A TD Securities report shows there were 30 single-stock ETF launches in Canada this year, as of Aug. 1.NicoElNino/iStockPhoto / Getty Images
A new crop of single-stock exchange-traded funds (ETFs) has hit the market in recent weeks, offering options and leveraged strategies on individual publicly traded companies.
Canadian asset managers Purpose Investments Inc., Ninepoint Partners LP and Harvest Portfolios Group Inc. each launched new single-stock ETFs using both leverage and covered calls.
In general, these funds are solutions for investors seeking high income with moderate growth, says Karl Cheong, head of ETFs at Ninepoint Partners, which listed its HighShares ETFs in August.
“These often perform well in moderate markets,” he says, noting that this allows the ETFs to generate high monthly income from option premiums without the underlying stock being called away.
While covered-call ETFs have been in Canada for several years – and the first single-stock ETFs arrived last year – the recent offerings provide exposure to Canadian-listed companies.
They cover a broad range of large-cap firms such as Bank of Nova Scotia through Purpose Scotiabank Yield Shares ETF BNSY-T and Suncor Energy Inc. through Ninepoint Suncor HighShares ETF SUHI-T.
Notably, the distributions are monthly, with Ninepoint Suncor HighShares ETF paying 11 cents a unit, or a potential annual yield of about 12 per cent. All of Ninepoint’s HighShares ETFs charge a management fee of 40 basis points, although the firm is waiving it for the first six months.
Previously, single-stock ETFs in Canada, including ones released earlier from Harvest and Purpose, were available only for large-cap U.S.-listed stocks, which have been popular, says Daniel Straus, managing director of ETFs and financial products research at National Bank of Canada Financial Markets (NBCFM).
“A couple from Harvest have hundreds of millions of dollars” in assets under management (AUM), he says. For example, Harvest MicroStrategy Enhanced High Income Shares ETF MSTE-T has more than $400-million in AUM.
Innovating to meet demand
These aren’t the only Canadian firms with launches. In the spring, relatively new firm LongPoint Asset Management Inc. launched its Savvy ETFs, which are double-leveraged single-stock ETFs. More recently, it released inverse versions in the series.
The latest launches reflect an industry innovating to meet demand, Mr. Cheong says.
“Initially, these [Canadian ETF] products were only for U.S. stocks because they used a trust framework,” he says, adding that tax rules prevented trusts from holding a single Canadian-domiciled company.
“We saw investors likely wanted to own Shopify but wouldn’t because it didn’t generate income, or in the case of Royal Bank of Canada, it didn’t generate enough income,” he says. Both are offered in single-stock ETFs by Ninepoint, Harvest and Purpose.
Mr. Cheong adds that the industry solution was ETFs with a corporate class framework, making it viable to hold a single Canadian company.
Even without the most recent launches, a recent TD Securities report shows there were 30 single-stock ETF launches in Canada this year as of Aug. 1.
Enhanced-yield versions, typically writing covered calls on a maximum of 50 per cent of the underlying stock with light leverage as high as 1.25 times performance, have been the most popular.
These have garnered 88 per cent of inflows or about $1.1-billion in AUM, year-to-date, the TD Securities report notes.
A July NBCFM report shows growth in covered-call single-stock ETFs in the U.S. with exceptionally high distribution rates. Some have attracted capital quickly, including YieldMax NVDA Option Income Strategy ETF NVDY-A. Offering roughly a 52 per cent annual distribution rate, it has grown to $1.9-billion in AUM in two years.
These high rates may be unsustainable, the report cautions.
The report points to modelling NBCFM ran for 10 years, similar to the past decade, revealing that a 50-per-cent distribution rate would erode the original net asset value (NAV) by more than 90 per cent in five years, with the distribution falling to 11 per cent of its initial dollar amount.
NBCFM adds that lower distribution rates – 12 per cent annually – are likely sustainable and could even see distributions and NAV grow.
The ultra-high-yield products may be designed partly to attract inflows, which, in turn, help maintain high distributions, the report adds.
Mr. Straus says the higher yields in the U.S. are also the result of writing options on most, if not all, of an ETF’s underlying positions.
“You basically get more money today for the chance the stock won’t appreciate enormously in the future,” he says.
While yields are more sustainable, Canadian-domiciled enhanced-income single-stock ETFs also offer more upside because they only write calls on 50 per cent or less of the portfolio, says Chris Heakes, senior portfolio manager with Harvest.
“We want the other half of the portfolio to participate in growth,” he says, adding that light leverage can add growth.
As well, Canadian single-stock ETFs still offer significantly higher income than fixed income and dividends.
For example, Harvest Nvidia Enhanced High Income Shares ETF NVHE-T has a one-year yield of about 22 per cent with its unit price up about 14 per cent.
That said, Nvidia Corp. NVDA-Q stock has grown by about 54 per cent in the past year.
Mr. Heakes notes these ETFs aren’t created for growth. Yet, the mostly income-oriented ETFs have the potential to increase distributions in challenging times, he adds.
“In markets with a lot of uncertainty, higher volatility can result in higher option premiums,” and in turn, distributions, he says.
Risks of single-stock ETFs
Like any investment, single-stock ETFs have their share of risks. The leverage-only products, involving two or three times the daily direction of underlying stocks, have the most obvious downside risk, making them ill-suited for many clients, says Alan Fustey, portfolio manager at Bellwether Investment Management Inc.
“The longer you hold them, the further you can get from the intended objective,” he says, noting these are designed to be held a few days at most.
Enhanced-yield ETFs can be held long term, but their light leverage adds more risk.
Limited upside is another potential problem.
“Most people own stock for long-term capital appreciation,” Mr. Fustey adds, noting investors in these ETFs may not fully realize just how much growth they forgo and could be disappointed.
A steep drop in the underlying stock is also a potential risk.
“You could end up locking in [options] at the valleys,” Mr. Straus says, noting that as the stock price recovers, the ETF’s price may lag when part of the portfolio is called away.
Given the risks, Mr. Fustey says single-stock ETFs may have limited appeal to risk-averse, income-seeking clients.
Yet, the enhanced-income products may be useful to advisors who are already running these strategies on their own.
“These offer a simpler way to do that,” he adds.
While it’s difficult to gauge advisor use, Mr. Heakes says more could utilize them now that the first crop of ETFs has a one-year-plus track record.
“Out of the gate, these resonated with do-it-yourselfers, but advisors tend to wait to see how things trade, and I believe we’re at that point.”