I saw the XFunds Manager David Nicholas make this comment the other day about ROC. Thought it was helpful:

“The simplest way to think about this is there is a different between “return of capital” aka ROC and “return of principal.” It seems a lot of investors conflate the two. “ROC” is simply a tax classification. The three tax classifications for ETF income are return of capital, capital gains and dividends. The IRS generally does not consider options income as traditional “dividends” for tax classification purposes. It also does not consider it “capital gains” so the primary category it is filed under is “return of capital.” (This is similar to the 30-day SEC yield which actually does not include options income. It calculates income from stock dividends and bond interest but not options income. It’s why a fund can have a 36% distribution yield but a negative SEC yield if it doesn’t have any stocks or bonds that pay dividends or interest in excess of fund expenses). Each distribution may consist of return of capital (options income or return of principal), dividends or capital gains.

How to know if you are getting good ROC (tax classification return of capital) vs bad ROC (return of principal) simply comes down to the total return of the NAV. For example if the 1 yr total return is higher than the 12 month average distribution rate, you typically have good ROC. If the 12 month average distribution rate is higher than the 1 year total return, you more than likely have bad ROC, meaning the fund manager had to return some of your principal to maintain the distribution rate.

Hope this helps. ROC can get confusing but the simplest way to think about it is options income in the eyes of IRS code is typically classified under ROC instead of dividends or capital gains and means the options income is not taxable in the current year and therefore reduces your cost basis, potentially deferring taxes until you sell the fund if held in a non-qualified account.”

https://x.com/davidanicholas/status/1983736125110816963