Why high dividend covered call ETFs make perfect sense

Why high dividend covered call ETFs make perfect sense

Why high dividend covered call ETFs make perfect sense

With market conditions shifting and no end in sight for the ongoing trade disputes, many client portfolios are in need of something new and a bit different. Uncertainty is spreading and while portfolios should be capturing the ongoing growth in the market, they should also be positioned for a market shock or downturn.

For Alain Desbiens, Director, ETF Distribution, BMO GAM, allocating assets to high dividend covered call ETFs makes perfect sense in the current environment.

“One of the main benefits is that covered calls ETFs are able to harness the volatility inherent in global equities in order to generate yield,” Desbiens says. “Another key benefit is related to the fact that the equity recovery is now 10 years in. While on balance the global economy is strong, it’s likely that forward returns over the next couple years will not be as high as prior returns. Covered call strategies are ideal in a modest bull market environment.”

Canada’s changing demographics are also boosting the importance of covered call strategies. Canadian investors are aging and demand for income among baby boomers is becoming more acute, with the TSX yielding 2.7% and the S&P 500 1.5%.*

Covered call strategies enable investors to generate sustainable yield without taking on additional risk. But, as Desbiens explains, the biggest risk is the trade-off between generating yield and potentially sacrificing upside return.

“It means the portfolio management team has to manage this trade-off prudently, through our methodology, to ensure upside participation is strong,” Desbiens says. “They stick to 50% portfolio coverage, and utilize ‘out of the money’ (OTM) options, so that underlying equities have the potential to appreciate without being overly hindered by the call options. They are not greedy for yield, which would compromise potential upside, but target a modest 2-3% yearly increase in incremental income from selling of call options.”

Covered call ETFs provide investors with some other key benefits, including low cost, lower beta, tax efficiency and transparency.

“The portfolio methodology is explained clearly and 100% of portfolio holdings are disclosed to investors,” Desbiens says. “We also publish any updates on the strategy monthly on the BMO ETF dashboard. We have the biggest asset base of covered call-options in Canada (over $5 billion in assets), so investors are able leverage the knowledge and expertise of the BMO ETF team.”

BMO GAM currently offers five high dividend covered call ETFs: the Canadian High Dividend Covered Call ETF (ZWC), Europe High Dividend Covered Call ETF (ZWP), Europe High Dividend Covered Call Hedged to CAD ETF (ZWE), US High Dividend Covered Call ETF (ZWH) and US High Dividend Covered Call Hedged to CAD ETF (ZWS). The funds have been performing well in recent months, something Desbiens attributes to the high dividend suite’s methodology, which is focused on creating well-diversified core equity dividend-oriented portfolios.


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“The BMO ETF portfolio manager team screen for blue-chip dividend payers that have at least a three year history of paying sustainable dividends that have not been cut, and preferably are increasing,” he says. “As well, the equities are weighted by yield, and tend to be large cap as we screen for option liquidity. These two screens impart a value and large cap bias to the portfolio.”

“Sector and country exposures are capped where applicable and sector balance is considered in order to provide a balanced core solution in each geography, to which we can supplement the dividend yield with call option premium.”

*Source: BMO Asset Management Inc. As of August 31st, 2018

This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

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