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Appetites for defensive investments are growing alongside recession fears in Canada, and asset managers are offering new ways of quenching those desires.
Horizons ETFs Management (Canada) Inc. became the latest provider to launch a product designed to offer stability amid persistent market volatility. Its new exchange-traded fund (ETF), Horizons Canadian Utility Services High Dividend Index ETF UTIL-T started trading on Aug. 10.
Joining a handful of other ETFs composed of infrastructure assets that can provide consistent earnings and high dividend yields during economic downturns – such as electricity distribution, telecommunications and pipelines – each product takes a different approach to the space.
Common among them all is the increased attention the sector is receiving as advisors hunt for defensive, dividend-paying holdings. For example, assets under management in the three-year-old Harvest Equal Weight Global Utilities Income ETF HUTL-T have grown by roughly 60 per cent since the start of 2022, with net inflows of more than $50-million.
While citing plans to launch at least one more utilities-focused ETF in the coming months, Horizons’ chief executive officer Steve Hawkins in Toronto says utilities funds are designed to thrive during an economic downturn.
“We’re either in a recession now or we’re heading into one, and it’s going to be a deeper recession,” he says. “Consumers are cutting discretionary and non-essential spending, but they need electricity and their cell phones to work.”
Investors have been “hungering for yield” and the historic bond market sell-off earlier this year has left advisors struggling to find safe harbour for their clients, Mr. Hawkins says.
Lesley Marks, chief investment officer for equities at Mackenzie Investments in Toronto, says the next 10 years of investing are going to look very different from the past 10 as higher interest rates and ongoing economic uncertainty linger.
“Advisors need to be open to ideas, strategies and asset classes that they might not have had to focus on for the past 10 years,” she says. That means taking a closer look at “the type of industries or companies in which there are high barriers to entry and no significant fluctuation in the outlook for earnings as a result of an economic slowdown.”
Utilities ETFs, which tend to hold companies that own multibillion-dollar physical assets and offer services considered essential to most households, align well with that new investing thesis. Even though the Horizons product represents only the fifth fund of its kind in Canada, the pros and cons of the options that are available can vary.
BMO Equal Weight Utilities Index ETF ZUT-T and iShares S&P/TSX Capped Utilities Index ETF XUT-T both invest solely in Canadian utilities stocks and offer dividends based on the average yield of their underlying holdings.
Then, there are BMO Covered Call Utilities ETF ZWU-T – by far the largest fund in the space with more than $1.6-billion in assets under management – and the aforementioned Harvest Equal Weight Global Utilities Income ETF.
Both BMO Global Asset Management (BMO GAM) and Harvest Portfolios Group Inc. write covered-call options every month on these ETFs’ holdings to maximize dividend yields.
Does the geography of investments matter?
Horizons’ new product is closest to the first two with a strictly Canadian mandate, although pure-play utilities only need to account for half of these funds’ holdings. Canada’s largest telecommunications providers and oil and gas pipeline operators account for the rest.
“We aren’t dealing with any foreign exchange, we aren’t dealing with any hedging or macroeconomic risk from an outside-of-Canada perspective,” Mr. Hawkins of Horizons says. “We look at this as a low-volatility, high-yielding strategy.”
But staying exclusively within Canada can actually create more risk, says Mike Dragosits, portfolio manager at Harvest who manages the Harvest Equal Weight Global Utilities Income ETF.
“They can be at the mercy of specific regions or governments and you also have to look at natural disaster risk,” he says.
The Harvest ETF, which also invests in telcos and pipelines in addition to pure-play utilities, has a broader geographic footprint with holdings that span Canada, the U.S. and Western Europe.
“By having a globally diversified portfolio of companies, you’ll be able to diversify away those types of risks or government changes and regulatory risks as well,” Mr. Dragosits says.
But Mr. Hawkins says the appeal of utilities ETFs is more about the “continued chase for yield” than geography.
“That’s why I believe BMO Covered Call Utilities ETF is significantly so much bigger than just the straight utilities investing products that are out there in the Canadian marketplace,” he says. “It’s already a high-yielding sector and then [BMO GAM] is adding an additional overlay to generate even more yield.”
Horizons just completely revamped its own covered call strategy set of funds, Mr. Hawkins says, with utilities likely the next sector the firm plans on targeting.
Rather than making changes to existing funds, he says enough demand exists for at least one more utilities ETF.
“There’s a very high probability that you would see us come to market at some point in the next six months or so with a new covered-call strategy,” he says, “or even several covered-call strategies that are targeting these high-yielding sectors.”
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