Stock Market: 3 ETFs for Income Investors

Most younger investors want to see their money grow. Cash flow is not a concern; what they want is to find the next Shopify and watch as a thousand dollars turns into a million. It can happen, but rarely.

Older people, especially those who are retired, are more interested in cash flow. They want securities that produce steady income with the least possible risk.

My Income Investor newsletter focuses on those types of securities. Here are three ETFs we have recommended that you may want to check out. Prices are as of the close on Oct. 1.

Harvest Healthcare Leaders Income ETF (TSX: HHL.U)

Type: Exchange-traded fund

Current price: $8.50 (figures in US dollars)

Annual payout: $0.696

Yield: 8.2 per cent

Risk: Moderate

Website: www.harvestportfolios.com

Comments: This ETF invests in an equally balanced portfolio of 20 leading health service companies, including insurers, equipment manufacturers, biotechnology, and pharmaceutical companies. Pharmaceuticals account for 39 per cent of the portfolio.

Some of the top names include Regeneron Pharmaceuticals, Medtronic PLC, Stryker Corp., AbbVie, Thermo Fisher Scientific, Abbott Laboratories, and UnitedHealth Group. All are large-cap companies (minimum capitalization is $5 billion) and most are US based. The managers write covered call options on a portion of the holdings to generate additional cash flow.

There are three investment options. HHL.U is denominated in US dollars; HHL is hedged back into Canadian dollars and priced in loonies; HHL.B is also priced in Canadian dollars but is unhedged. We are tracking the US dollar version.

You’d think healthcare stocks would be top performers in this environment, but the fund is only up about 7 per cent since it was recommended in 2018. But the key as far as this newsletter is concerned is income, and the managers have consistently delivered that, with monthly distributions of US$0.058. That translates into an 8 per cent yield. It’s rare to find a portfolio of this quality that delivers this level of cash flow.

The one major negative is a management fee of 0.85 per cent, very high for an ETF.

BMO Covered Call Dow Jones Industrial Average Hedged to CAD ETF (TSX: ZWA)

Type: Exchange-traded fund

Current price: $26.35

Annual payout: $1.22 (trailing 12 months)

Yield: 4.6 per cent

Risk rating: Moderate

Website: www.bmo.com

Comments: This ETF tracks the Dow Jones Industrial Average (hedged to Canadian dollars) and uses covered call options to generate additional income. The options are written out of the money, which means the stock is trading below the potential sale price (the strike price). The option premium provides limited downside protection. The underlying portfolio is rebalanced to maintain better representation of the broad market, and options are rolled forward upon expiry.

We last reviewed this ETF in June in The Income Investor. Since then, the Dow has hit several new records, but the fund is only up by few pennies over that period. Why? Because of the covered call options that are written to generate income. They’re doing just that – the distributions are a steady $0.10 a month (there was a $0.02 top up in December). But the trade-off for the good yield is lower capital gains.

If your main goal is income, you can live with that. But if you want a fund with more upside potential, look elsewhere.

Brompton Flaherty & Crumrine Investment Grade Preferred ETF (TSX: BPRF, BPRF.U)

Type: Exchange-traded fund

Current price: C$27.09, US$26.86

Annual payout: $1.248

Yield: 4.6 per cent

Risk: Moderate

Website: www.bromptongroup.com

Comments: This fund invests in US preferred shares, an area in which most Canadian investors have little knowledge. It is overseen by Flaherty & Crumrine, a highly respected specialty US preferred share manager.

The US preferred market is much larger, more liquid, and less volatile than the Canadian market, so it’s a good choice for investors who want to diversify.

The goals of this ETF are to provide reliable monthly cash distributions (currently $0.104 a unit) and a stable net asset value. The managers actively invest in a portfolio consisting primarily of US dollar-denominated corporate preferred securities, trust preferred securities, and other corporate debt. At least 75 per cent of the portfolio consists of securities that are rated investment grade at the time of purchase.

There are two types of units. BPRF is hedged back into Canadian currency, while BPRF.U is denominated in US dollars.

Almost 62 per cent of the assets are invested in financial industry preferreds (banks and insurance companies). Utilities account for 15.9 per cent and energy for 9.9 per cent.

The fund was launched in October 2018. The Canadian dollar units have posted a 7.9 per cent average annual compound rate of return since inception (all performance numbers to Aug. 31) and are up 4.1 per cent year-to-date in 2021. The US dollar units are faring somewhat better, with an average annual return since inception of 8.7 per cent and a year-to-date gain of 4.4 per cent.

The yield is very attractive at 4.6 per cent.

This continues to be an undiscovered gem, with only $74 million in assets under management. Trading volume is very light so it’s best to place a limit order.

The management fee is high for an ETF, at 0.75 per cent, but the results make it worthwhile.

This fund is best suited for investors seeking regular income who want to diversify their portfolio with preferred shares denominated in US dollars.

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/subscribe

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