As BMO Global Asset Management continues to launch ETF products designed to produce income, Christine Cantrell, sales director, explains that the traditional ways in which investors have accessed income have become even scarcer.
In her meetings with financial advisers and wealth managers, Cantrell has unearthed increased demand for income as the existing ways are falling short of the required levels.
“Talking to private wealth clients, I have found there is demand for pure income portfolios with a higher income target than what a blend of traditional equity and bond benchmarks currently provide.”
The arrival of MiFID II in January will limit wealth managers who have been supplementing client income by writing options; firms will only be able to write options for clients classed as professionals.
Cantrell explains that their income ETF range splits into three: the dividend yield targeted Income Leaders’ range, the lower beta, options based Enhanced Income equity ETF range, and the traditional corporate bond exposure ETFs.
In terms of dividend yield, Cantrell says that it depends on people’s appetite for yield. “If you were trying to access dividend yield through stocks using an index, it might provide you with a higher yield than the benchmark but with associated risks. If you naively allocated to the highest yielding stocks you would be overweight in certain sectors such as utilities or underweight technology, but exposed to some companies that could not sustain that dividend yield because it might be artificially high for other reasons.”
BMO Global Asset Management thinks of it from an active manager perspective who has looked at corporate fundamentals a great deal, with first a quality screen to identify companies that are highly profitable with stable earnings growth and that haven’t been funding their dividends through debt.
They also considered the systematic perspective, which can try to avoid the human behavioural biases of markets. For example, an active manager may become emotionally influenced by what a company’s story may be.
“These indices can still be quite focused, narrowing your universe to a small group of stocks making it akin to an active fund. So, as with any concentrated portfolio, the performance may be driven in the short term by sector exposures.”
The Enhanced Income ETFs offer an alternative: “It is now possible to tap into a source of income that is still exposed to broad diversified equities, avoiding sector biases,” Cantrell says. “We write call options on major equity indices and this gives you the output of 2-4 per cent income on top of the dividend yield while also reducing volatility. This strategy has shown to have a consistent reduction of volatility by about 10 per cent relative to its underlying benchmark.”
Comparing dividend yield and options-based income strategies, “These can be seen side by side, allowing you to be precise in how much income you want and whether you want to diversify the source of that income. Dividend yields can be driven by the macroeconomic cycle, while the premium from call options is driven by market conditions such as volatility.”
Within fixed income, Cantrell’s products have had most significant demand for the highest yielding part of the fixed income universe, lower-rated `junk’ status bonds.
While performance has been impressive in global high yield (returning nearly 8 per cent over 1 year*), this has meant when the yield narrowed to 3.9 per cent, investors start looking at the longer duration part of the investment grade universe, e.g. 7-10 year bonds yielding 2.9 per cent. n
*Source: BMO Global Asset Management, Bloomberg, as at 17/11/2017. Yield = Yield to worst.
For professional investors only. Past performance is not a guide to future performance. Stock market and currency movements mean the value of investments and the income from them can go down as well as up and investors may not get back the original amount invested. Investing in ETFs involves risk, including risks associated with market volatility, currency rate fluctuations, replication strategies, and changes in composition of the underlying index and assets.
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