An equity play for income and growth, all in one

With interest rates so low, fixed income isn’t providing what it used to. Advisors across Canada are fielding client calls explaining that the income streams they were expecting from an allocation to domestic bonds may not be coming. One of the strategies advisors and portfolio managers are turning to is dividend payers. By reallocating to blue-chip dividend paying equities, those dividends are anticipated to make up the income shortfall. Taking on more equity, though, means taking on more risk and many of the top performing stocks in today’s market don’t pay a dividend. Targeted, specific strategies can be key to a successful dividend play.

Two ETFs from TD Asset Management (TDAM) are built to deliver income in an innovative way, both from dividends and options. The TD Active Global Enhanced Dividend ETF (TGED) and the TD Active U.S. Enhanced Dividend ETF (TUED) are each designed to offer clients exposure to an actively managed core of quality stocks.  On top of this, using active call & put writing to enhance income from dividend payers and create income from non-dividend payers. Benjamin Gossack, Portfolio Manager of the TGED and TUED funds, says the funds are engineered to help deliver for clients on multiple fronts.

“We're trying to achieve growth and income,” says Gossack, who came to TDAM after another solution-seeking career in aerospace engineering. “The market says you either have to buy a product for growth, or a product that delivers income…the biggest issue is that the products that focus on income typically sacrifice growth for income. Instead, by working actively, we believe we can achieve both. And the results¹ have proven themselves.”

Gossack says the strategy differs from the typical systematic covered calls that define most income ETFs. While those funds deliver income at consistent yields, investors often fail to see the return beyond their yield. That return, Gossack says, is often underperforming because the calls need to be written so close to the current stock price, minimizing upside. That’s tough for savers, Gossack says, because while they’re generating income their money isn’t growing. Gossack says he believes he has a better strategy, using active management.

Gossack and his team focus on secular winners and cash compounders, whether or not they pay a dividend. If they don’t, he and his team can write a call to extract an income stream from them. They write their calls based on fundamental analysis, something that requires active management.

Gossack cites the example of Nike, which saw its stock rise 8 percent in late September on the back of a great earnings report. Because they expected solid performance from Nike, Gossack’s team wrote their strike a couple of dollars higher than the peak of Nike’s growth. They extracted good income, without having to sacrifice upside. It’s something you can only do actively, he says, because the strike he’d write for Nike is very different from JPMorgan or Apple. Picking and choosing what call to write and when, is the only way to do this.

Alongside the call strategy, Gossack and his team write puts on their holdings to seek to maximize the yield on cash. In writing a put on a stock, he essentially sets the stock price lower while getting paid to potentially buy it at a discount. It’s an especially solid strategy in a volatile market, as option premiums are typically higher during these times. The put will mean cash holdings can earn income from the premiums, similar to selling insurance, but if the stock that the cash is written against falls below the price threshold, the fund will have to buy the stock at the lower price. Gossack has made such a play with Nvidia, the semiconductor chip company, that he would like to own at a lower price. While it’s above his price threshold, the cash is earning high yields, if the stock price of Nvidia dips below the price at which Ben wrote the put, the fund will buy it at that lower price. 

“It’s about trying to pull on every resource we have, to deliver income and growth for clients” Gossack says.

In his past career as an aerospace engineer, Gossack designed mathematical models preventing plane engines from exploding if they hit a bird. He knows a thing or two about risk. He moderates risk in the TGED and TUED portfolios by focusing on blue chip stocks and companies with robust balance sheets. High quality equities, he says, don’t usually swing with such massive volatility, especially when put in a diversified basket of other blue chips.

These strategies and Gossack’s management talent are packaged in a convenient ETF wrapper. At a 65bps management fee, the TGED and TUED ETFs are competitively priced in the active ETF universe. Investors get a package of income and growth generating strategies and a mind for risk management. Gossack says that his team aren't trying to reinvent the wheel. Rather, they’re using their whole toolkit to help deliver the income and growth clients need.

“It's three pillars: we pick the stocks, we write calls, and we aim to turn stocks that don’t pay dividends into payers,” Gossack says. “we try to maximize the yield on our cash and get paid to buy stocks that we like. That's all we're trying to do every day. That's our rinse, wash, repeat.”

Footnotes:

Note: Returns for periods over one year are annualized; net of expenses.