Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Call Option ETFs showed their value in 2022

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This was not an easy year for markets, but one asset class delivered cash flow for investors despite these headwinds

Pixels/Javon Swaby

By Paul MacDonald, CFA, Harvest ETFs

(Sponsor Content)

After the euphoria of 2021’s everything rally, 2022 brought many investors right back down to earth. The asset classes that led in the latter periods of the most recent bull market  lost ground in this year as the ‘permacrisis’ — Collins dictionary’s word of the year — was felt across markets and asset classes since the end of February.

We know the story: inflation, supply chain challenges, rate hikes, and war in Ukraine all conspired to wreak havoc.

As the graphs below show, few areas of the market were immune from 2022’s tribulations.

 

Source:  Bloomberg, Harvest Portfolios Group Inc. December 21, 2022

Sector & Market Returns YTD

 

Source:  Bloomberg | Data as on December 22, 2022; prices normalized to 100 (starting December 31, 2021)

While markets have been decisively in the red for the year, the path has been marked by significant volatility spikes – both to the upside and downside.  As a proxy for volatility, the VIX Index, aptly called the CBOE Volatility Index, visually shows the volatility spikes that were experienced by most investors. One can also see that volatility has been at levels on average that are meaningfully higher than in recent history.

Source:  Bloomberg, December 20, 2022.  Additional Information:  https://www.cboe.com/tradable_products/vix/

The dramatic and volatile swings in equity markets outlined above should, in a normal year, have been offset by investors’ bond holdings. That’s the logic of the traditional 60/40 equity/bond portfolio.

2022 was not a normal year. Rising interest rates pushed down the value of bonds at the same time as equities were falling. The FTSE Canada Universe Bond Index, for example, was down 9.91% YTD as at December 21st.

Certain funds in one asset class, despite the negative overall returns in the market, were able to earn and deliver solid tax efficient cash flows for investors by monetizing some of the market volatility: call option ETFs.

What are call option ETFs?

Call Option ETFs — also called equity-income ETFs — are investment funds that hold portfolios of equities, but use call option strategies to generate income for unitholders. Those call option strategies trade a certain amount of market upside potential for certainty of some cash flows during a specific period: selling the option to buy a stock tomorrow at today’s price in exchange for a premium. Call Option ETFs pass those premiums on to unitholders as tax-efficient cash flow. They forego a certain amount of market upside, if markets swing higher, but generate a consistent amount of ‘income’. A ‘bird in the hand’ as it were.

That ‘bird in the hand’ income came at high rates in 2022. Many of Harvest’s call option ETFs had annualized yields  of more than 8% or even 10% during the year. That income — when considered a portion of total returns — was able to offset some of the losses in underlying equity values through the year, as the below example of the Harvest Healthcare Leaders Income ETF (HHL:TSX) demonstrates.

For illustrative purposes only.

The chart above is based on a hypothetical initial $100,000 CAD investment and only shows the market value per unit of Harvest Healthcare Leaders Income ETF (“HHL”) using the daily market close on the TSX and identifies the monthly cash distributions paid by HHL on a cumulative basis. The cash distributions are not compounded or treated as reinvested, and the chart does not take into account sales, redemption, distribution or optional charges or income taxes payable by any unitholder. The chart is not a performance chart and is not indicative of future market values of HHL or returns on investment in HHL, which will vary.

Why actively managed call option ETFs offer advantages

All of Harvest’s call option ETFs use an active and flexible call option writing strategy. That means the ETFs’ portfolio managers can sell as many or as few calls as they need to generate the ETF’s monthly distribution: up to a hard 33% write limit. That means at all times a minimum of 67% of each ETF’s holdings is fully exposed to potential market upside. It also allows these ETFs to capture market opportunities in a way that passively managed call option ETFs cannot.

Key to this advantage is the fact that options generate a higher premium when markets are more volatile. When stock prices swing wildly in the way they did throughout 2022, options cost more. Therefore the premium earned is higher. Since covered call ETFs sell options, they can generate the cash for their monthly distributions by potentially selling fewer options when markets are more volatile. This means that more of the ETF’s portfolio may be exposed to potential market upside compared to a passive systematic covered call strategy.

As much as 2022 was treated as a down year on markets, it’s notable that many of the volatile swings we’ve seen have been to the upside. By earning higher premiums from options during periods of volatility, Harvest ETFs have been able to capture some of those upswings, but have also been able to generate high and consistent cash flows for investors.

Many of the macro conditions that had negatively impacted markets in 2022 have shown signs of abating, too. Inflationary pressures have let off slightly, and the final Federal reserve rate hike of 2022 was only 0.5%: lower than the year’s cadence of 0.75% increases. If a less hawkish fed and signs of inflation dropping manifest more fully in 2023 we may see a market recovery. In such an instance these actively managed call option ETFs may be better able to capture more market upside than a passively managed call option ETF, but until that recovery is in full bloom, the Harvest ETFs can generate significant monthly cash flows.

The right strategy for the right time

In a year where everything seemed to be falling, many call option ETFs offered Canadian investors attractive income yields: paid monthly these were a source of returns at a time when returns were hard to find. The greater opportunities for upside capture afforded by an active & flexible call option writing strategy may give Harvest’s call option ETFs an advantage over passively managed ETFs.

As predictions for 2023 roll in, with the prospects of both market recoveries and economic recession on the horizon, the aspects of call option ETFs that delivered for investors this past year may prove themselves valuable once again. 2022 may have been the year call option ETFs announced their importance for Canadian investors, but we believe that importance will continue to be borne out in the years to come.

Paul MacDonald is the Chief Investment Officer and Portfolio Manager with Harvest Portfolios Group Inc. 

 

 

 

Commissions, management fees and expenses all may be associated with investing in HARVEST Exchange Traded Funds (managed by Harvest Portfolios Group Inc.) Please read the relevant prospectus before investing. The funds are not guaranteed, their values change frequently and past performance may not be repeated. All comments, opinions and views are of a general nature and should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage in personal investment strategies. Tax, investment and all other decisions should be made with guidance from a qualified professional.

Investing in Crypto or Stocks: Which is safer for your Portfolio?

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Considering whether to buy crypto or stocks? Investing in top stocks makes a lot more sense than buying crypto and we explain why in this article.

Are you interested in investing in crypto or stocks? I still can’t think of anything that would make me optimistic on bitcoin or any cryptocurrency, even after the deep slump the whole sector has gone through recently. The best thing I can say about bitcoin is that it will probably remain volatile, rather than vaporizing like the worst crypto performers.

Please don’t misunderstand. I respect and agree with the many investors who have high expectations for the future of blockchain. (That’s the digital technique that serves as a foundation for bitcoin and other crypto creations.) Some investor/digital gurus think blockchain will change the world. They may be right. However, bitcoin is simply the earliest and most widely known blockchain user.

Bitcoin’s stature as a blockchain poster child has earned it plenty of media and public recognition. But bitcoin’s link with blockchain has no bearing on the future of bitcoin (or any other cryptocurrency) as a substitute for money.

This may surprise respondents to a recent survey about their plans for retirement financing. One quarter of those surveyed, and 30% of millennials, said they were planning to rely on “cryptocurrencies” to finance some of their golden years.

Should I invest in crypto or stocks? Understanding false narratives and how it relates to Bitcoin investment risk

The term “false narrative” has been around at least since the 1830s, but came into common use around the time of the 2016 U.S. Presidential Election. Each of the two main political parties accused the other of concocting and spreading an incomplete and/or biased story that falsely showed their candidate in a bad light.

However, it’s easy to concoct your own false narrative and let it guide your financial decisions. Widespread false narratives happen rarely enough that they find a way into history. Personal false narratives happen much more often. But each one is a little different from the next, and most people would prefer not to talk about them.

Here is a look at a false narrative involving Bitcoin investment risk: Continue Reading…

Retired Money: Inflation and some compensations in federal tax brackets and contribution limits

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My latest MoneySense Retired Money column has just been published and can be accessed by clicking the highlighted headline: Inflation and investments: Heads up if you’re retired or retiring soon. 

It looks at the anxiety of would-be retirement savers in the light of soaring inflation and in particular, a recent Leger Questrade poll that looked at how inflation is affecting Canadians’ intentions to contribute to TFSAs and RRSPs. My Hub blog on this includes 4 charts on the topic.

Not surprisingly, inflation is a particular concern for retirees and those hoping to retire soon. The 2023 RRSP Omni report found that while 87% of Canadians are worried about rising prices, it also found 73% of RRSP owners still plan to contribute again this year, and so do 79% of TFSA holders. That’s despite the fact 69% fret that inflation will impact their RRSPs’ value and 64% worry about their TFSAs’ value. Seven in ten with RRSPs and 64% with TFSAs are concerned about inflation and a possible recession: 25% “very” concerned.

A Silver Lining

The MoneySense column also summarizes some of the compensating factors that Ottawa builds into the retirement saving system: as inflation rises, so too do Tax brackets, the Basic Personal Amount (BPA: the tax-free zone for the first $15,000 or so of annual earnings), and of course TFSA contribution limits (now $6500 in 2023 because of inflation adjustments). This was nicely summarized late in 2022 by Jamie Golombek in the FP, and reprised in this Hub blog early in the new year.

Because tax brackets and contribution levels are linked to inflation, savers benefit from a little more tax-sheltered (or tax deferred) contribution room this year. The RRSP dollar limit for 2023 is $30,790, up from $29,210 in 2022, for those who earn enough to qualify for the maximum. And TFSA room is now $6,500 this year, up from $6,000, because of an inflation adjustment. As Golombek noted, the cumulative TFSA limit is now $88,000 for someone who has never contributed to one.

Golombek, managing director, Tax & Estate planning for CIBC Private Wealth, wrote that in November 2022, the Canada Revenue Agency said the inflation rate for indexing 2023 tax brackets and amounts would be 6.3%: “The new federal brackets are: zero to $53,359 (15%); more than $53,359 to $106,717 (20.5%); more than $106,717 to $165,430 (26%); more than $165,430 to $235,675 (29%); and anything above that is taxed at 33%.”

Another break is that the yearly “tax-free zone” for all who earn income is rising. The Basic Personal Amount (BPA) —the annual amount of income that can be earned free of any federal tax — rises to $15,000 in 2023, as legislated in 2019.

CPP and OAS inflation boosts in late January

 On top of that, retirees collecting CPP and/or OAS can expect significant increases when the first payments go out on or around Jan. 27, 2023. (I include our own family in this). There’s more information here. Continue Reading…

Are Dividend investors leading the charge?

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By Dale Roberts

Special to Financial Independence Hub

Where have all of the investors gone? It’s no surprise that “advised” Canadian mutual fund investors have been bailing on the wealth building thing. Most of them are sold high-fee funds and see little or no advice. They lose out on two counts. And in 2022 even ETF investors have largely bailed on buying growth assets (stocks and REITs) as they go on sale. The ETF’ers are moving to cash ETFs and bonds. Where I see continued enthusiasm (OK, they are rabid) is in the Canadian dividend investor camp. They love the lower prices that can bring bigger dividend payments. Dividend investors are leading the charge on the Sunday Reads.

ETFs gained while mutual funds felt pain in 2022.

From that Advisor’s Edge post …

As of the end of November, Canadian mutual funds had outflows of $35.6 billion in 2022, or 2% of 2021 year-end assets, National Bank Financial (NBF) said in a report on Jan. 5th. (Full-year mutual fund data is yet to come.)

“Only money market mutual funds recorded inflows, an indication of the capital-preservation mode that informed many investor decisions this year,” it said.

During 2021’s rising markets, mutual fund sales soared to a dramatic record-breaking $112 billion, outselling ETFs for the first time since 2018.

ETFs back on top

Canadian ETF inflows in 2022 landed back on top, with a “whopping” $35.5 billion in net flows in 2022, or 10% or of 2021 year-end assets, the report said.

As part of tactical positioning, cash-alternative ETFs were a “major story” of 2022, the report said, describing them as “an inflow darling” since the first such fund was launched in 2013. In 2022, the funds more than doubled in assets to $15 billion amid the year’s bond selloff. CI High Interest Savings ETF was the fund with the most inflow ($3.2 billion) for the year.

Equity ETFs scored $13 billion in 2022, or about 37% of ETF net flows.

(Back to Dale)

The move to safety

So while ETF investors did add equities in modest fashion, there was a greater move to safety: cash and bonds. Of course, we’re supposed to do the opposite: buy more growth assets as they go on sale. You know that ‘be greedy when others are fearful’ Warren Buffett kind of thinking.

I’ve continued to ask readers:  what stocks and ETFs are you buying? That post was from the end of September. Looking back that was near the bottom for 2022. Stocks have bounced back modestly from the time of the post. We could go below September of 2022 prices or not. Who knows? But sale prices are good, that we know.

On Findependence Hub: how to navigate the coming worldwide recession.

Dividend investors are on FIRE

While focusing (too much) on the dividends can have its drawbacks, there’s no denying that dividend investing leads to very good behaviour. I am truly pleased to see that Canadian dividend investors (friends) are chomping at the bit to buy more stocks and greater dividends.

On My Own Advisor, Mark offers the Weekend Reading: Dividends on FIRE edition. Thanks to Mark for including my Canadian Wide Moat Stock Portfolio update.

In Mark’s post you’ll find a few portfolio and dividend focused updates for the investing year of 2022. Included in the mix – drip investor, and Jordan at Money Maaster.

Mark also offered his recent portfolio update.

Rob at Passive Canadian Income updated his dividend and portfolio performance for December in this post.

Totals For 2022

Dividends Year To Date Total – $10,692.84
Other Passive Income Year to date – $13,491.23
Total Passive Income for 2022 —– $24,184.07
Year End Goal – $25,000

Canadian stocks are offering very good value these days. Kyle delivered a very good post on MoneySense – Making sense of the markets. Kyle included some very good broader market and investment commentary. And on Canadian stocks …

Our current P/E valuation discount relative to the U.S.’s S&P 500 shows that as a group, Canadian stocks are substantially cheaper than in the past when compared to American stocks.

That crazy good savings rate

For some inspiration Bob offers 9 weird things he did to save money in his 20s. Bob has always had a crazy (good) savings rate. That is certainly one of the keys to building wealth. It’s not what you make, but what you keep, and then what and how you invest. Continue Reading…

All good things must come to an end: There by the grace of Paul Volcker went Asset Prices

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Image courtesy Creative Commons/Outcome

By Noah Solomon

Special to Financial Independence Hub

During the OPEC oil embargo of the early 1970s, the price of oil jumped from roughly $24 to almost $65 in less than a year, causing a spike in the cost of many goods and services and igniting runaway inflation.

At that time, the workforce was much more unionized, with many labour agreements containing cost of living wage adjustments which were triggered by rising inflation.

The resulting increases in workers’ wages spurred further inflation, which in turn caused additional wage increases and ultimately led to a wage-price spiral.The consumer price index, which stood at 3.2% in 1972, rose to 11.0% by 1974. It then receded to a range of 6%-9% for four years before rebounding to 13.5% in 1980.

Image New York Times/Outcome

After being appointed Fed Chairman in 1979, Paul Volcker embarked on a vicious campaign to break the back of inflation, raising rates as high as 20%. His steely resolve brought inflation down to 3.2% by the end of 1983, setting the stage for an extended period of low inflation and falling interest rates. The decline in rates was turbocharged during the global financial crisis and the Covid pandemic, which prompted the Fed to adopt extremely stimulative policies and usher in over a decade of ultra-low rates.

Importantly, Volcker’s take no prisoners approach was largely responsible for the low inflation, declining rate, and generally favourable investment environment that prevailed over the next four decades.

How declining Interest Rates affect Asset Prices: Let me count the ways

The long-term effects of low inflation and declining rates on asset prices cannot be understated. According to [Warren] Buffett:

“Interest rates power everything in the economic universe. They are like gravity in valuations. If interest rates are nothing, values can be almost infinite. If interest rates are extremely high, that’s a huge gravitational pull on values.”

On the earnings front, low rates make it easier for consumers to borrow money for purchases, thereby increasing companies’ sales volumes and revenues. They also enhance companies’ profitability by lowering their cost of capital and making it easier for them to invest in facilities, equipment, and inventory. Lastly, higher profits and asset prices create a virtuous cycle – they cause a wealth effect where people feel richer and more willing to spend, thereby further spurring company profits and even higher asset prices.

Declining rates also exert a huge influence on valuations. The fair value of a company can be determined by calculating the present value of its future cash flows. As such, lower rates result in higher multiples, from elevated P/E ratios on stocks to higher multiples on operating income from real estate assets, etc.

The effects of the one-two punch of higher earnings and higher valuations unleashed by decades of falling rates cannot be overestimated. Stocks had an incredible four decade run, with the S&P 500 Index rising from a low of 102 in August 1982 to 4,796 by the beginning of 2022, producing a compound annual return of 10.3%. For private equity and other levered strategies, the macroeconomic backdrop has been particularly hospitable, resulting in windfall profits.

It is with good reason and ample evidence that investing legend Marty Zweig concluded:

“In the stock market, as with horse racing, money makes the mare go. Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate – primarily the trend in interest rates and Federal Reserve policy – is the dominant factor in determining the stock market’s major direction.”

To be sure, there are other factors that provided tailwinds for markets over the last 40 years. Advances in technology and productivity gains bolstered profit margins. Limited military conflict undoubtedly played its part. Increased globalization and China’s massive contributions to global productive capacity also contributed to a favourable investment climate. These influences notwithstanding, 40 years of declining interest rates and cheap money have likely been the single greatest driver of rising asset prices.

All Good things must come to an End

The low inflation which enabled central banks to maintain historically low rates and keep the liquidity taps flowing has reversed course. In early 2021, inflation exploded through the upper band of the Fed’s desired range, prompting it to begin raising rates and embark on one of the quickest rate-hiking cycles in history. Continue Reading…