- Covered Call ETFs: Combining sector-specific covered call ETFs can offer high yields and competitive returns compared to traditional market benchmarks.
- Risk Management: Adding bond ETFs to a stock-heavy portfolio can reduce losses during market downturns, offering a more balanced approach.
- Yield Optimization: Including covered call bond ETFs may enhance dividend yield, though their long-term performance requires further evaluation.
Investors seeking exposure to the overall market while also wanting to receive periodic dividends may consider covered call ETFs. In Canada, several firms offer a variety of covered call ETFs. Among these, Harvest covered call ETFs stand out for providing exposure to specific sectors.
My favorites include the Harvest Healthcare Leaders Income ETF (HHL.TO) and Harvest Tech Achievers Growth & Income ETF (HTA.TO). These ETFs offer exposure to the healthcare and technology sectors, respectively, while generating high income through their covered call strategy. The healthcare sector is recognized for its defensive qualities and modest capital gains, while the technology sector is known for leading market growth, currently being the largest component of the S&P 500.
I've constructed a portfolio with an equal weighting of 50% in each of the covered call ETFs, providing a balanced exposure to both the healthcare and technology sectors. As of writing, this portfolio yields approximately 8% in dividends. Portfolio comparison data indicates that it closely tracks the S&P 500 (SPY) in terms of overall value over the last five years. Notably, while the capital appreciation of this healthcare and technology covered call ETF portfolio has been similar to SPY, the investors are able to capture high dividends as well.
While this outlook appears optimistic, investors should consider the uncertainties of future risks and the desire to de-risk their investments. A well-known strategy for reducing risk in a stock-only portfolio is to incorporate fixed-income or bond-based ETFs, typically following a 60:40 allocation, where 60% is allocated to stocks and 40% to fixed income or bonds.
In Canada, numerous bond-based ETFs are available, and I have chosen to include ZAG.TO and ZRR.TO. ZAG.TO provides a diversified mix of short, medium, and long-term bonds, while ZRR.TO offers real-rate-return bonds that protect against inflation, also featuring a mix of short, medium, and long-term maturities.
When examining backtested data against SPY over a five-year period, it becomes evident that this portfolio has generated less capital appreciation over the long term. However, its strength lies in its performance during bear markets. Over the last five years, we encountered two significant bear markets: the first during the 2020 stock market crash at the onset of COVID-19 and the second in 2022 when interest rates began to rise due to inflation.
During the 2020 stock market crash, SPY lost approximately 35% of its value from peak to trough, while this portfolio only experienced a loss of around 20%. In the 2022 bear market, SPY declined nearly 40% from its peak value, while our portfolio saw a loss of about 25%.
It's worth noting that the portfolio's dividend yield has decreased to 6.28% from around 8%, as both ZRR and ZAG provide lower dividends compared to the Harvest covered call ETFs. While this yield remains relatively high, some investors may seek even higher dividend returns. In such cases, Harvest's treasury covered call ETFs could be a viable addition. For instance, I have considered adding HYPT.TO, the Harvest Premium Yield Treasury ETF, which focuses on long-term U.S. bonds and includes a substantial allocation to the iShares 20+ Year Treasury Bond ETF (TLT), while generating high income through a covered call strategy.
Investors might opt to split the 40% bond allocation into 20% traditional bond ETFs (ZAG, ZRR) and 20% in the Harvest covered call bond ETF. This approach maintains the 60:40 strategy for slow capital appreciation while mitigating market volatility, all while preserving a high dividend yield of 8.72% as of writing.
However, before implementing this strategy, it’s essential to note that while Harvest's sector covered call ETFs have a relatively long track record, their bond-based covered call ETFs are newer products, making long-term performance evaluation challenging. Comparing HPYT.TO with XTLT.TO over six months shows that both have exhibited similar performance when accounting for dividends. Whether this performance can sustain itself for investors to adopt HPYT or other bond-based ETFs as part of their fixed income strategy remains to be seen. For now, incorporating these covered call bond ETFs as a minor component of your overall portfolio appears to be a prudent approach.