wasting your most valuable tax-sheltered space on a lower-return investment.

In a non-registered account, covered call ETFs are a tax headache. The T3 slips are complex, the return of capital adjustments to your ACB require careful tracking, and the heavy option premium income pushes up your annual tax bill. Compare that to XEQT, where much of your return comes as unrealized capital gains that you don’t pay tax on until you sell.

The bottom line on taxes: covered call ETFs are the worst of both worlds in taxable accounts – messy to track and often heavily taxed as income. XEQT’s total return approach, where most of your wealth builds as unrealized capital gains, is far more tax-efficient for investors in the accumulation phase.

6. Why XEQT’s Total Return Approach Wins Over 10+ Years

Let me take a step back and explain why XEQT’s seemingly boring approach is actually the smarter one for long-term wealth building.

XEQT doesn’t try to generate income. It doesn’t sell options, use leverage, or engineer artificially high distributions. It simply owns 9,000+ stocks across the entire global economy and lets compounding do the work. When those companies grow their earnings, expand into new markets, raise their dividends, and buy back shares, XEQT’s unit price goes up. The return comes primarily as capital appreciation, with a modest dividend on top.

This matters for three critical reasons:

Compounding works best when you leave it alone

Every dollar that gets paid out as a distribution is a dollar that’s no longer compounding inside the fund. With XEQT, the bulk of your return stays invested and compounds. With covered call ETFs, a large chunk gets paid out (and potentially taxed), breaking the compounding chain.

Even if you reinvest distributions through DRIP, you’re still at a disadvantage – you pay tax before reinvesting in non-registered accounts, and the fund’s NAV has already been reduced by the payout.

Full market participation

Equity returns don’t arrive in smooth increments. They come in bursts – a handful of exceptional years drive a disproportionate share of long-term wealth creation. Covered call strategies systematically clip your participation in exactly these burst periods. When the market runs up 20-30% in a strong year, covered call ETFs capture maybe half of that.

XEQT captures 100% of market returns (minus a tiny 0.20% MER). No capped upside. No option obligations. Just pure, unfiltered global equity growth.

Lower costs compound over time

XEQT’s 0.20% MER vs. HDIV’s ~1.30% MER might not sound like a big deal in any single year. But over 25 years on a $200,000 portfolio growing at 8% annually:

• XEQT (0.20% MER): ~$1,299,000
• Covered call ETF (1.30% MER, same gross return): ~$1,045,000

That’s a difference of roughly $254,000 – just from fees. And that’s assuming the same gross return, which we’ve already established is unlikely since covered calls cap your upside. In reality, the gap would be even larger.

7. When Covered Call ETFs Might Actually Make Sense

I want to be fair here. I’m not saying covered call ETFs are a scam or that they have zero place in anyone’s portfolio. There are specific situations where they can serve a legitimate purpose:

Retirees who need monthly cash flow

If you’re already retired, drawing down your portfolio, and need predictable monthly income to cover living expenses, covered call ETFs can simplify cash flow management. The monthly distributions mean you don’t have to sell units to generate income. For someone in their 70s with a shorter time horizon, the capped upside matters much less.

Investors with very short time horizons

If you’re investing for a goal that’s only 1-3 years away and you expect a flat or slightly bearish market, covered calls can modestly outperform due to the premium income cushioning modest declines. But this is a tactical bet, not a long-term strategy.

A small satellite allocation

Some investors use covered call ETFs as a small percentage (5-10%) of an otherwise XEQT-dominated portfolio to generate some monthly income for psychological comfort. If it helps you stay invested and avoid panic selling during downturns, there’s an argument for it – but be honest about the cost.

Here’s what all these scenarios have in common: they are not the typical situation of a 25-to-55-year-old Canadian who is in the accumulation phase and investing through a TFSA or RRSP. If that describes you, covered call ETFs are almost certainly not the right choice.

8. The Psychological Trap: Why Monthly Income Feels So Good

Let me be honest about something: I understand the appeal on a gut level. There is something deeply satisfying about seeing cash hit your brokerage account every month. It feels tangible. It feels like your money is doing something. Watching XEQT’s unit price slowly climb doesn’t trigger the same dopamine hit.

The covered call ETF industry knows this. The marketing is built around it. “Get paid every month.” “Replace your salary with passive income.” “Financial freedom through dividends.”

But wealth building doesn’t happen in monthly deposits. It happens through compounding over decades. The investor who resists the siren call of high monthly income and lets their XEQT compound untouched for 20 years will almost certainly end up wealthier than the investor who chased yield with covered call ETFs. Nobody looks at Warren Buffett’s Berkshire Hathaway – which pays zero dividends – and says, “What a terrible investment.” Total return is what matters.

9. A Real-World Comparison: $50,000 Invested Over 10 Years

Let’s make this concrete.

Investor A: Buys XEQT – $50,000, 9% annualized total return, after 10 years: ~$118,400. Unit price grew steadily, dividends reinvested.

Investor B: Buys a covered call ETF – $50,000, 7% annualized total return (generous), after 10 years: ~$98,400. Collected ~$42,000 in distributions but unit price dropped from $20 to ~$14 due to NAV erosion.

Investor B received way more cash along the way. That felt amazing. But Investor A ended up with $20,000 more in total wealth. And that gap only widens the longer you hold. Use our calculator to plug in your own numbers and see exactly how much the total return gap costs you over your specific time horizon.

10. The Bottom Line: XEQT for Wealth Builders, Period

If you’re a Canadian investor in the accumulation phase – building wealth through your TFSA, RRSP, FHSA, or non-registered accounts – XEQT is the better choice over covered call ETFs in almost every scenario.

Here’s the summary:

• Higher total returns over 10+ year horizons due to full market participation
• Lower fees (0.20% vs 0.65-1.35%) that compound into massive savings over decades
• Better tax efficiency in non-registered accounts since most return comes as deferred capital gains
• Superior diversification with 9,000+ stocks vs. concentrated sector bets
• Simplicity – no complex option strategies, leverage, or return of capital adjustments to track
• No capped upside – you capture 100% of market rallies, which is where most long-term returns come from

Covered call ETFs are a tool, and they have their place. If you’re retired and drawing income, or if you have very specific cash flow needs, they can be worth a look. But for the vast majority of Canadian investors who are still working, saving, and building toward financial independence, the siren song of 10%+ yields is a distraction from what actually works: buying a globally diversified index fund, contributing consistently, and letting compounding do the heavy lifting over decades.

That’s what XEQT does. No gimmicks, no yield tricks, no capped upside. Just patient, boring, historically proven wealth building.

And honestly? Boring is beautiful when it makes you rich.

Related Reading

• What is XEQT? A Comprehensive Guide
• XEQT for Beginners
• XEQT vs Preferred Share ETFs in Canada
• Does XEQT Pay a Dividend?
• XEQT Return of Capital Explained
• XEQT TFSA vs RRSP: Where Should You Hold It?
• Get started with Wealthsimple and earn a $25 bonus