Put Your Income on Steroids with a Global Enhanced Income Fund

Key Takeaways

• Despite ongoing deceleration in headline inflation, consumer price growth remains stubbornly high and is expected to continue adding to market volatility.
• BMO’s Covered Call strategy gives investors exposure to capital growth while buffering against market swings by generating steady income.
• Now offering an even bigger yield; the monthly distribution on F Series units was recently raised to 5.5-cents per unit from 4 cents.¹

As a portfolio manager looking at where to allocate capital, what are your expectations for the balance of 2023—are you more bullish on markets stabilizing or bearish about continued volatility?

CH I’m generally an optimistic person, but it’s important for investors to manage risk. And in my view, the BMO Global Enhanced Income Fund is about defensive growth and high-quality stocks, so it fits with a cautiously positive outlook which is appropriate right now. The TSX Composite Index and S&P 500 have been up and down so far this year, while the growth outlook for the economy overall has been resilient. But there are still going to be challenges, inflation being a big one. Rate hikes have taken a toll on valuations over the last several quarters, and while we may be near or even at an end to the current rate-hiking cycle, that is certainly not a given. Fed Chairman Jay Powell has indicated that further tightening of monetary policy remains firmly on the table if not inevitable in order to stem inflation. Moreover, rates may need to remain elevated for a prolonged period. Inflation remains well above many central banks’ target rate of 2%, and when businesses and consumers face higher interest rates, it creates challenges for stocks from a profitability perspective as financial conditions tighten and spending is pressured. To that end, we still expect earnings growth to slow amid the potential for a shallow downturn in the economy. I have full confidence we'll get through this period successfully, but there are still some challenges.

Base on that outlook, explain how a fund like the BMO Global Enhanced Income Fund can effectively navigate through that scenario?

CH Being in a diversified portfolio of high-quality companies that are mature, are generating strong cash flows and paying healthy dividends is a good place to be for the year, in my view, which is exactly what this fund provides. It’s a simple and elegant solution to gain exposure to income-oriented global equities, which is hard to do on an individual basis. This fund is well-suited for clients who want to mitigate some risk in equities, but still want to remain invested, and then to offset some of that risk with income generation. When you look at the composition of the Fund, it's diversified across all developed markets. As importantly, we're using Covered Call ETFs extensively to increase those dividend payouts and tilt the portfolio further towards cash-flow generation. As a result, I view it as a kind of one-ticket diversified income solution that has an asset allocation profile that is incredibly hard to replicate anywhere else.

Speaking of global diversification, what’s your take on emerging and international markets this year? They were driven down by a variety of factors over the past several quarters, but are now rallying.

CH We have not looked to allocate to emerging markets directly but have benefitted from indirect exposure, holding international companies that have gained from the improving macro backdrop that’s being led by China’s economic re-opening as that country moves on from zero-Covid policies. We have increased direct weightings in Europe, which we have become more constructive on and which experienced a strong end to 2022, outperforming U.S. and Canadian stock markets by several percent. The shift has been in coordination with our BMO Global Asset Management Multi-Asset Solutions Team (MAST) colleagues. We leverage their viewpoints when making some of those regional asset allocations. On a relative basis, European valuations have become attractive over the last quarter or so. That reflects the lower pressure that consumers and businesses in that market are experiencing with respect to interest rates and inflation compared to North America, where rates and consumer prices have moved higher, faster.

Like the broader economy, growth stocks have regained some of their footing to start the year. Can growth sustain this momentum or will value regain the market leadership it’s held for the past several quarters?

CH In our view the wind is still at value’s back until we see a real ‘Fed pivot,’ or decrease in interest rates. While Growth stocks have experienced this burst of momentum, they will remain challenged over the medium-term, so long as rates remain at these higher levels—and in our view, rates have to remain where they are, or perhaps even go a quarter- or half-percentage point higher in order to bring inflation back toward 2%. That will be a significant headwind for growth. So, the balance of power, so to speak, still remains with value this year and that translates well to the BMO Global Enhanced Income Fund’s portfolio, because there's a natural connection between value and companies that we invest in, which have attractive yet sustainable dividend yields. The tilt in the portfolio towards dividend growth has benefited from our exposure to value since we launched the fund in May, 2022. And that will remain the case for 2023: the wind is still at the backs of value stocks, and therefore our overall strategy.

Though consumer prices are moderating, inflation remains stubbornly high. Should investors still be looking to hedge their portfolios against rising prices?

CH Absolutely. Even though we’ve seen the monthly CPI prints edging lower, we are still looking at annualized inflation that is north of 5%. When you look at what types of low- to medium-risk investment strategies can match or exceed that percentage, there aren't many. Covered call strategies, and particularly covered calls on top of dividend-based strategies, can deliver that. The ETFs that this Fund holds, led by the BMO Global High Dividend Covered Call ETF and BMO Canadian High Dividend Covered Call ETF have yields of between 6-8%.² They ensure investors keep pace or exceed the rate of inflation and their investments are not losing purchasing power in terms of the income they’re earning. And on the capital-returns side, yes the market is still dealing with volatility, but we know in the long term the market will move higher. An investor in this fund is keeping up with inflation while also maintaining exposure to capital appreciation on quality stocks.

What about downside mitigation - how does this fund provide protection in more volatile markets?

CH This fund is heavily invested in BMO’s Covered Call ETFs, which by definition have two components to protect against downside risks. First, are the types of equities that are being invested in. The second component is the covered call overlay. Starting with individual equities, we are laser focused on high-quality names that are established, blue-chip dividend payers: Microsoft Corp., Home Depot, Verizon Communications and the like—companies who have a history of generating strong cash flows, and paying out sustainable dividends. Firms of that stature and maturity tend to have less risk than the broader market. And then layering on the covered call overlay, you're increasing your income based on the options premiums that are collected. As an example, the F-Series of the BMO Global Enhanced Income Fund is paying a current annual yield of around 6.8%, paid out monthly. For a $250,000 investment, that means a client would receive income each month of $1,423. That comes with the trade-off of limiting some upside, but investors still get exposure to meaningful capital growth, all while buffering against big market swings—because you have that higher income stream, that's going to mitigate some of the volatility.

Lastly, we sometimes ask portfolio managers and investment experts we interview about a book or podcast that they’ve read or listened to lately that relates to their approach to investing. Do you have any recommendations?

CH I found a book on my bookshelf I revisited not too long ago. I’m Back!: More Rare Air by Michael Jordan. Among other things, he talks about being prepared for games, mentally and physically. Eating a consistent diet and visualizing the upcoming opponents and game, and as a result he comes to the arena ready to play. I think there is a similarity to good portfolio construction – where if investors have solid preparation and balance in their portfolios, they can be more ready and effective in managing live markets.