An ETF investment expert shares the strategy his company used to develop and actively manage an income-generating and well-diversified portfolio
Harvest Portfolios follows a philosophy: invest in quality income-generating companies with long-term growth aspects. This is what they had in mind when they created Harvest Brand Leaders Plus Income ETF (HBF). The fund was launched in 2014 to include companies that can grow and prosper across multiple business cycles.
Paul MacDonald, CIO of Harvest Portfolios, attributes the fund’s success to two factors. Firstly, including the top-20 leading global brands in the ETF. Secondly, actively manage the ETF portfolio using financial metrics to eliminate deteriorating companies and buy better opportunities. MacDonald believes it is an attractive option for advisors.
MacDonald said: “When you look at the companies in the portfolio, advisors can go to their investors and say, ‘you own these great companies’ in any type of market. It provides advisors a diversified solution of quality companies that have performed well across economic cycles. It has an income strategy, so we think it can be a core position for advisors looking to get a quality portfolio with a high tax-efficient income.”
Selecting from the best of the best
MacDonald discussed the selection process when it came to the companies included in this actively managed fund, which includes 20 large-cap, US-listed companies that have leading global brands. He said: “They are 20 picks from the World’s Top 100 Brands”. MacDonald cited examples of brands like McDonald’s, Johnson & Johnson, Pepsi and Microsoft. “These are great-quality leading businesses, many of which have been around for a long time, and people want to own them.”
The thought behind the selection of these companies didn’t just lie in their popularity but in their likelihood to have robust dividends and their ability to withstand a potential recession. Though Harvest is not too concerned about listing jurisdictions because the companies are global businesses, all 20 holdings are North America listed. With the exception of utilities, REITs, and resources, which tend to be more regional—the fund is well-diversified over a variety of sectors.
Evaluating the value of a stock
Harvest doesn’t randomly select from the World’s top 100 brands but evaluates their stock value individually. MacDonald explains that there are three factors Harvest uses for their evaluation. First, they measure value by looking at a company’s price-to-earnings ratio and cash flow valuation metrics. Second, they factor quality, which Harvest measures by looking at the return on equity and the volatility of cash flows. Lastly, Harvest looks at income. They don’t just look at the dividends themselves, but the growth of income, free cash flow and dividends.
Once the companies are selected, Harvest analyses what the proper allocation should be so that the portfolio is well-diversified. Being actively managed, the fund is reviewed every quarter and the 20 companies that are included in the fund are reviewed and rebalanced to equal weight. When a company’s financial situation either deteriorates or a new candidate shows superior financial metrics, Harvest makes changes to ensure optimum growth and income.
Implementing a covered-call strategy
Another way that Harvest generates income is through their covered-call strategy. As explained by MacDonald: “If you write a covered call, you are given a premium for that call option and are required to sell the stock at a predefined price.” He continued: “What we like to do is put a maximum on any one position, which we can write up to 33%. That means we always have a long bias to the other 67%. So, if the stock goes up, we will capture the growth of the company.” He said utilizing the covered-call strategy enhances the income in the portfolio, which typically leads to less volatility in down markets because the premium insulates it.
Having the 33% maximum gives the opportunity for growth but the fund is positioned more for those who value equity exposure and income. MacDonald said: “You can look at the portfolio and, in an up or down market, say, ‘I still own these great companies and I have earned a very high distribution.’ From that perspective, the strategy has performed well.”
Mixing all these winning ingredients
Though many ETFs may follow an index instead of relying on a fund manager, the lead Portfolio Manager on the Fund James Learmonth’s, work speaks for itself. The fund is generating income for its investors plus they get to own equity of 20 of the world’s best companies. It’s appealing to investors and advisors alike.
The selection of good and profitable companies also plays a huge role in ensuring that the risks stay low and that there are still rewards to be collected. Ultimately, all the elements in play like the company selection, covered call strategy, and stock analysis is what makes this ETF particularly successful.
Learn more about the Harvest Brand Leaders Plus Income ETF (HBF) by downloading this White Paper.