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Higher-for-longer interest rates is the reality rippling through bond markets. As rates go up, prices of bonds go down, offering more attractive yields. While that has put a squeeze on many fixed income returns this year, it’s also giving investors the chance to capitalize on the best new-issue yields in decades.

The current market dynamics represent an ideal window to launch a new premium-yield fund, says Michael Kovacs, chief executive officer of Harvest ETFs in Oakville, Ont. “This will be the highest-yielding fixed income product in Canada.”

With Harvest Premium Yield Treasury ETF HPYT-T, investors can expect an approximate annual target yield of 15 per cent. That’s based on the initial offering price of $12 (as of Sept. 28), and a target monthly distribution of 0.15 cents per unit. The yield will provide the steady source of stable cash flow that many investors are looking for, especially in retirement.

As advisors seek to help their clients generate higher yields with lower risks from fixed income, Harvest ETFs’ target distribution may be appealing. This level of payout, given the risk, is substantially better than what most fixed-income products are paying in Canada, regardless of duration.

That payout is achieved through an options writing strategy, also known as covered calls, that Harvest ETFs has developed and implemented across an extensive lineup of equity exchange-traded funds (ETFs). With the interest rate cycle potentially peaking soon, the firm is turning its attention toward the bond market to launch its first covered-call fixed-income product.

“We feel very comfortable that we have the depth of experience and leadership to achieve the same thing we’ve been doing for years with equities now with a bond product,” Mr. Kovacs says.

The new fund will have exposure to longer-dated (10 years and up) U.S. government bonds by investing in a selection of U.S. Treasury ETFs.

“Some big bond ETFs in the U.S. have anywhere from US$6-billion to US$40-billion in market capitalization, and they own all those bonds. A traditional portfolio would purchase individual bonds and ladder the maturities out, but it’s much more efficient to buy four or five underlying bond ETFs. It simplifies the process and reduces costs,” Mr. Kovacs says.

Yet, the secret sauce of such a high-yielding product is options writing. Harvest ETFs is the second-largest covered-calls fund operator in Canada and the largest outside of the country’s dominant Big Six banks.

A benefit of the deep liquidity of U.S. bond funds is the equally liquid options market for them. Through flexible and frequent writing of options on its underlying holdings, Harvest ETFs can push the fund’s yield well into the double digits. That’s a level well above the short-term fixed-income products many investors have favoured this year.

“Because of the options levels we’re writing, we can triple the yield of a short-term bond, or cash account, or one of these [high interest savings account]-type products,” Mr. Kovacs explains. “The credit risk is the same because we’re buying U.S. Treasury ETFs, or a selection of ETFs that hold U.S. Treasury bonds. But we’re going for longer duration, accessing a bigger options market and writing more to generate extra cash flow.”

Long-dated U.S. Treasury yields are hitting their best levels in years, with the market pricing in one more hike from the U.S. Federal Reserve Board before the central bank is expected to commence cuts in 2024.

There are also tax considerations to weigh. Conventional bond income is the interest collected by the investor and is taxed fully. However, options premiums are treated as capital gains, with only half the return derived from the premium subject to taxation.

“That’s another benefit to this type of strategy – preferred income treatment,” Mr. Kovacs says.

A distinction between Harvest ETFs’ equities-based ETFs and Harvest Premium Yield Treasury ETF is the percentage of the portfolio subject to options writing.

Options writing limits the upside potential of the underlying security. So, Harvest ETFs keeps a long position on two-thirds of its equity funds. That enables clients to generate some income as well as participate in an underlying stock’s price appreciation over time. In the new Harvest Premium Yield Treasury ETF, the firm is writing up to 100 per cent of the portfolio of ETFs that hold longer-dated U.S. Treasury bonds, or of the U.S. Treasury ETFs held by the fund.

“Because we’re really invested for long-term capital growth of those equity portfolios, we only write about 33 per cent, so there’s always a long bias on the equity fund. That’s done by design. In this case, we’re right up to 100 per cent, also by design,” Mr. Kovacs says. “Capital growth is not the main objective of this bond portfolio. We’re trying to generate as high a level of income as possible.”

Harvest ETFs can use its covered-call strategy confidently across the entire portfolio of fixed-income ETFs, which have a liquid options market and hold U.S. Treasury bonds. These are backed by the full faith and credit of the U.S. government, and represent the soundest investment instruments available.

Even with their distant maturity dates, long-dated U.S. bonds are assigned very little credit risk.

“We have exposure to underlying securities. And by writing on the selection of ETFs in the portfolio, for an investor who wants stability and a high degree of income, we can generate the cash flow to deliver both,” Mr. Kovacs says.

Advertising feature produced by Globe Content Studio with Harvest Portfolios Group. The Globe’s editorial department was not involved.

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