Monetize volatility, generate yield: how structured products can help bridge the uncertainty gap

Rising equity volatility, falling bond yields

For yield-oriented clients, the current environment seems challenging—at least on the surface. Interest rates in the United States and Canada have diverged quite significantly, with the Bank of Canada cutting rates more aggressively than the U.S. Federal Reserve and most other major developed nations. As a result, yields on interest rate-sensitive products—including bonds and guaranteed investment certificates (GICs)—are down compared to a year ago. At the same time, equity market volatility driven by geopolitical and trade-related uncertainty have made stocks seem riskier, especially for Advisors’ more conservative clientele.

There are historical precedents for this kind of higher-volatility, lower-yield environment. In 2020, just after the start of the COVID pandemic, equity market volatility spiked and the stock market dropped,¹ triggering a cycle of monetary policy easing to counter slower economic growth. During that turbulent period, many institutions and other sophisticated investors found the yield they were seeking in a different type of rate-sensitive instrument: structured products.

Monetizing volatility

Like bonds and GICs, structured products—including structured notes—are sensitive to interest rates; this is because some of their funding comes from the interest rate environment. However, the key difference with structured products is that they have the ability to monetize volatility through the use of options. The coupon levels on structured products aren’t just a function of interest rates, but also a function of the underlying volatility, as well as some other factors. In 2020, the uptick in equity market volatility caused coupon levels to soar north of 20% on some equity-linked autocallable structures, which were among the highest coupons our team has ever seen in the structured notes space. More recently, we have seen better coupons on autocallable structured notes due to the uptick in volatility driven by policy uncertainty and escalating trade wars.

For clients, the potential benefits of structured notes are clear: attractive and stable coupons, even in lower-interest-rate environments. For Advisors, however, the complexity of structured products and the time commitment required to manage a portfolio of structured notes have historically been a significant barrier to access. This changed in 2023 with the launch of the BMO Strategic Equity Yield Fund (SEYF).

Simplifying access to structured products

Simply put, the BMO Strategic Equity Yield Fund uses derivatives to replicate exposure to a portfolio of structured notes, with the goal of generating stable cashflow. Rather than trying to beat the benchmark, the focus is on engineering a specific structured outcome—in this case, an 8% target yield.² Perhaps most crucially, SEYF is available in an evergreen mutual fund structure. While some Advisors do have access to structured notes, this type of simplified access—marrying the stability of structured notes with the familiarity and liquidity of the fund format—was virtually unheard of in Canada prior to the launch of SEYF.

Since SEYF’s rollout nearly two years ago, the structured notes space has continued to grow substantially. In 2023, there were about 150-200 structured notes available from Canadian issuers. Now, there are approximately 260 notes on the market. It’s a truly dizzying number of products that an Advisor would have to sift through if they were to manage a portfolio of notes themselves, especially given their different structures, protection levels, and underlying assets or indexes.

With SEYF, our robust and experienced portfolio management team does that work for you. From our modest start several years ago as a team of three, the BMO Global Asset Management (GAM) Structured Solutions team has grown to 13 members, including individuals with deep experience not only in structured notes, but in the trading and pricing of other types of structured products, asset allocation, swaps trading, and more. We believe that these capabilities are what differentiate us from our competitors in the structured solutions space.

Expanding our structured solutions suite

In 2024, we launched the second fund in our strategic yield suite: the BMO Strategic Fixed Income Yield Fund (SFIYF). In contrast to SEYF, which seeks to replicate a portfolio of structured autocallable (equity market-linked) notes, SFIYF aims to replicate the outcome of a diversified portfolio of structured interest rate notes.

Given the uncertainty being driven by the Trump administration’s trade policies, interest rate volatility in the U.S. is currently at a level not seen since the Global Financial Crisis. Capturing and monetizing that kind of volatility was the genesis of the BMO Strategic Fixed Income Yield Fund, which is why the Fund’s underlying exposure is almost entirely U.S. interest rates. In tight credit markets, like the one investors experienced in late 2024 and the first weeks of 2025, the typical way to enhance your yield would be to add more credit risk. SFIYF, like SEYF, enables clients to add a potentially higher level of stable cashflow to portfolios without the added credit risk. So far this year, SFIYF has performed well amid a backdrop of rising uncertainty, waning risk appetite and widening credit spreads, underscoring the Fund’s role as a complement to credit portfolio in risk-off markets. Despite souring consumer confidence, SFIYF continues to accrue and pay out 6% annualized coupons, with an even larger buffer for receiving coupons given the rally in U.S. rates. From an asset allocation perspective, if one is concerned about potential future declines in Investment Grade or Hight Yield bonds, now may be an opportune time to diversify a fixed income allocation into SFIYF.

BMO GAM’s structured solutions in action

In today’s uncertain environment, investors may not know whether equity or fixed income markets will go up or down, but they can be fairly sure that they will either go up or down a great deal. That is an ideal situation for structured outcome strategies like SEYF and SFIFY. By monetizing volatility, these funds ensure that markets don’t have to go up in order for clients to earn a stable yield. The funds’ embedded buffers also enables investors to receive a coupon in a wide range of market conditions. Together, this means that clients are effectively trading upside for fixed, stable cashflow and broader downside protection compared to more traditional investment products.

Active portfolio management from our experienced team also helps to mitigate risk—for instance, in SEYF, we’ve recently increased our exposure to broad-based indices in order to reduce industry-specific risk, and have rotated our exposure toward more defensive-type names as a hedge against overall equity market choppiness.

Markets may be uncertain, but clients’ cashflow requirements are not. For this reason, we’ve built the hypothetical portfolio below, which is constructed to satisfy clients’ cashflow needs while maintaining exposure to growth. (This hypothetic portfolio includes select BMO ETFs. To discuss mutual fund alternatives, please reach out to your BMO GAM wholesaler.)

Hypothetical and for illustrative purposes only. Please see disclaimers for hypothetical performance data disclosures.

*Pro-forma portfolio volatility is likely overstated for conservatism.

In addition to serving as a potential means of enhancing yield and reducing overall portfolio volatility, SEYF and SFIYF are also eligible for Registered Retirement Income Funds (RRIFs). Typically, RRIF clients need to withdraw somewhere between four and 20 percent of their assets every year in order to satisfy minimum withdrawal requirements, with the exact number varying by the client’s age. Because the main focus of these funds is on generating stable cashflow with downside protection, however, they can be included as part of a RIFF withdrawal plan and generate a premium that is potentially sufficient to satisfy most or all these withdrawals—without the erosion of capital.

*Management Expense Ratio (MER) is as of January 31, 2025.

BMO Global Asset Management, as of February 28, 2025.

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

¹ Bloomberg.

² For the F Series.

³ As the fund is less than one year old, the actual Management Expense Ratio (MER) will not be known until the fund financial statements for the current fiscal year are published. The estimated MER is an estimate only of expected fund costs until the completion of a full fiscal year, and is not guaranteed.

⁴ All investments involve risk. The value of a Mutual Fund can go down as well as up and you could lose money. The risk of a Mutual Fund is rated based on the volatility of the Mutual Fund’s returns using the standardized risk classification methodology mandated by the Canadian Securities Administrators. Historical volatility doesn’t tell you how volatile a Mutual Fund will be in the future. A Mutual Fund with a risk rating of “low” can still lose money. For more information about the risk rating and specific risks that can affect a Mutual Fund’s returns, see the BMO Mutual Fund’s simplified prospectus.

⁵ Past performance data for this fund may not be disclosed for any period until the fund has exceeded one year of history.