Income investors buy four kinds of security that have little in common on the surface. A preferred stock pays a fixed dividend and ranks ahead of the common. A business development company is a lender whose board sets the dividend each quarter. A covered-call fund sells options against a portfolio and pays out the premium. A preferred ETF holds a basket of the first kind. Each is sold on its yield, and each can lose an investor money in a way the yield does not show.
The Income Quality Score, or IQS, grades all four on one scale, from 0 to 10. That is the idea behind it. A preferred, a BDC, a covered-call fund and a preferred ETF are scored on separate measures, because the risks are different, but the result reads the same way for each: a single number, a word that describes it, and a breakdown that shows where the points went. That lets an investor compare a bank preferred with a covered-call fund on the same scale, which was not possible before.
The rating agencies rate preferreds, but a rating answers a lender’s question: how likely is the company to default, and how much would be lost if it did. It does not say whether a particular issue suits an individual’s income portfolio, and no agency rates a covered-call fund at all. Index providers group hundreds of preferreds into baskets, which helps a fund buyer and does little for someone weighing two issues on a watchlist. Most research written for individuals takes the form of a checklist, and a checklist gives two securities the same score when they fail in different places.
The IQS is built on the opposite principle. Two securities with the same score can be weak in different places, and the difference decides what the investor should do next. One preferred may be backed by a strong company but face redemption within a year. Another may have years of protection and a thin earnings cushion. A checklist gives both the same number. The IQS gives each a weighted average of its measures, every measure scored from 0 to 10 with partial credit, and shows the breakdown wherever the score appears. A preferred that scores 8 lost its two points somewhere specific, and the record says where.
The method is published here in full and is in use across the product. The weights and thresholds are reviewed as the record grows, and a score can change for that reason alone. When it does, the move says something about the method and nothing about the security. The score is one input among several, not a verdict.
One scale for four kinds of security
The four asset classes are scored independently. A preferred stock is judged on five measures: coverage, credit, buyback economics, structure and protection. A BDC is judged on ten readings of its loan book, its balance sheet and its costs. A covered-call fund is judged on where its payout comes from, what it sells options against, whether it kept its capital, what it charges and whether it will last. A preferred ETF is judged on the quality of the book it holds, what it charges to hold it, whether it earns its payout, how broad it is and how big it is. No measure crosses from one class to another, because none would mean the same thing on the other side. Asset coverage against a regulatory floor is the right test for a BDC and meaningless for an index-option fund.
What the classes share is the scale and the rules for using it. Every measure is graded from 0 to 10 in steps, and the class score is the weighted average. When a measure cannot be read, the others pick up its weight, and the record states how much of the weight was scored. Penalties for cuts, suspensions and thin coverage are applied the same way, and each one appears beside the score with the figure that caused it. The labels are the same across classes: High Quality at 8.0 and above, Good from 6.5, Average from 5.0, and Watch below that. So are the confidence grades: high when 85% or more of the weight was scored, medium at 60%, low below that.
The result is a score that means the same thing on every record. A 7 on a bank preferred and a 7 on a covered-call fund were reached by different roads, but each says the security earned seven-tenths of the credit its own class can earn, under the same grading rules and the same treatment of missing data. That is what makes the number useful to an investor who holds several kinds of income security at once, as most do. The sections that follow set out each class in turn, starting with preferreds, where the score began.
Four kinds of income security, each scored on its own measures, all read on one scale. The number means the same thing on every record, and the breakdown shows where the points went.The YieldDesk thesis
Scoring preferred stocks
A preferred stock or baby bond is judged on five measures. Each is scored from 0 to 10 from the security’s own data, and the overall score is their weighted average, with coverage counting most. The five are summarized below and set out in detail beneath.
Coverage
The first and heaviest measure asks how comfortably the company earns what it owes. A preferred is only as safe as the earnings in front of it. A strong rating and generous terms count for little if profits barely clear the payment, because that is where an income investor gets hurt.
What counts as comfortable depends on how the company makes its money. For an industrial company or a utility, the test is pretax earnings against fixed charges: five times or better earns full credit, three times scores 8, two times 6, one times 3, and below that zero. For a bank, an insurer or a mortgage company that funds itself with borrowed money, that ratio says nothing useful. Paying interest is the business, and even the soundest names come out below one. Those issuers are judged on the issue’s own payment record, counted from its listing date: ten years or more of payments earns full credit, five years scores 7, two years 5 and anything younger 3.
The split matters. Judged on the earnings ratio alone, one of the largest banks in the world would score zero on the heaviest measure, and every mortgage REIT with it. Those preferreds are not weak. The arithmetic is wrong for that kind of company, so the score does not use it there.
Credit
The second measure reads the financial strength of the company behind the preferred. For an individual investor, the most reliable gauge available is the credit rating.
The score grades the full rating ladder step by step, so a stronger rating always counts for more than a weaker one. The top of the ladder and the last investment-grade step are both investment grade, but they are not the same claim. Where Moody’s and S&P disagree, the score takes the more cautious of the two, as the index providers do. The optimistic case has already been made by whoever sold the issue.
About half the preferred market carries no Moody’s or S&P rating. For those issues an Egan-Jones rating fills in, counted one step below its face reading, because Egan-Jones is paid by investors rather than by the companies it rates and its scale does not line up exactly with the other two. An issue rated by none of the three is left unscored on this measure, and the other measures pick up its weight. An unrated issue is never treated as a zero.
One caveat. Rating firms usually grade a preferred one to three steps below the same company’s senior debt, because preferred holders stand further back in line. A preferred at the bottom of investment grade often comes from a company whose bonds sit several steps higher. The IQS uses the preferred’s own rating, because that is the rating on what the investor holds.
Buyback economics
Most preferreds give the company the right to buy them back at face value, usually starting five years after issue. That right matters because a buyback ends the income on the company’s schedule, not the holder’s.
The measure weighs the calendar and the price together, because the date alone decides nothing. Five or more years of protection earns full credit, stepping down as the date approaches, and a preferred the company can never buy back stays at 10. Price then adjusts the reading. Shares trading more than 3% above face value lose up to three points, because the holder has something to lose in a redemption. Shares trading more than 3% below face value gain two.
Once the date has passed, price decides. An issue at a deep discount scores 9, because a buyback there would hand the holder a gain. One near face value scores 6. One above face value scores 3, because the company can refinance at a profit and probably will. A windfall and a threat are not the same risk, and the score does not treat them as one.
Structure
A preferred dividend is not a bond coupon. The company can defer it or stop it, and what happens next depends on the fine print. On a cumulative preferred, skipped payments pile up as a debt the company must clear before it pays its common shareholders again. On a non-cumulative preferred, a skipped payment is gone.
The measure judges that fine print against each industry’s own conventions rather than as a flat yes or no. A cumulative preferred earns 10. A baby bond earns 9, because its interest is a contractual obligation and ranks ahead of preferred shares. A bank preferred without the make-good promise earns 8. Since the financial crisis, regulators have required a bank preferred to drop that promise for the shares to count toward the bank’s capital, so following the rule is not a defect. Outside the financial sector, where 99% of issues carry the promise, an issue without it is the exception and earns 5 with a flag for review.
Protection
The newest measure is the oldest test on the preferred desk: is the company still paying a dividend on its common stock?
The order of the queue is what matters. A company must stop paying its common shareholders before it can stop paying its preferred ones. A common dividend still being paid is a current, checkable sign that the preferred sits behind a cushion, and it scores 9. A company that has suspended its common dividend scores 1, with a red flag, because the cushion is gone. A company that never paid a common dividend scores 3. There is no cushion, which is a different condition from distress.
Penalties and missing data
The weighted average of the five measures is the starting score. Certain events then cut it directly. A recent dividend cut or suspension multiplies the score by 0.55. A likely deferral, meaning a cumulative issue that has gone more than two payment cycles without declaring and is not already marked suspended, multiplies it by 0.45. Two further checks cut the score by 15% each: a price below $10 on a $25 issue, and a company whose debts exceed everything it owns. All can apply at once. The score can never fall below a fifth of its starting value, and each cut appears in the product as a red flag next to the number, so no deduction is hidden. An issue the company has redeemed is no longer scored.
When one of the five measures cannot be scored, because there is no usable earnings figure and no payment history, or no rating from any of the three firms, the other measures pick up its share of the weight. The record reports how much of the data was available and grades its own confidence beside the score: high when 85% or more of the weight was scored, medium at 60%, low below that. A 9.0 built from complete information and a 9.0 built from half of it are different claims, and the record says which is on the page.
The score also carries a label where a word helps more than a number: High Quality at 8.0 and above, Good from 6.5, Average from 5.0, and Watch below that.
How the measures interact
The five measures are scored separately, but they inform one another, and the breakdown is most useful read as a whole.
The clearest pairing is Coverage and Credit. Coverage is arithmetic: how far current earnings clear the payment. The rating is a judgment about whether the company can keep paying through a bad stretch. Strong earnings under a weak rating often mean a company doing well today with longer-term problems the rating firms can see. A strong rating over thinning earnings can be an early warning the firms have not yet acted on. The breakdown shows this. The total alone does not.
A second pairing connects Buyback economics with Coverage. The buyback measure already reads price and date together, so a low score there means a redemption would cost the holder something. Whether that matters depends on how well the payment is earned. A richly covered issue trading above face value is a good problem to have. A thinly covered one is two risks pointing the same way.
A third pairing is Structure and Credit under stress. Structure says what the investor is owed if payments stop. Credit and coverage say how likely payments are to stop. A cumulative preferred from a shaky company may need its protection. A non-cumulative preferred from a strong company may never test its weakness. The score keeps the measures apart because they answer different questions. A careful reader holds both in mind.
Four principles behind the preferred score
The preferred score was built around four judgments about how the market misreads these securities. Each shapes a measure described above.
Judge coverage by how the company makes its money. Operating profit against interest cost is a fair test for an industrial company. For a bank, paying interest on deposits is the business, so the ratio comes out below one for even the soundest names. Mortgage REITs are funded the same way. Scored on that ratio, both would read as near-failures by construction, so the score sends them to the payment-record test instead.
Take the cautious rating and grade the whole ladder. Taking the more flattering of two ratings, or giving everything investment grade the same top mark, makes the strongest rating on the scale and the weakest investment-grade one indistinguishable. The score takes the more cautious view, grades step by step, and reads Egan-Jones where Moody’s and S&P are both silent, which is about half the market.
Do not penalize a bank for following the rules. Since the financial crisis a bank preferred must drop the make-good promise for the shares to count toward the bank’s capital. Read as a flat yes or no, that looks like a defect. Read against the industry’s conventions, it is the norm.
Read price alongside the buyback date. An issue past its buyback date and trading well below face value has nothing to fear from a redemption, which would hand the holder a gain. An issue trading above face value that the company could profitably refinance has much to fear. The date alone cannot tell them apart. Price can.
Safeguards sit under all four. A score built on less than half its data is pulled toward a neutral 5 rather than allowed to look impressive on two facts. Implausible figures, such as a balance sheet off by a factor of a thousand, a price under $10 on a $25 issue, or a company whose debts exceed everything it owns, are screened or penalized instead of scored at face value. Thin trading is a disclosure beside the score, not a deduction inside it. A preferred is not a trading instrument, and a quiet issue that has paid for decades is not lower quality for being quiet.
Convertible preferreds
About forty preferreds in the universe convert into their issuer’s common stock, and they come in two kinds. An optional convertible may be exchanged for common shares at the holder’s choice. It is usually perpetual and callable, and it trades partly on its income and partly on that right. A mandatory convertible becomes common stock on a set date whether the holder wishes it or not, with the number of shares set by the stock’s price over the days before. Until that date it pays its dividend like any preferred. Its price, though, follows the stock rather than interest rates or the prospect of a call.
The score treats the two differently. For a mandatory, the four income measures stand. Coverage, credit, structure and protection ask whether the dividend is safe, and that question is the same for a mandatory as for any preferred. The buyback measure, which weighs the time to a call against the price, measures nothing real on a security that can never be called and whose premium to par is the stock’s doing. In its place a conversion measure at the same weight, 16%, reads the years to the conversion date on the ladder the buyback measure uses for years to call, and nothing else. Where the stock sits against its band is shown on the record and is never part of the score.
An optional convertible keeps the buyback measure, with two changes. Most of these issues can be converted out from under the holder once the stock passes a trigger the issuer set in the prospectus, usually 130% of the conversion price, and that is a call by another name. So the measure also reads how far the stock sits below the trigger. More than 50% away leaves the ordinary reading alone, within 50% reads 8, within 25% reads 6, within 10% reads 4, and at or above the trigger the issue is scored as past its call. The lower of the two readings counts. On a callable issue the premium a call would take away is measured against the higher of par and today’s conversion value, since the holder keeps the conversion right when called. A convertible with no fixed ratio, one that converts by a formula or into a fund, is scored as a plain preferred.
The record says so. On a mandatory the score is labelled income factors only, with a note that it describes the dividend until the conversion date and says nothing about what the shares will be worth at conversion, which depends on the stock. Yield to call and yield to maturity are not shown, since neither par nor a call is ever repaid. A yield to conversion, the dividends to the date plus the move from today’s price to today’s conversion value, stands in their place. The conversion terms are read from the filings and reviewed before they appear, and every figure on the record carries its source and as-of date. None of it is a view on the stock.
In practice
A live example from the preferred universe: Morgan Stanley’s 6.875% Series F, a bank preferred whose buyback date has passed. The card shows the record’s score as it stands today, the measures behind it with their weights, and the inputs that set each measure. It refreshes with the score, so the figures here are the figures on the record.
Scoring BDCs
A business development company is a lender, and its shares are common stock in that lending business. The board sets the dividend each quarter. Nothing is promised in advance, there is no face value and there is no buyback date. The questions change accordingly. Is the dividend earned by the lending, and is that income holding up? Are the loans performing, and is the equity behind them keeping its value? How much room is there above the regulatory floor? What do the managers and the market take for themselves?
The BDC score follows the same rules as the preferred score: measures graded in steps, a 0-to-10 result, weight shifted to what could be measured when something is missing, the same labels and the same confidence grades. Ten readings feed the four questions shown on the record. Every reading is taken over four quarters, so one odd quarter, one workout or one special dividend moves nothing on its own.
| Reading | Basis | Scores 0 | Scores 10 | Weight |
|---|---|---|---|---|
| Coverage of the regular dividend | trailing four quarters of NII against the regular dividend at its run rate | 0.90× | 1.25× | 15% |
| Income trend | NII per share, the last four quarters against the four before | −30% | +5% | 10% |
| Non-accruals | share of fair value, median of four quarter-ends | 4% | 0% | 15% |
| NAV per share | change over four quarters | −10% | +3% | 15% |
| Income paid in kind | share of total investment income, median of four quarters | 15% | 3% | 8% |
| Asset coverage | against the 150% floor, average of four quarter-ends; debt and preferred together where preferred exists | 155% | 215% | 15% |
| First-lien share | share of the portfolio at fair value, four-quarter average | 40% | 95% | 5% |
| Cost of management | external: base fee plus a tenth of the incentive fee; internal: expenses over total assets, 4.0% to 1.5% | 4.5 | 2.0 | 5% |
| Price against NAV | latest price over NAV, capped at 1.00; a premium neither helps nor hurts | 0.60× | 1.00× | 10% |
| Scale | market capitalization on a log scale | $150M | $5B | 2% |
Earned
The first measure asks whether the regular dividend is paid out of lending income, and whether that income is holding up. It compares four quarters of net investment income per share with four quarters of the regular dividend at its current rate. Supplemental dividends stay out of that denominator and are shown beside it. Regulation requires a BDC to pay out about 90% of its income, so 1.25 times earns full credit and 0.9 times none. The trend reading compares the last four quarters of income per share with the four before.
Coverage carries less weight than credit, because a company that cuts its dividend covers the smaller one easily. The readings that see trouble coming deserve the weight.
Credit
The heaviest measure reads the loan book three ways. Non-accruals are the share of the book, at fair value, that has stopped paying, taken on the median of four quarter-ends so one workout cannot set the score. Net asset value per share is read as its change over four quarters, because a lender whose equity is shrinking is losing on its loans whatever its income statement says. Income paid in kind is the share of investment income received as paper rather than cash, again on the median of four quarters. Income in kind may never arrive in cash, and a rising share of it is one of the earliest signs of strain in a portfolio.
Balance sheet
The third measure reads the cushion above the 150% asset-coverage floor the Investment Company Act sets, on the average of four quarter-ends, rather than a bare debt ratio. The floor is what regulation enforces, and a balance sheet run at half a dollar of debt per dollar of equity is underused, not safe. Where a company has preferred stock outstanding, that counts as senior too. The second reading is the share of the book that stands first in line to be repaid, also on the four-quarter average.
Cost and market
The fourth measure reads what the managers and the market take. Fees are graded on a band the class can reach, so standard terms of 1.5% and 20% score in the middle rather than at zero. An external manager is read on its base fee plus a share of its incentive fee, and an internal manager on its own expense ratio. The share price is read against NAV one way only. A deep discount means the market doubts the marks. A premium means the market will pay for the book, and it lets the company raise capital above NAV, so it is never penalized. Size is read on a log scale. Yield is not a reading at all. The highest yields in the class belong to the companies in the most trouble.
Penalties and missing data
Three events cut the score. A regular dividend covered under 0.85 times over four quarters multiplies it by 0.85. A cut in the regular dividend over the last year is graded by size: a trim of up to 5% rides the rate cycle and passes, up to 15% costs 0.93, up to 30% costs 0.85 and deeper cuts cost 0.75. Asset coverage inside fifteen points of the floor on the four-quarter average costs 0.9. Each appears beside the score with the figure that caused it. A company that pays no regular dividend is scored on what remains and shown without a tier. A company listed under three years carries a note that its readings are untested through a cycle. A reading the ledger cannot support is set aside rather than guessed: a first-lien share under 25%, a non-accrual quarter above 30% or income in kind above 60% is treated as a units error, an incentive fee under 5% as a parsing error, and a coverage figure outside 0.3 to 3 times as a ledger fault, unless a person has confirmed the figure from the filing. When less than 60% of the weight can be read, the score is drawn toward 5 and the record says so.
Six principles behind the BDC score
The BDC readings follow six judgments about how this class is commonly misread.
Read four quarters, not one. A single workout, a single special dividend or one odd quarter of leverage should not set a company’s grade. Coverage and the income trend are read on the trailing four quarters, and the point readings on the median of four quarter-ends.
Grade coverage on a band the class can reach. Full marks for income of 1.6 times the dividend would be out of reach for a company that regulation requires to pay out about 90% of what it earns, and the median company would score under 3 on the largest measure. The band runs from 0.9 to 1.25 times, measured against the regular dividend at its run rate with supplementals set aside. Coverage carries less weight than credit, because a company that cuts its dividend covers the smaller one easily, and the readings that see trouble coming deserve the weight.
Never reward yield. A reading that scored 5% as zero and 15% as full marks would give the eight highest yields in the class, all of them companies in distress, a perfect grade on part of the score. Yield is not a reading. Credit is: loans that have stopped paying, the direction of net asset value, and income paid in kind.
Measure leverage against the regulatory floor. A bare debt ratio gives full marks to a balance sheet carrying a tenth of a dollar of debt per dollar of equity, which is underused rather than safe. The reading is the cushion above the 150% asset-coverage floor the Investment Company Act enforces, with preferred stock counted as senior where a company has it.
Read price against NAV one way only. Penalizing a premium as hard as a deep discount would give the companies the market pays the most for the same price score as the most distressed. A discount means the market doubts the marks. A premium is neither help nor harm.
Grade fees on the terms the class charges. A band that begins at the industry’s default 1.5% base fee and 20% incentive fee scores standard terms at zero. The band runs across the terms the class charges, an internal manager is read on its own expense ratio rather than on terms it charges outside funds, and the terms themselves are read from the advisory agreements. The result is that the lowest band means the ledger says the dividend is at risk, not that the yield was too low or the price too high.
In practice
A live example from the BDC universe: Ares Capital, the largest externally managed BDC. The card shows the record’s score as it stands today, the measures behind it with their weights, and the inputs that set each measure. It refreshes with the score, so the figures here are the figures on the record.
Scoring preferred ETFs
A fund that owns preferreds is judged on what it holds and what it charges to hold it. The five measures below follow the same rules as the rest of the score: graded from 0 to 10, weighted, with weight shifted to what could be measured when something is missing. The manager’s own published figures lead wherever they exist, because these funds own $1,000 institutional preferreds that no listing of exchange-traded holdings can cover.
Portfolio quality
The heaviest measure reads the credit breakdown the fund’s manager publishes each month: the share of the book rated investment grade, rated below it and unrated. Each investment-grade share counts 10, each rated high-yield share 2, and each unrated share a neutral 5, because half the preferred market carries no rating and unrated is not the same as junk. A book 84% investment grade and the rest high yield reads 8.7, and one 98% investment grade reads 9.8. A fund that publishes no breakdown takes the average score of the holdings we can match, when at least six of them match.
Expenses
The second measure grades the fund’s expense ratio along a line: 10 at 0.20%, 6 at 0.50%, 3 at 0.80% and none at 1.20% of assets. An ordinary active fee is marked down rather than zeroed. For a fund that borrows, the cost of borrowing is charged once, under the penalties below, and not again here.
Earned payout
The third measure asks whether the fund earns what it pays, rather than rewarding the fund that pays the most. The payout rate is compared with what the portfolio earns after expenses. The payout rate used is the lower of the trailing yield and the fund’s 30-day SEC yield, so a trailing figure swollen by one special distribution cannot pass on its own. Paying out up to 1.25 times what the book earns takes full credit, since a portfolio bought at a discount yields somewhat more than its stated rates. Beyond that the grade falls along a line, 7 at 1.5 times, 4 at 1.8 times and zero at 2.2 times, because a payout far past what the book earns is borrowed money or the investor’s own capital coming back. For a fund that borrows, costs here are its management fee alone.
Breadth
The fourth measure grades the number of holdings the fund reports along a line: 2 at 20, 5 at 50, 8 at 100 and full credit at 200 or more. A fund spread across many issuers is less exposed to any one of them stopping its dividend.
Size
The fifth measure grades the fund’s assets on a log scale, none at $50 million, 5 at $500 million and full credit at $5 billion, since the risk of a fund closing falls fast past a few hundred million dollars and barely moves after that.
Penalties and missing data
Two protections sit on top of the weighted average. A fund that borrows to amplify its returns, or that is structured as a single bank’s note rather than a fund holding assets, is multiplied by 0.8, a cut of a fifth, and flagged. A fund with neither a published credit breakdown nor a usable cross-check from our records can never score above 6.9, inside the Good range, because missing data must never read as excellence. When a measure cannot be read, the others pick up its weight and the record states how much of the weight was scored.
Three principles behind the preferred-ETF score
Trust the manager’s book before our own holdings list. A preferred ETF owns institutional preferreds that never trade on an exchange, so a credit breakdown built from listed holdings alone would miss much of the book. The manager’s monthly figure leads, and our own records are the cross-check.
Judge the payout against what the book earns. The highest-paying fund in the class is not the best one. A payout the portfolio does not earn is borrowed money or the investor’s own capital, and the measure reads the lower of two yields so a single special distribution cannot flatter it.
Draw lines, not cliffs. An ordinary active fee, a mid-sized fund or a payout ratio a hair past a line is marked down, not zeroed, and books above about 83% investment grade still rank against one another instead of sharing one top mark.
In practice
A live example from the preferred ETF universe: the iShares Preferred & Income Securities ETF, the largest fund in the class. The card shows the record’s score as it stands today, the measures behind it with their weights, and the inputs that set each measure. It refreshes with the score, so the figures here are the figures on the record.
Scoring covered-call ETFs
A covered-call fund is a different bargain. The investor puts up capital and gives away most of the upside, and the fund pays a large monthly distribution in exchange. The advertised rate is the least useful number on the page. What matters is where the money comes from: option income and gains, or the investor’s own capital handed back. The tax rules make that hard to see, because the same return-of-capital label sits on a fund paying out a shrinking portfolio and on a sound index-option fund whose payouts are taxed that way while the portfolio grows.
The covered-call score follows the same rules as the others: measures graded in steps, a 0-to-10 result, weight shifted to what could be measured, and no score shown when too little data is available. Five measures feed it.
Payout integrity
The anchor measure reads how much of the distribution is the investor’s own capital coming back, always from a documented source and never from a label. The final year-end tax form comes first. When that is not yet out, the fund’s own running estimate is used and shown as an estimate, since these tend to run high. For funds whose fiscal years leave no calendar-year figure, the audited annual report fills in.
Two checks against the fund’s one-year return then apply. If the fund lost money, this measure can score no better than 3, because paying distributions out of a shrinking portfolio is the failure the score exists to catch. If the fund returned 8% or better, it scores at least 5, because a high return-of-capital share beside a growing portfolio is a tax outcome, not lost capital.
Exposure
The second measure grades what the fund sells options against, and it carries weight equal to the first because it showed the strongest link to later returns in our testing. A broad index earns full credit, and the grade steps down through bond, basket and sector funds to a single stock at zero. Two points come off where the fund bets against the market, where the payout is owed by a single institution rather than an options market, and where the fund’s exposure runs past 100% on borrowed money.
Capital preservation
The third measure grades the one-year return with distributions counted as reinvested, which asks whether the investor’s capital held its value once the payout is counted. Funds between six and twelve months old are judged on the year so far. Younger funds leave the measure blank rather than guessed at.
Cost
The fourth measure grades the full expense rate from the prospectus fee table, from 0.35% at full credit to 1.50% at none. Where a fee waiver with a stated end date is in force, the lower rate counts until it expires.
Scale & continuity
The fifth measure asks whether the fund will still be here in a few years. Verified assets are graded from $10 million toward $1 billion, with the sponsor’s figure checked against regulatory filings before it counts. Age caps hold any fund under six months to 4 and under a year to 6 regardless of size. A large young fund still has no record.
Penalties and missing data
When less than 60% of the required information is available, no score is shown, rather than a low number a reader might mistake for a verdict. A fund that has never documented where its payout comes from is never marked better than partly measured, whatever else is available. Under these measures, as of August 2026, 143 of the 155 funds in the covered-call universe receive a score. The twelve that do not are recent launches with no return history.
Two principles behind the covered-call score
Set the weights by testing. Every candidate measure was scored using only what an investor could have known at a year-end, then checked against the return that followed, and the weights follow that evidence. Tested results describe one stretch of history and promise nothing about the next.
Read the source of the payout, not its label. The same return-of-capital label sits on a fund paying out a shrinking portfolio and on a sound index-option fund whose payouts are taxed that way while the portfolio grows. The score reads the tax documents and the one-year return together, so the label alone never decides.
In practice
A live example from the covered-call universe: the Neos S&P 500 High Income ETF, an index call-spread fund. The card shows the record’s score as it stands today, the measures behind it with their weights, and the inputs that set each measure. It refreshes with the score, so the figures here are the figures on the record.
The four examples together
Each class section above ends with a live example: MS-F, ARCC, PFF and SPYI. Where a measure could not be read, the card says so, and the other measures carry its weight. Read the four together and the thesis is visible. The numbers were reached by different roads. The preferred is judged on earnings, rating, buyback terms and fine print. The BDC on its loan book and its balance sheet. The preferred ETF on the book it holds and what it charges. The covered-call fund on where its payout comes from and what it sells options against. Yet each score reads the same way, each label means the same thing, and each card shows where the points went. Two records with the same score and different shapes call for different reading, and the breakdown is where that reading starts.
The breakdown travels with the score. An investor scanning a watchlist sees the single number. The same investor, opening a holding, sees the measures behind it. Both are always available.
Not investment advice. The Income Quality Score is a research tool for income investors weighing individual securities. It is not investment advice, not a recommendation to buy or sell any security, and not a promise of any outcome. Investors should consult their own financial adviser before making investment decisions.
When the scores update
The scores are recomputed every trading day after the close, but not every measure moves every day. Each one updates on the schedule of the data behind it.
On a preferred, coverage updates when the company reports earnings or changes its dividend, so it moves on the reporting calendar. Credit updates when a rating firm changes its view of a company we follow. Rating actions arrive through licensed market-data feeds and SEC filings and reach the score at the next recompute. Protection and the penalties update when a company declares, suspends or reinstates a dividend. Routine declarations change nothing. Suspensions and reinstatements move the score at once. Buyback economics updates daily by the calendar, easing down as the buyback date draws closer, and with the price. BDC readings update when the quarterly filing lands and the four-quarter window rolls forward.
Covered-call measures move on the tax calendar. Payout integrity resets each January through March, when sponsors publish final tax figures for the prior year. Between year-ends it runs on the funds’ own estimates, shown as estimates, and the yearly reset is itself a score change. Cost steps up from the discounted rate to the full one when a fee waiver expires. Scale & continuity updates as sponsor asset figures are refreshed and checked against quarterly filings.
When a measure moves enough to shift the overall score by a point or more, the move appears on Market Trends, which lists the week’s largest score changes in each class. How a score has moved lately is often as telling as where it stands.
How to read a score
Two habits get the most from the score.
Follow the deduction. The score does not replace the prospectus. It points to the sections that deserve the closest reading. A preferred scoring 7 with its deduction in buyback economics sends the reader to the call provisions. A deduction in coverage sends them to the issuer’s latest earnings. The number is a guide to the diligence, not a conclusion from it.
Read the shape. Two securities with the same overall score can have opposite profiles. One is strong on coverage and credit but close to its buyback date. The other is the reverse. The breakdown shows that difference instead of collapsing it into a ranking. Which profile matters more is a question the score raises and does not answer.
The score never says how much to hold. It describes the quality of a single security and says nothing about what share of a portfolio it should be. That depends on the investor’s other holdings, taxes, income needs and tolerance for risk, none of which the score can see.
What the IQS does not do
Scoring systems are often assumed to do three things this one does not.
The IQS is not a recommendation. A security with a high score is not automatically a good purchase at today’s price. A security with a low score may be a sensible holding for an investor who wants more yield in exchange for more complexity. The score describes the security. It does not advise on the trade.
Two rules follow from that principle. First, the score never drives notifications. YieldDesk alerts fire on things that happen at the security itself: a price level the user sets, a declared distribution, a call notice, an insider filing. They never fire on a movement in the score. Second, the score is never combined with a reader’s holdings to produce rankings or personalized output. A security’s score is the same for every reader and knows nothing of anyone’s positions. Holdings pages show the same figure every other page shows, and nothing more.
The IQS does not predict returns. We make no claim that high-scoring securities beat low-scoring ones over any holding period. The score measures qualities we believe matter to income investors making long-term decisions. Whether the market has already priced those qualities in at any given moment is a separate question.
And the IQS does not replace the prospectus. The measures are numerical summaries of complicated legal terms. The prospectus holds the full text, from the buyback provisions to the payment mechanics to any conversion features, and an investor putting real money into a single issue should read it. YieldDesk links the issuer’s EDGAR filings from every record.
Keeping the method current
The measures reflect our current judgment about what matters most to investors who hold these securities one at a time. As markets change, as new structures appear and as readers tell us what helps, the method will change with them. When a rule changes, this page changes with it, and the date at the top moves. A change to the method produces a one-time step in the affected scores on the day it lands, and that step says nothing about the securities.
The score runs through the whole product. The full breakdown appears on every record. The single number appears on the watchlist, in the screener and wherever space is tight. Market Trends lists the week’s largest moves.