Today’s Investor Still Needs An Inflation-Fighting Fund

Key Takeaways

• Persistently higher inflation creates greater pressure to have your investments generate higher cash flow as well as growth.
• The fund invests in a basket of ETFs, focused on BMO’s Covered Call suite as a means of enhancing the total yield of the portfolio.
• The premiums collected deliver a secondary source of cash over and above the dividend yield.

1. Soaring inflation was the most important theme in portfolio construction in 2022, but will that be the case this year?

MR Certainly high inflation was the story for 2022, and it continues to be for the present time. We’ve seen a very strong response from central banks to try to get consumer prices back under control, but the concern hasn’t fully been resolved yet. The latest inflation prints from Canada and the United States were 6.3% and 6.5%, respectively. Those numbers were lower than previous prints and we expect that trend to continue, yet headline inflation is still well above the 2% target from central banks. How fast consumer prices move up will remain the story for at least the first half of the year, because until price growth slows, the risk of additional rate hikes will persist and continue to be the number one investor focus.

2. Are you encouraged by the deceleration in CPI we’ve seen in Canada and the United States?

MR Directionally, yes, but in terms of magnitude, less so. The Fed and Bank of Canada are trying to balance the size of hikes against getting inflation under control in order to achieve a soft landing for the economy—to ensure we don’t tip into a deep recession as we attempt to stamp out inflation. Consumer price growth is headed in the right direction, but central banks are looking for a significant reduction in inflation, which has yet to occur. In Canada, core CPI, which strips out more volatile items, is still running well over 5%--again, moving in the right direction but not fast enough to ease inflation worries just yet. Meanwhile, the Fed has indicated that despite market expectations that they may not be done hiking.

3. How can clients use their portfolios to offset inflationary pressures?

MR Higher inflation simply creates pressure to have your investments working harder for you. Aside from the obvious need to protect principal, there are a couple of components to achieving the required upside. One, you want to increase the cash flow from your portfolio, which a fund like the BMO Global Enhanced Income Fund aims to do. The fund invests in a basket of ETFs, focused on BMO’s Covered Call suite as a means of enhancing the total yield of the portfolio. The premiums collected from the covered calls deliver a secondary source of cash over and above the dividend yield. As an added bonus, the call premiums are taxed as capital gains. However, you also want to access growth in your portfolio, in order to stay ahead of inflation as much as possible. As a rule, covered calls trade off some upside potential in exchange for enhanced yield, but our portfolio managers address this trade-off by only writing call options on half the portfolio, leaving half of the portfolio fully exposed to market returns. This can improve market participation compared to funds that write similar call options on the entire portfolio.

4. Expand on the BMO Global Enhanced Income Fund’s investment approach—what value does it add for clients?

MR With this fund you’re getting two benefits. The first is strong monthly cash flow generated by dividends and option premiums, and the second is defensive growth. The F-Series is paying a current annual yield of around 5%, paid out monthly. For a $250,000 investment, that means a client would receive income each month of $1,042. The fund’s holdings are invested in high-quality equities that will benefit from a market rally. The top three holdings—the Global, Canadian and U.S. High Dividend Covered Call ETFs—account for more than half the portfolio and are skewed toward reputable names that carry strong balance sheets. The Fund also holds a growth sleeve that includes ETFs invested in portfolios like the S&P 500, where our active portfolio management can add further growth exposure as markets recover. Owning a fund like this, is pretty appealing to what an Advisor is trying to do in today’s market.

5. How does the Fund help clients who are nearing retirement in 2023?

MR Though the income aspect of the solution does favour retirees, it is also applicable to anyone who is still wants a defensive growth tilt to their portfolio. That's exactly what we're talking about here relative to the broader market. This fund takes some of the risk off and is less growth-oriented relative to some of the portfolios and stocks that have been hit hardest by last year’s volatility. So, what you get with that is extra cash flow while retaining upside potential, all through a more defensive, yield-focused approach. We think that’s pretty appealing right now.

6. If inflation continues to cool and we get that soft landing, are inflation-protection vehicles still necessary?

MR There’s still a lot of volatility out there. Despite the emerging consensus view that inflation is going to come down, key details like how fast and when are very much up in the air. There will likely be points of time this year where the market grapples with both upside and downside surprises. That's going to create more volatility for Advisors to explain—and for clients to deal with. Re-positioning the portfolio with a defensive stance is logically more appealing right now, in our view, though it’s equally important to keep clients invested through the volatility. Why? Because when the market moves back toward a sustained period of growth, this fund can be tactically tilted toward a growth weighting and away from a defensive allocation strategy—the fund can pivot its growth sleeve to the current environment while still maintaining strong monthly cash flow. We may all agree that inflation is eventually going to get under control, but it’s what to do in the interim that causes confusion. Advisors who prefer to wait out the volatility in today’s market should consider diving deeper into their toolkit and accessing an entire basket of ETFs through a single solution—the BMO Global Enhanced Income Fund—which should in turn free their time for better, more meaningful conversations with clients.