Building a portfolio that pays every month can take a lot of time and tinkering, particularly when working toward a larger income target. Another alternative for investors to consider is a monthly income ETF.
That represents another, simpler way to get started. That’s especially appealing for investors who want exposure outside of the usual universe of well-known Canadian dividend stocks.
One option that’s worth a closer look right now is Hamilton Enhanced U.S. Covered Call ETF (TSX: HYLD).
What this monthly income ETF actually owns
As of the time of writing, the fund offers a yield of 11.9%. That yield will likely be the first thing that attracts income investors.
The fund is a fund-of-funds that primarily holds U.S. equities. This spreads exposure across more companies than holding a single stock.
The funds that are part of this monthly income ETF span multiple sectors, including financial services, technology and health care.
HYLD also hedges its currency exposure to the loonie. That minimizes the influence of exchange rate shifts, but it doesn’t offer any protection from the risks in the underlying stocks.
How HYLD generates its monthly income
One of the main questions for investors looking at this monthly income ETF is how it can generate that double-digit distribution. The answer to that is that the underlying funds use options strategies to generate cash alongside dividends from their investments.
With covered calls, a fund collects a premium by selling someone else the right to buy shares at an agreed price within a specified period. The premium provides income, but it can limit gains on the shares covered by those options.
The fund also uses cash borrowing to increase its investment exposure. The fund allows nearly 25% leverage. This means that returns or losses can be amplified.
For income-seekers, a $10,000 investment in HYLD will generate about $99 each month. That can provide a boost to retirement income or fund other investments.
Investors who aren’t ready to draw on that income can also choose to reinvest it. Once reinvested, that $99 per month works out to a little over a half-dozen new shares generated without additional funding.
What investors give up for that yield
Prospective investors should remember that the yield shows how much cash an investment pays relative to its price. What it doesn’t reveal is how much investors will earn overall.
If, for example, the unit price falls, that decline can offset some or all of the income earned. That’s why the total return is important to consider. If a $1,000 position falls to $850 over a year while paying $110 in distributions, the investor still ends up with a $40 loss.
Another risk to note during rising markets is the covered call part. When stocks climb sharply, the options can restrict how much of that increase the underlying funds capture.
Leverage also needs to be mentioned. Borrowing increases exposure when markets rise, but it can also accelerate losses when markets fall. Interest costs can reduce the benefit of that exposure.
Finally, there’s the distribution itself. There’s no guarantee that a monthly income ETF with an 11% yield will maintain its current payout.
Where HYLD fits in an income portfolio
HYLD is an intriguing option to consider in a portfolio where monthly cash flow is needed.
It shouldn’t be the sole anchor for that income portfolio. It’s a supplementary income producer that can work alongside other investments.
That makes the fund an option to consider as a small position, as part of a larger, well-diversified income portfolio.