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Some retirees may welcome rising interest rates, as their fixed income investments now yield more than they have in a decade, including double where they were at just a year ago. Yet, for investment advisors, and many of their clients who are in or approaching retirement, a big challenge remains. Inflation is boosting the cost of living and can put a damper on the growth or income their investments produce.

“Real income remains negative with inflation continuing to outpace current fixed income yields,” says Paul MacDonald, chief investment officer at Harvest Portfolios Group Inc. in Oakville, Ont.

In short, traditional fixed income is unlikely to generate sufficient cash flow for retirees to deal with current and future rising costs.

“The good news for investors is that there’s a higher level of income available from income-oriented investments,” says Doug Nelson, president and senior financial planner at Nelson Financial Planning Corp. in Winnipeg and author of the book Master Your Retirement.

He points to creative equity strategies such as covered calls, which can produce cash flows that outpace high inflation, even at a time of higher interest rates. Using covered calls, investors can expect a yield between 7 and 12 per cent based on dividends and options premiums, Mr. Nelson says.

That compares favourably to guaranteed investment certificates that offer interest rates of 5 per cent, and individual bonds that yield between 3 and 4 per cent.

Covered-call strategies were popular during the bull market with a growing array of exchange-traded funds (ETFs). These strategies give up a certain amount of market upside potential for the certainty of cash flows during a specific period. That happens by selling the option to buy a stock tomorrow at today’s price for a premium. Call option ETFs pass on those premiums to unitholders as tax-efficient cash flow.

This solution is designed to provide high income no matter the market conditions and tends to perform even better in an environment like we’re in today.

“With volatility so high, the premiums generated on call options are actually higher than during the low-interest rate, low inflation, bull market,” Mr. MacDonald says.

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A prime example is Harvest’s Healthcare Leaders Income ETF (HHL-T), with a 12-month trailing yield of about 8 per cent from dividends and premiums from covered calls, written on a flexible amount of its 20 large-cap, equity holdings, capped at a maximum of 33 per cent.

“Advisors and investors should ask whether they want to be invested in an area of the market with in-demand goods and services, and in companies with high margins, low commodity exposure and relatively good visibility into their businesses. Few other market areas offer that,” Mr. MacDonald says.

Investors can also receive a high monthly distribution while waiting for a market recovery, he adds. “Those are the boxes that should be ticked off for people considering HHL.”

HHL and all of Harvest’s call option ETFs use an active and flexible call option writing strategy. Portfolio managers can sell as many or as few calls as needed to generate the ETF’s monthly distribution (up to a hard limit). That also allows these ETFs to capture market opportunities in a way that passively managed call option ETFs can’t.

ETFs offer a benefit

Producing enough income for retirement is an evergreen worry, perhaps more than ever at a time when Canadians are living longer. A December report from the National Institute on Ageing at Toronto Metropolitan University found only 35 per cent of Canadians aged 50 or older believe they can afford retirement. The report noted that more Canadians are carrying debt for longer, even into retirement, and fewer have workplace pension plans.

“The recent spike in the cost of living has emphasized the importance of inflation protection,” says Jason Heath, a certified financial planner with Objective Financial Partners Inc. in Markham, Ont. “Many retirees need to hold assets providing an inflation hedge and capital growth.”

Although covered calls can generate higher income than can be found elsewhere, the strategy isn’t without downsides, including giving up some of the chance of capital appreciation should markets take off again.

One challenge is that running a covered-call strategy across a diversified portfolio of individual securities is likely too complex and time-consuming for most advisors, let alone investors, Mr. Heath notes. “It’s definitely a niche investment strategy,” he adds, and one that’s likely better accomplished with an ETF.

Economies of scale are a major benefit of using an ETF. Providers can receive institutional pricing for options strategies, with significant trading efficiencies and synergies with teams that are dedicated to managing an active call option overlay, Mr. MacDonald says.

For a few dozen basis points, advisors or individual investors can implement a diversified covered-call strategy in client portfolios to generate income regardless of the market’s direction.

“We could have an up year as easily as a down or a sideways one,” Mr. MacDonald says. “What is likely, though, is that volatility will be high, resulting in more cash flow generated from a covered-call strategy.”

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

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