Low interest rates are a pain for yield-hungry investors.
While government bonds and guaranteed investment certificates offer safe but uninspiring returns, exchange-traded funds (ETFs) can provide alternative sources of income – albeit not without some risk.
These investments range from dividend-paying and preferred share ETFs to funds using options strategies that may appeal to sophisticated investors. Unlike traditional plain-vanilla index ETFs, these income-oriented funds also come with higher fees.
Given the array of products on the shelf, we asked two analysts to give their top picks among ETFs that offer income opportunities.
Daniel Straus, ETF analyst at National Bank Financial Inc.
The pick: Toronto PowerShares S&P 500 High Dividend Low Volatility ETF
Management fee: 0.35 per cent (expense ratio not available yet)
This U.S.-focused ETF owns high-yielding stocks that provide dividend income but are also less volatile than the overall market, says Mr. Straus.
Launched last month in Canada, this ETF replicates its four-year-old U.S.-listed ETF peer – PowerShares S&P 500 High Dividend Low Volatility Portfolio ETF.
The risk to this ETF is that its major holdings are in sectors, such as utility, real estate and consumer staples, that can lag when interest rates rise, he notes. Top names include Welltower Inc. and Entergy Corp.
By only owning less-volatile stocks, investors also could miss out on the potential upside from other equities in a bull market, he adds. This ETF, which has a monthly payout, is best held in a tax-sheltered account as U.S. dividends are treated as foreign income, he says.
The pick: First Asset Canadian REIT Income ETF
Management expense ratio (MER): 0.97 per cent
This real estate ETF run by a portfolio manager picking securities has been able to outpace passive benchmark ETFs, says Mr. Straus. It has outperformed even after converting from a closed-end fund in mid-July of 2015.
"It has [since] posted a 15.6-per-cent annualized return versus 6.5 to 7.4 per cent for the main benchmark ETFs," he says.
The ETF, which has a monthly payout, also owns smaller real estate investment trusts (REITs) than in the S&P/TSX Capped REIT Index, he notes. A risk is rising interest rates, which raises borrowing costs for firms, while investors may sell REITs to buy higher-yielding bonds.
The ETF's fee is a fair price to pay managers to pick less rate-sensitive REITs or raise cash in rocky markets, he says.
The pick: BMO U.S. Put Write ETF
MER: 0.70 per cent
This ETF generates income by selling put options written on U.S. large-cap stocks, says Mr. Straus. (The fund doesn't hold the equities, but owns cash equivalents to cover stock purchases.) A put option gives a buyer the right to sell a security at a fixed, or "strike," price, by a certain date.
The ETF continually makes money from the option premium it gets from the buyer of the option contract. The risk stems from the losses that might be incurred if a stock falls below the strike price, forcing the ETF to buy it at a price higher than its market value.
The ETF, which has a monthly payout, benefits from BMO Global Asset Management's option expertise, he says. Its fee is in line with ETFs using options strategies, he adds.
Denise Davids, ETF and mutual funds analyst, Scotia Wealth Management
The pick: Toronto Horizons Active Preferred Share ETF
MER: 0.64 per cent
This ETF offers a steady flow of monthly dividend income from preferred shares of mainly Canadian companies, and can provide diversification in a portfolio, says Ms. Davids.
Unlike some ETFs using a passive indexing strategy, this one is an actively managed fund with Montreal-based Fiera Capital picking the securities. Because preferred shares can get hurt when interest rates rise, Fiera can use its expertise to seek out the best opportunities to reduce the risks, she notes.
This ETF, whose fee is on the low side among actively managed ETFs, has outperformed the S&P/TSX Preferred Share Index for more than five years on an annualized basis, she says. The ETF's top holdings are in banks, insurers and pipeline companies.
The pick: Horizons Active Global Dividend ETF
MER: 0.92 per cent
This global dividend-stock ETF, which is an actively managed fund, has an advantage over passive indexing when interest rates climb, says Ms. Davids.
"As interest rates rise, defensive stocks tend to suffer," but Guardian Capital LP, which oversees the ETF, has the flexibility to select the best dividend opportunities at any given time in any sector of the global economy, she says.
The ETF invests in high-dividend-paying, mature companies as well as higher-growth companies with lower yields, but greater capital gains potential. Top holdings include JP Morgan & Chase Co. and Apple Inc. The fee for this fund, which pays a monthly distribution, is reasonable for actively managed ETFs, she says.
The pick: BMO Covered Call Canadian Banks ETF
MER: 0.72 per cent
This ETF uses a covered call options strategy on a portfolio of Canadian banks to earn income above their dividends, Ms. Davids says.
The fund, which is run by BMO Global Asset Management, sells or "writes" call options while owning shares of the underlying stock. (A call option is a contract allowing the buyer to purchase a stock at a specific price over a certain time period.)
The ETF's extra income stems from an option premium paid by the buyer of the option contract. Financial stocks tend to rally when interest rates rise, so that is a risk, she notes. Should the stock price rise above the exercise price, that would cap the potential gain because the shares must be delivered to the option buyer, she says.