Collecting Tolls in a Sideways Market
BMO Global Asset Management continues to expand its ETF-based mutual fund offerings by making the BMO Premium Yield ETF (ticker: ZPAY) available to all Advisors. With a yield of 6.6%1, the BMO Premium Yield ETF has had a unique history of providing high income to Canadians via call—and put—options. Portfolio Manager Chris McHaney introduces this sophisticated strategy.
May 2023
Key Takeaways
- The BMO Premium Yield ETF is now available as a mutual fund
- The underlying ETF generates enhanced income on an underlying basket of U.S. blue chip equities
- An attractive, high-yielding solution for income-oriented investors
Thanks for speaking with us, Chris. What is the rationale for launching the BMO Premium Yield ETF in a mutual fund version? Why now?
CM The hallmark of the BMO Premium Yield ETF is earning income premiums whether the stock goes up or down. Bringing a prudent strategy of this type to a whole new group of investors via a mutual fund wrapper just makes sense, especially given its 6.6% yield at a target MER of 0.73% for the F-Series1,2. There are a couple main reasons why the BMO Premium Yield ETF Fund is a potentially great fit for today’s market environment. Firstly, volatility in markets has stayed relatively high even as the economy has emerged from the pandemic—it’s never really returned to “normal,” pre-COVID levels. A strategy that can profit from volatility through the options market makes sense for a lot of investors, especially those who are income oriented. At the same time, expectations for equity returns are a bit lower going forward. That calls for a solution that is somewhat more conservative in nature. Rather than purely seeking equity growth, the BMO Premium Yield ETF Fund uses volatility to generate an attractive income stream on top of any capital appreciation.
Can you give us an overview of the Fund’s exposure, and how its return profile differs from traditional equity and fixed income investments?
CM The first step is to construct a model portfolio of quality U.S. equities. Once that model is in place, instead of fully investing in those equities, we use option strategies to gain exposure and generate income. Given the high income generated in addition to a cash position, investors benefit from some growth participation in the underlying equities and a less volatile investment than the basket of stocks held. Given these characteristics, the fund tends to generate above-average returns given its level of risk, and with less volatility than traditional funds.
The underlying Fund was launched in early January 2020, just before the pandemic. Since then, we’ve seen a lot of market volatility. How has it performed since inception?
CM There’s no question that in hindsight, early 2020 was an interesting time to launch—no one knew what was around the corner. But COVID turned out to be a great validation of the mandate’s strategy. In the early days of the pandemic, the fund provided the downside protection it was designed for, outperforming equity funds. Through its option mechanism, its stock portfolio began to build up in weight as the market declined. And then in April and May 2020 we saw a quick rally, and the ETF was able to participate in that growth because the equity positions had been built up. The Fund performed exactly as we’d anticipated, but because of COVID, the scenario played out much more quickly than it would have under normal conditions—it was a very quick, V-shaped recovery.
Since then, and especially in 2022, we’ve seen an equity market selloff and an across-the-board revaluation of equities considering higher interest rates. This has led to a slower, U-shaped recovery compared to what we saw with COVID. But again, the scenario is playing out as expected—equity markets sell off, our equity positions gradually build up, and then as markets rebound, so does the Fund.
BMO Premium Yield ETF (ticker: ZPAY) Fund invests in a concentrated basket of 40-50 large-cap U.S. equities. What are some of those holdings, and can you break down the selection process for us?
CM As mentioned earlier, our focus is on quality, and the metrics we use to define quality include consistent earnings streams (meaning earnings that don’t fluctuate significantly from quarter to quarter), low levels of debt (which has helped companies weather the storm as interest rates have risen), and high return on equity. Overall, the goal is to build a portfolio of companies that we’d like to own regardless of valuation. That typically means large-cap stocks with good liquidity; names like Apple, Microsoft, Costco and Coca-Cola are at the top of the market cap spectrum, and we also like companies in the payment space like Visa and MasterCard. Blue-chip companies that lead their industries are the priority.
What types of investors do you think would benefit from having the BMO Premium Yield ETF (ticker: ZPAY) Fund in their portfolio?
CM Income-oriented investors could certainly see a great value-add with this type of portfolio—generally, a high level of income is being distributed on a monthly basis, and it is tax-effective as well because it’s taxed as capital gains. The Fund also makes sense for tactical investors who are looking for some element of equity exposure, but maybe in more of a defensive way. If, for instance, an investor believes that the market has rallied too much and there might be some downside risk, they can shift to this type of portfolio and its more defensive posture.
Is this strategy intended to be a core or satellite holding?
CM We believe that this type of portfolio can serve as both a satellite position for investors seeking a higher-yielding solution, as well as a core position for retirees and other income-oriented investors. A lot of investors that like BMO’s covered call strategies invest in this type of fund as well. Covered calls are another attractive source of equity-based income. The BMO Premium Yield ETF Fund can serve as nice complement in that it can supplement the income stream but in a lower-risk, less-equitized way.
Chris, one last question. We often ask our portfolio managers to provide a book or podcast recommendation that they think our Advisor audience would enjoy. What has piqued your interest lately?
CM I’ve recently started listening to the NPR podcast Planet Money. It takes everyday topics and relates them back to the economy, exploring how they tie into the financial system. It’s oriented more toward newcomers to the financials space, but it’s well-made and might be a good podcast for Advisors to recommend to their clients.
Please contact your BMO Global Asset Management wholesaler for any additional support and guidance.
1 As of April 16, 2023. Annualized Distribution Yield: The most recent regular distribution, or expected distribution, (excluding additional year-end distributions) annualized for frequency, divided by current NAV.
2 Target MER – Management Expense Ratio is an estimate only as this fund is less than one year old.
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