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One Easy Method to Turn Volatility into Income

In a rising rate environment, portfolio manager Chris McHaney discusses how BMO High Dividend Covered Call strategies are positioned to combat inflation.

August 2022

Photo of Chris McHaney

Chris McHaney

Director, Portfolio Manager, Exchange Traded Funds

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Key Takeaways

  • BMO High Dividend Covered Call strategies have the ability to earn more income even while market volatility remains high
  • The portfolios have exposure to dividend-paying blue-chip companies, such as Apple and Microsoft, Canadian banks, telecoms, etc.
  • After a challenging year for fixed income, investors should consider alternative sources of income for their portfolios

Volatility has been elevated recently. Does this help or harm BMO Dividend Covered Call strategies?

CM When equity market volatility is elevated, you can harness a lot more premium per “unit of risk” within the portfolio. Specifically, when volatility increases, the Fund may be able to generate more income for investors. Today’s volatility is also driven, in part, by rising interest rates. Fortunately, interest rates are an input into option pricing formulas, and as rates increase, option premiums tend to climb as well. The rising interest rate environment and volatility landscape make for a near-perfect storm for clients looking for incremental cash flows into their portfolios.

You’ve previously said that dividend-based portfolios perform well during rising inflation cycles. Can you explain further?

CM Actually, when inflation is high—like we're experiencing now—investors tend to flock toward companies that are currently generating income. These companies hit the sweet-spot, producing steady cash flow from ongoing operations and growing their dividends over time. They will, more than likely, benefit over growth-oriented businesses that expect to see earnings somewhere in the future. It’s the dividend growers that generally perform well during periods of elevated inflation.

What kind of companies are held in these Funds? And how are they positioned in the current environment?

CM In Canada, larger-cap companies, like the Canadian banks, are a big part of the BMO Covered Call Canada High Dividend ETF Fund. Outside of banks, you have energy businesses, including Enbridge and TransCanada. Then you see the major telecoms, such as Bell and Rogers. Our BMO Covered Call U.S. High Dividend ETF Fund also holds telecoms like AT&T and Verizon, and larger tech-oriented businesses, such as Apple and Microsoft—two significant blue chip technology companies that are well established. On the other hand, the BMO Covered Call Europe High Dividend ETF Fund is focused on consumer and staple-type organizations like Unilever and Nestlé, as well as mass health care companies such as Roche and Novartis.

The rising rate environment has been challenging for bondholders. Should income investors be looking for creative solutions to supplement their income?

CM Absolutely. For a number of years, we would tell income-focused investors to look to these strategies because bond yields were so low. Now, investors realize there’s volatility potential in fixed income as well. Finding those alternative sources of cash flow is very important for risk management and risk mitigation. If you look at enhanced dividend solutions and assess how they’ve done year to date—specifically with fixed income falling off 10% to 12%—they are generally positive or slightly negative. Their correlation to interest rates isn't necessarily as strong, and the income level remains high from both dividends and the options premiums. That said, fixed income still plays an important role in risk mitigation against equities in general. That defensive aspect isn't always present, which was the case this year, but it still provides a nice balance overall. Therefore, to preserve safety while boosting payouts, investors should consider alternative income sources to balance out their portfolios.

In April, we saw banks increase dividends in the U.S. and Canada1. What can investors expect in the coming months?

CM That will depend on GDP growth going forward. A slowdown is anticipated, and many people are predicting a recession. In that environment, I wouldn’t expect huge dividend increases simply because the banks may want to bolster their balance sheets against any potential losses on the loan side. But, if governments and central bankers are able to orchestrate an economic soft landing where there’s a bit of a slowdown, no recession and no real economic pain, you could see dividends increase. There’s a long history of that in Canada. It’s also possible to see share buybacks, which are more popular in the U.S.

With a global energy supply crunch, are Canadian dividend payers poised to increase their payouts?

CM There is certainly some potential there as well. But it all depends on the economic backdrop. We've seen oil spike to $120 and come back down to under $100 based on lower expected demand in the future. A global recession or a slowdown will be an important determinant in whether or not companies increase their dividends. Currently, energy companies are very cash generative, holding in the $70 to $80 price range for oil. If we see steadiness, the Energy sector will be in a good position to increase dividends, especially in Canada. The ongoing Russian invasion of Ukraine compounds the complexity of forecasting oil prices. How will things play out? The supply of natural gas in Europe will likely make for a very difficult winter, and, even though it’s a regional market, it tends to have global effects, which also adds difficulty to energy price predictions.

We often ask portfolio managers to provide a book or podcast recommendation for our Advisors audience. Chris, you said Thinking in Bets by Annie Duke in your April 2021 article, Why Retirement Portfolios Continue to Attract. What has piqued your interest lately?

CM My 14-year-old daughter starts high school in the fall, and I’ve been very focused on her reading list lately. For all the parents out there, I strongly recommend listening to the Connected Parenting Podcast with Jennifer Kolari. She’s an expert on child and family psychology, yet the show still manages to be light and entertaining. It touches on topics like financial literacy, things to do in the summer with your kids and how to keep an open dialogue with them on important topics—including money.

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

BMO Covered Call Canada High Dividend ETF Fund

FundSERV Codes Front End
Advisor (Front End) BMO99127
F (Fee Based) BMO95127

BMO Covered Call U.S. High Dividend ETF Fund

FundSERV Codes Front End
Advisor (Front End) BMO99766
Advisor (Front End – US$) BMO79766
F (Fee Based) BMO95766
F (Fee Based – US$) BMO40766

BMO Covered Call Europe High Dividend ETF Fund

FundSERV Codes Front End
Advisor (Front End) BMO99767
F (Fee Based) BMO95767

1 Bloomberg, BMO Asset Management, as of April 30, 2022.

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