A stable income from equities in 2018? Think again...


Morgane Delledonne
ETF Investment  Strategist 

Christine Cantrell 
Sales Director, ETFs -----

Past performance is not a guide to future performance. Stock market and currency movements mean the value of investments and the income from them can go down as well as up and you may not get back the amount originally invested. Investing in ETFs involves risk, including risks associated with market volatility, currency rate fluctuations, replication strategies, and changes in composition of the underlying index and assets.


For many investors, equity markets have, in recent times, been the ‘yield generator’ of choice, as bond yields have struggled to move above historic lows. But looking into 2018, headwinds from central bank tightening, the resulting likely domestic currency appreciation, as well as notable geopolitical flash points, mean that equity markets could be under pressure. I asked our ETF strategist, Morgane Delledonne, why she believes a ‘covered call’ ETF strategy could be your best income option in these conditions.

Christine: What is the main risk for equity markets in 2018 as Western central banks start normalising monetary policies?

Morgane: While the improving global economy is generally supportive for equity markets, the likely appreciation of currencies in developed economies along with tighter monetary policies pose risks to equity markets in 2018. Equity indices that include large multinational companies are the most vulnerable to an appreciation of domestic currencies as it results in lower, or negative, currency translations on foreign earnings. For example, overseas sales represent about half of the total sales for the S&P 500 and the Euro Stoxx 50 companies, and almost three-quarters for the FTSE 100 companies. With reduced central bank dominance, volatility can rise, mostly driven by currencies and political events.

Sources: Bloomberg, BMO Global Asset Management as at 8.12.17.

Christine: Do you think the BMO Enhanced Income strategy will be favourable across Western developed markets in 2018? 

Morgane: Yes, but not for the same reasons. In the UK, with the Bank of England starting to normalise monetary policy, the real interest rate differential between the UK and the US is likely to put upward pressure on sterling, which clouds the outlook for the FTSE 100 index. In this context, we believe the defensive nature of the strategy can outperform in a likely range-bound market. In the US and the eurozone, the strategy may underperform slightly in strongly rising markets but it can help to reduce volatility in the long run. In the US, the current equity bull market is vulnerable to a more aggressive-than-expected increase in interest rates amid new Federal Reserve governance and rising inflation. Furthermore, the rise of political uncertainty amid the probe on alleged Russian intervention in Trump’s election campaign, as well as persistent geopolitical risks with North Korea and China, has increased market volatility in the past month. In the eurozone, stronger economic activity and loose monetary conditions are likely to continue to support the Euro Stoxx 50 index. However, the index typically exhibits higher volatility than its US and UK counterparts.

Sources: Bloomberg, BMO Global Asset Management as at 8.12.17

Christine: What sort of investors may be interested in the strategy?

Morgane: Because the strategy is first and foremost aimed at generating income, both fixed income and equity investors can find it attractive – although from a different perspective. As with traditional fixed income instruments, the strategy distributes a continuous stream of income from writing call options on the underlying index. However, the cash flows received from option premiums do not have duration (price sensitivity to changes in interest rates) or credit risks, and the option yield ranges between 2 to 4% compared to money markets which yields below 2%. In addition, the defensive nature of the strategy can be utilised as an alternative to ‘low volatility’ and ‘high dividend yield’ equity factor investing, or as a good complement to ‘riskier’ conviction investments as it can improve the risk-adjusted return of the overall portfolio.

Christine: What is the time horizon to fully benefit from the strategy?

Morgane: The time horizon should be long term to benefit from the higher level of income and reduced volatility, as well as the potential for capital gains.

Shares are listed on the London Stock Exchange and may be purchased and sold on the exchange through a broker-dealer. Purchasing and selling shares may result in brokerage commissions. Applications for subscriptions directly to the funds may only be made by authorised participants.

Shares purchased on the secondary market cannot usually be sold directly back to the Fund. Secondary market investors must buy and sell ETF Shares with the assistance of an intermediary (e.g. a stockbroker) and may incur fees for doing so. In addition, investors may pay more than the current Net Asset Value per Share when buying ETF Shares and may receive less than the current Net Asset Value per Share when selling them.

Commissions, fees, costs and expenses all may be associated with investments in exchange traded funds. Investment objectives, risk information, fees and expenses and other important information about the funds can be found in the prospectus.

The S&P 500 is a product of S&P Dow Jones Indices LLC or its affiliates (“SPDJI”) and has been licensed for use by F&C Management Ltd. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by F&C Management Ltd. BMO Enhanced Income USA Equity ETF is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, or their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500.

The Eurostoxx 50 is the intellectual property (including registered trademarks) of STOXX Limited, Zurich, Switzerland (“STOXX”), Deutsche Börse Group or their licensors, which is used under license. BMO Enhanced Income Euro Equity UCITS ETF is neither sponsored nor promoted, distributed or in any other manner supported by STOXX, Deutsche Börse Group or their licensors, research partners or data providers and STOXX, Deutsche Börse Group and their licensors, research partners or data providers do not give any warranty, and exclude any liability (whether in negligence or otherwise) with respect thereto generally or specifically in relation to any errors, omissions or interruptions in the Eurostoxx 50 or its data.

All rights in the FTSE 100 Index (the "Index") vest in FTSE International Limited (“FTSE”). “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE under licence. The BMO Enhanced Income UK Equity UCITS ETF (the "Fund") has been developed solely by BMO Global Asset Management which is a trading name of F&C Management Limited. The Index is calculated by FTSE or its agent. FTSE and its licensors are not connected to and do not sponsor, advise, recommend, endorse or promote the Fund and do not accept any liability whatsoever to any person arising out of (a) the use of, reliance on or any error in the Index or (b) investment in or operation of the Fund. FTSE makes no claim, prediction, warranty or representation either as to the results to be obtained from the Fund or the suitability of the Index for the purpose to which it is being put by BMO Global Asset Management which is a trading name of F&C Management Limited.