Paul MacDonald understands why Canadian investors tend to favour domestic companies in their portfolios. The chief investment officer at Harvest Portfolios Group Inc. in Oakville, Ont., explains that the scale, dividend yield and familiarity Canadians get from our Big Five banks, leading insurers, integrated oil and gas giants, and diversified telecommunications companies make these stocks attractive.
Yet, investors seeking income can still struggle to get the results they want. With inflation stubborn at around 6 per cent, a dividend yield of 7 per cent or higher is needed to produce a positive real yield. That’s more than double the dividends yields of 3 per cent or so those stocks deliver these days.
“While volatility typically isn’t as high with these kinds of companies compared with growth-oriented stocks like technology, generating high enough real income remains challenging,” Mr. MacDonald says.
In a still-uncertain market, many investors want exposure to Canada, but with a high-income yield. There’s a prudent way to get it through options strategies, particularly covered calls.
“Call options writing allows an investor to exchange potential future appreciation of an underlying security, for a predetermined price and time horizon, in exchange for a cash payment,” says Alan Fustey, portfolio manager at Bellwether Investment Inc. in Winnipeg.
Doing that consistently for several equity positions can be complex. Investors have an easier way to get exposure to covered-call strategies for equity holdings via specialized exchange-traded funds (ETFs).
Harvest has a suite of such ETFs across several sectors, including one for the Canadian large-cap dividend payers. Harvest Canadian Equity Income Leaders ETF HLIF-T captures the traits of leading domestic companies and combines that with a covered-call strategy. Harvest ETFs is a market leader in such strategies, having offered a suite of equity income ETFs using covered calls since 2016.
“In this environment of uncertainty, elevated volatility is to be expected. A covered-call strategy offers benefits, providing additional upside from paid premiums. The design of the fund is to capture the largest, highest dividend-paying companies in Canada,” says Mike Dragosits, portfolio manager at Harvest.
ETF holds 30 top Canadian companies
Covered-call ETFs have become more popular over the past decade. That’s because they provide a higher yield than their holdings’ dividends, which is generated by writing call options on a percentage of holdings in the underlying portfolios.
Depending on the equities’ level of expected volatility, covered-call strategies can boost cash flow and income anywhere from 150 to 400 basis points, Mr. MacDonald says. “Having that strategy in an equity ETF can make sense to boost income streams exceeding inflation.”
Harvest’s HLIF holds 30 of Canada’s largest publicly-traded companies that are also among the top dividend yielders, with histories of increasing their payouts steadily. With each position weighted equally, the fund provides diversified exposure to Canada’s largest financial companies, pipeline firms, utilities, energy producers and retailers, among others.
These are resilient sectors and companies, Mr. Dragosits notes. “Canadians continue to use [these companies’] products and services, recession or not.”
While the average dividend yield is about 5 per cent, the overall yield is enhanced with the ability to write calls flexibly, up to a maximum of 33 per cent on each name in the fund. Using an active options strategy, while charging an overall fund management fee of 0.65 per cent, HLIF can generate about an additional two percentage points of yield.
Using year-end 2022 data, the portfolio yield was almost 5.2 per cent from dividends alone. “But with the covered-call strategy, HLIF’s overall yield was boosted to about 7.85 per cent,” Mr. Dragosits says.
He points out that investors are giving up some upside potential of underlying assets with call options written on them. That can happen if the share values rise significantly, exceeding the option strike price, resulting in the sale of those shares.
Still, call option ETFs like HLIF can provide steady monthly income, making them a good option for retirees. As well, HLIF offers a dividend reinvestment plan, which is noteworthy for investors seeking a little more capital appreciation amid choppy markets, Mr. MacDonald says. “Either way, it’s not a bad time to have that bird in hand from dividends and option premiums.”
Nevertheless, advisors must be clear with clients that these ETFs’ strategies aren’t a panacea for volatility, Mr. Fustey says. “Clients must look beyond the yield to really understand what they’re investing in.”
For example, he notes that income from call option premiums wouldn’t fully offset a 20 per cent drop in the value of an ETF’s underlying portfolio.
“Ultimately, what’s going to drive success of the strategy is the performance of the holdings,” Mr. Fustey says.
An ETF like HLIF, with its mix of leading Canadian stocks, can provide long-term growth potential for client portfolios with the surety of consistent income paid monthly.
“It offers a solid portfolio of Canadian companies, only with higher yields than investors can get buying an individual Canadian stock or a basic basket of domestic equities,” Mr. MacDonald says.
Advertising feature produced by Globe Content Studio with Harvest Portfolios Group. The Globe’s editorial department was not involved.