High Yield and Reduced Portfolio Risk? It’s Possible Even Now.

The Ideal Yield Strategy for Current Markets

With interest rates and bond yields even lower than they were previously, there’s a greater need for income investors to maintain some exposure to equities, while at the same time being prepared for our new normal of persistent volatility. Amid drastic market swings and diminished global growth, it’s now more important than ever that Advisors ready themselves for what lies ahead with practical – and effective – yield strategies.

In this post COVID-19 reality, many of you are rightfully focused on generating that healthy 6%-8% return that your clients have come to rely on to fund their lifestyles. This is particularly relevant as demographics shift, and aging Canadians – especially those in the pre-retirement or retirement stages who face longevity risk and a rising cost of living – require higher yields from their investments and sustainable monthly income over the long term. According to a recent study, 63% of retiring Boomers’ biggest worry is running out of money, and the latest market turmoil only adds to this pressure.¹ Add to this, for North American Advisors, 79% of total client relationships are with older clients born in 1965 or earlier.²

From this perspective, a defensive covered call strategy is an ideal solution because not only does it lock in yield, it is the lowest risk option when compared to both high dividend and dividend growth investments in this environment. Aggressive yield tactics such as high-payout energy stocks simply won’t provide value now given the substantial decline in oil prices, and many clients in this climate are naturally more cautious. Covered calls, meanwhile, provide a double source of cash flow, with option premiums collected acting as a buffer against price declines – an important characteristic amid the inevitable economic fallout from the COVID-19 carnage.

Our Approach: High Income + Peace of Mind

BMO Global Asset Management – through our entire covered call suite – employs its systematic overlay method to write out-of-the-money (OTM) calls on roughly 50% of the shares to earn premiums, while maintaining long exposure to the remaining 50% to provide upside potential (as market conditions change, equity and option exposure varies). On top of dividend income, we seek to generate an additional 2% to 5% yield (depending on market environment) from the selling of the call options.

In the current tumultuous environment, our focus on OTM options commands better value because of investor uncertainty on where stocks are headed. Effectively, we’re monetizing volatility, so our premiums increase in an unstable climate since we’re able to sell options further OTM at a higher price, and still achieve our income targets.

While our approach doesn’t fully eliminate the downside, the covered calls strategy leads to lower risk since full market exposure is also capped, while at the same time targeting incremental yield. From a defensive standpoint, this combination is attractive for clients who want greater peace of mind during these uncertain times, as both governments and central banks struggle to overcome the shock from COVID-19.

These mandates offer a range of client benefits, such as higher yield with lower volatility, a bias toward quality stocks, and stable, tax-efficient income – all at a competitive cost. In the end, it’s a practical solution to safeguard investments from short-term risks, while boosting returns.

Benefits for Your Clients:

• Higher yield - additional premiums collected from covered calls and high-quality underlying stocks with strong balance sheets, history of dividend payout, etc.
• Lower volatility – call options provide downside protection relative to owning the assets outright, while long exposure is also capped
• Greater tax efficiency – income generated by call premiums is typically taxed as capital gains
• Upside capture – ability to stay invested, and participate in global growth on the other side of the Bear market
• Lower costs – competitive cost for an enhanced yield strategy

A Tactical Time to Add Exposures to:

A Toolkit Essential: Higher Returns Without Higher Risk

At BMO Global Asset Management, we remain committed to creating solutions that run counter to the traditional expectation that higher yield necessitates higher risk. Our expansive covered call suite, which includes both ETFs and ETF-based mutual funds, allows your clients to better meet their income needs through a proven strategy – without having to budge on their risk comfort levels. While these solutions are not a fixed income replacement, in that they’re still equity market exposure, they provide necessary comfort for risk-averse clients seeking stable yield in this rocky climate.

And, no matter how your business is structured, as the largest options manager in Canada, we have a solution that fits. Within the construct of ETF-based mutual funds, we’ve set out to efficiently access covered call options with a one-stop, low-fee, professionally managed mutual fund. We do the portfolio construction, implementation, risk management and the monitoring, levering our relationships with more than a dozen counter parties to attain the best pricing, so Advisors can focus on servicing clients and growing their business.

In this heightened period of uncertainty, we will continue to provide you with timely resources, and new ideas to enrich your practice. To learn more about BMO Global Asset Management’s covered call solutions, contact your Regional Sales Representative, and access the materials below:

BMO Covered Call Option Strategy
BMO Covered Call Funds – Whitepaper

¹ CIBC Economics, June 2016.
² The State of Retail Wealth Management 2018.