CIO outlines why his firm launched four ETFs holding only one stock each
On Wednesday Harvest ETFs launched four new products, based on the Oakville firm’s traditional wheelhouse: covered call income. The new ETFs — which Harvest has called “high income shares” each hold shares of a single company — one of Eli Lilly, Amazon, Microsoft, or NVIDIA, overlaid with a covered call strategy to generate a monthly income distribution. This is the second series of ‘single stock’ ETFs launched in Canada — after Purpose’s “yield shares” series, and the first to be traded on the TSX.
Paul MacDonald, Chief Investment Officer and Portfolio Manager at Harvest ETFs, explained why his firm is offering these ETFs now. He outlined some of the reasons why these companies were chosen as well as the mechanics underlining their income yield. He put these products in the context of today’s macro environment, and explained why he thinks these four companies still have room to run.
“They’re widely held, they’re massive liquid companies and they’re leaders in their respective fields, we don’t overcomplicate that,” MacDonald says. “A lot of people will own these names, who have owned them for a long time, their requirements and needs may change over time, meaning there are a lot of people who would love cash flow from these names, and are willing to give up some upside in favour of that cash flow.”
Each ETF will write covered calls on up to 50 per cent of the position to generate a monthly distribution. MacDonald notes that this does cap some degree of the potential upside from these holdings. Considering the past growth trajectory we have seen from these companies, a cap on that growth may not appear as advantageous on first glance. MacDonald notes, however, that these highly valued companies have tended to experience more volatility lately. Thanks to the volatility connection in options pricing, he argues that the covered call strategy can monetize some of these companies’ stock volatility while maintaining some upside exposure.
He also emphasizes cash flow — $0.14 per month for Amazon and Microsoft, $0.16 for Eli Lilly, and $0.18 for NVIDIA. The units are priced at $12 at launch. Harvest is also launching an “enhanced series” of these ETFs which add a leverage component of roughly 25 per cent, increasing the yields and heightening the risk ratings of these ETFs.
The four names Harvest has selected are among the most expensive stocks on the US market. Microsoft is currently trading at over 35x earnings, Amazon at over 40x, NVIDIA at over 70x, and Eli Lilly at over 115x. MacDonald pushes back on the valuation issue, however, noting that these companies’ valuations have run up because they’ve managed to grow their earnings. He views these companies as long-term holds.
He notes, however, that following the run in these stocks, there could be a tactical advantage to trading off some upside for cash flow, which can help monetize or offset some of the volatility that comes as these stocks face tougher and tougher comps.
Despite the relative novelty of these strategies, MacDonald emphasizes their straightforwardness. He notes that beyond an understanding of capped upside, the potential impact of the levered series, and the nature of the stocks themselves, there’s not much in the way of added complexity.
“You’re owning an individual stock that many people already own, a lot of advisors may even write options on them already, now you get to do that in a Canadian trust structure,” MacDonald says.
The menu of ETF and securities options for advisors is a long one at this point. MacDonald notes, however, that many advisors and investors favour a more targeted tactical approach. He argues that these products complement that approach, allowing for either long-term holds with cash flow, or tactical shifts for exposure to massive names with some income.
“The high-level point is that if you own the stock and you want to have some income on it, you can now buy this on the TSX, it pays an attractive cash flow and its tax efficient,” MacDonald says. “Options are generally taxed as capital gains, and these are available as a Canadian trust, but it really comes down to wanting to add this name and wanting that cash flow.”
