Stock Smarts: Harvesting More Income

Rising interest rates can pose a dilemma for income investors. Here’s how you might find your way around it.

Rising interest rates are both good and bad news for income investors. On the plus side, they could eventually lead to better rates from the banks on GICs, which are still a popular choice for many people.

The downside is the negative effect that higher interest rates have on bond prices and interest sensitive securities, such as REITs and utility stocks.

So where can you find some decent income stocks that aren’t vulnerable to rising interest rates? One of my brokers, Jeff Finkelstein of RBC Dominion Securities, came up with an idea that I like very much.

He is buying units in Brand Leaders Plus Income ETF (TSX: HBF). This is a small ($37.7 million) fund from a company called Harvest Portfolio Group. It’s an equal weighted, currency-hedged portfolio of 20 blue chip U.S. multi-national corporations with a minimum market cap of US$10 billion (the actual valuations are much higher). The managers use covered call options on 33 per cent of the securities to generate additional cash flow beyond the dividends received.

Here are the details:

Type: Exchange-traded fund (ETF)
Trading symbol: HBF
Exchange: TSX
Recent price: $8.78
Annual payout: $0.65
Yield: 7.4 per cent
Management fee: 0.75 per cent
Risk: Higher risk
Recommended by: Gordon Pape
Website: harvestportfolios.com/etf/etfbrand-leaders-plus-income

The fund has been around since July 2014 but got off to a slow start. The price dropped to below $8 in early 2016. It has gradually trended higher since then, closing on Aug. 18 at $8.75.

The portfolio roster reads like a Who’s Who of American blue-chip stocks. You’ll find names like Disney, Intel, Citigroup, Johnson & Johnson, McDonalds, Visa, PepsiCo, 3M, Nike, Apple, IBM, JPMorgan Chase, Microsoft, Starbucks, etc. There is only one European company, Royal Dutch Shell.

These are not interest-sensitive securities. Rather, they are economically sensitive, meaning that when GDP is growing they tend to do well. Much of their earnings come from overseas operations, providing exposure to economies that in many cases are growing at a faster pace than the U.S.

Because of the way it is structured, this ETF is unlikely to produce significant capital gains. But the cash flow is very attractive. The managers target a monthly distribution of $0.0542 per unit ($0.65 per year) and so far they have delivered. That works out to a yield of 7.4 per cent based on the Aug. 18 closing price.

There is also a tax break here if the units are held in a non-registered account. In 2016, the entire distribution was treated as return of capital, meaning no tax was payable for the year. The cost base of the units is adjusted accordingly, resulting in a larger capital gain when and if they are sold.

This fund is attractive for readers who want more exposure to U.S. blue-chip stocks and are seeking above-average cash flow. There is also a U.S. dollar version available, trading as HBF.U.

One word of caution. Because of its small size, this is a thinly traded security. Daily volume rarely exceeds 10,000 units. So place a limit order and be prepared to wait for a fill.

Discuss this recommendation with your financial advisor before making a decision.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.