It hasn’t been easy to generate cash flow from investments lately. Rising interest rates have had an impact on fixed income assets, while inflationary pressures have compressed real returns. At the same time, volatility has hit equities, including those paying dividends.
Paul MacDonald oversees an approach that has been providing investors with a relatively high level of income through these challenging markets. MacDonald is chief investment officer and a portfolio manager at Harvest ETFs, and his team runs eight sector-specific equity income exchange-traded funds (ETFs), plus the Harvest Diversified Monthly Income ETF (HDIF), which holds equal weights of six of the others with no additional management fee.
Each of these equity income ETFs benefits from a focus on areas of the market with a record of long-term growth. Within sectors, the team seeks out good-quality businesses that have proven they can adapt to changing environments. Meanwhile, security selection is complemented by an actively managed covered call strategy applied to up to 33% of each portfolio. Current yields, as at August 31, 2022, ranged between 7.09% and 10.19%.
“With covered calls, there’s a trade-off. You forego some of the upside in favour of current high cash flow,” MacDonald explains. “We’re participating in the longer-term growth of our underlying businesses…and, at the same time, we’re able to generate really consistent, steady, tax-efficient monthly cash flows.”
Covered calls capitalize on volatility
Covered calls generate income by selling options to buy long positions in the portfolio. They’re best applied to holdings that are unlikely to move up or down very much during the life of the option. Harvest’s active approach examines every portfolio, and every security within it, on a monthly basis to determine what and how much to write within the 33% limit.
MacDonald emphasizes that this active overlay is critical when markets are volatile. After all, one of the key drivers of option pricing is volatility, so it is precisely in this type of environment that his team can monetize more cash flows.
To enhance its distribution yield, Harvest’s multi-sector ETF HDIF incorporates 25% leverage. As of September 20, it had attracted more than $175 million in assets.
“The leverage used in HDIF allows us to enhance the income generation of the underlying ETFs it holds by 25%…for those who are looking for a little bit more torque on their income, over and above the core ETF,” MacDonald says. “For every $100 invested, this ETF is generating cash flow on $125.”
HDIF provides advisors with an additional option to deliver the regular stream of inflation-beating monthly income their clients need.