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GICs vs. Fixed Income? How to Earn Your Way Through a Crisis

As inflation approaches 8%, even attractive GIC rates may lose money in real terms. To add income and greater upside potential, portfolio managers Chris Heakes and Omanand Karmalkar discuss the benefits of the new BMO Global Enhanced Income Fund.

August 2022

Chris Heakes

CFA, M.Fin., Head of Disciplined Equity, Portfolio Manager, Global Structured Investments, BMO Asset Management Inc.

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Omanand Karmalkar

CFA, Portfolio Manager, Exchange Traded Funds

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Key Takeaways

  • BMO Global Enhanced Income Fund focuses on generating high cash flow from a broadly diversified global equity portfolio
  • Underlying ETFs hold companies with strong balance sheets, such as Microsoft, Apple and the big six Canadian banks
  • The fund targets a 5% payout*, which means a client with $250,000 in assets can generate $1,042 in tax-efficient income** per month

What was the rationale for introducing the BMO Global Enhanced Income Fund? Why now?

CH Overall, the driving force was all about ease-of-access. We wanted to give investors a one-ticket solution for global equities that focused on income generation. Markets have been very challenging in 2022; there are a lot of risk drivers, and generating a high-income stream can be a way to address some of those risks. What this fund is doing is sourcing yield globally from all kinds of developed markets, and taking a defensive approach—but also a tactical one—in order to make sure that investors are able to stay invested and earn their way through volatile markets.

OK Exactly. It’s a one-stop shop that provides three core benefits. First, there’s income, which clients are always looking for. Second, it provides tactical asset allocation, which provides flexibility to position the portfolio in different market environments. Third, it gives investors broad diversification across different regions so they don’t have to do it on their end. They obtain exposure to U.S., Canada, International and Emerging Markets, plus multiple currencies—all within a single fund.

High inflation and rising interest rates are major concerns for investors right now. How are the underlying ETFs likely to perform?

CH Historically, you have to go back a fair amount of time to get data on high inflation regimes. It’s been more than 40 years. Long-term research shows that dividend-paying equities tend to perform well when prices are rising, and also that value typically outperforms growth during these stretches. We’re seeing that play out this year. Once inflation provoked central banks into raising interest rates, we then saw a negative impact on growth companies and favour rotated toward those with healthier cash flow. The fund targets a 5% payout,* which means a client with $250,000 in assets can generate $1,042 in tax-efficient income per month.**

OK And remember, there’s upside potential over and above the income yield. By contrast, on the bond side, we saw government and corporate debt have one of their worst starts in over a decade. Overall, bonds failed to provide the diversification and income that they have in the past, and markets continue to price in higher rates moving forward, which suggests that the underperformance could continue into the foreseeable future. Some investors are moving to GICs as a potential solution but, with inflation as high as 8%, their real returns are still negative. Equities are able to do better because they at least have the potential for capital appreciation. Some companies can also pass on the higher costs to the consumer. For instance, both Visa and MasterCard have done well because they take a percentage of all transactions from the merchant. So, if a TV that costs $1,000 is now selling for $2,000, and you pay for that by credit, that results in higher revenue for these companies.

What’s the ideal use case for the fund? Should it be considered a core or satellite holding?

CH We designed this exposure to be a core holding. When you look at what’s under the hood, the centre pieces are drawn from the High Dividend Covered Call suite, all of which are composed of blue-chip companies that have a long track record of paying and raising dividends. As Omanand mentioned, we combine ETFs that target distinct regions to provide a portfolio that’s well-diversified at a global level. That’s the heart of the strategy. We then add tactical positions to help achieve our targets on the growth side, though ultimately the strategy is designed for investors who want to take a bit of risk off the broad market.

OK It’s also important to understand the relationship between income and growth. The covered call strategies offer extra income by writing call option contracts, and, in exchange, they trade off some upside potential relative to the broad market. That’s why we have the tactical asset allocation component. We allocate approximately 25% of the fund to be able to navigate different environments. Let’s say we return to a 2020 environment where markets come off and then sharply rally; we would position the fund accordingly so that the end client has both the income and the upside participation. The covered calls may not achieve the full 100% upside by themselves, but with the tactical component in place they won’t have to.

There are many successful ways to build a global equity portfolio, each with their own particular advantages. What are the key benefits of using ETFs?

CH Quite honestly, the biggest advantage is the covered call layer. It can be both expensive and time-consuming to write and manage covered call options on a broadly diversified portfolio, especially one that seeks out high-quality stocks across the entire world. That’s a big investable universe. Our suite of High Dividend Covered Call ETFs makes it easy to dial up (or down) a regional position while maintaining the options overlay. It simplifies a complex process.

Different asset managers may have alternate approaches to this strategy. What kind of companies are held in the High Dividend strategies?

CH What’s important to understand is that we’re not only looking for the highest yielders. That can be a bad way to look at dividend investing, given that it often foreshadows future trouble with the company, such as a dividend cut or cash flow concerns. Our focus is on companies with sustainable yields that grow over time. For example, Canadian banks are included because they have a long history of payouts, with some going back beyond 100 years, and on the International side we hold companies like Nestle. This blue-chip bias in the portfolio helps us get to the equities that have strong fundamentals, and it also makes them effective from a risk management perspective in the late cycle.

OK Microsoft and Apple are another two great examples. Though neither have had the strongest year-to-date performance, both are very safe from a balance sheet perspective. Apple and Microsoft both have more than $100 billion in cash and cash equivalents. Neither company is highly leveraged. These are exactly the kind of equities that you want to be holding in an environment with interest rates rising; firms with enough cash to fund their operations even if there is a slowdown and consumer demand begins to falter. Canadian banks are also held within the portfolio given their long history of stable growth and dividend payouts.

We often ask portfolio managers to provide a book or podcast recommendation for our Advisors audience. Chris, you already gave one in your June 2022 article, Lottery Tickets and Low Volatility. Omanand, do you have one that comes to mind?

OK One book that had a huge impression on me was the Random Walk Down Wall Street by Burton G. Malkiel. It’s a classic—and a great primer for anyone who’s looking to take a step back and refresh their understanding of finance. Rather than some books that focus on only theory, I found that the author includes practical investing advice that’s backed by really strong, in-depth economic analysis. Highly recommended.

Please contact your BMO Global Asset Management wholesaler for any support and guidance.

BMO Global Enhanced Income Fund - Series F

FundSERV Codes Front End
Advisor BMO99166
T6 BMO34212
F (Fee Based) BMO95166
F6 BMO36166

* Series F -Target distribution yield is estimated based on the expected distributions from the underlying holdings of the Fund, annualized for frequency, divided by current NAV. Subject to change without notice.

** As compared to an investment that generates an equivalent amount of interest income

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BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.

Commissions, trailing commissions (if applicable), management fees and expenses all may be associated with mutual fund investments. Please read the ETF facts, fund facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.

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