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Mar 1, 2023

Portfolio Confidential

by Barbara Stewart

Q: I recently retired and now think that I need to take over my investment portfolio. Quite frankly, I feel that I'm not being served very well by my investment advisor. I have been considering this for a few years now, and I have developed a strategy that I think will work for me. I've put together a theoretical portfolio of 27 holdings with a combination of 12 covered call Exchange-Traded Funds (ETFs), three regular ETFs, and 12 stocks, all with a minimum six per cent yield.  Income would be the objective, and capital growth very secondary. What are your thoughts?

A: Diversification is good, but there is such a thing as too much diversification. Given your overriding investment objective to generate income for the long-term, it is unclear as to why there are so many different ETFs in your overall portfolio. In particular, why do you need so many different covered call ETFs? Why not pick two or three? I think it is better to have fewer holdings and keep your portfolio structure as simple as possible.

When you are putting together your portfolio, always ask yourself, "What role does this stock or ETF or fund play?" If you can answer that question for each holding, you will be more comfortable with volatility and less likely to keep switching things around. In an ideal world, you will have a simple yet solid list of holdings that you understand and expect to deliver on your objectives over time.

Q: How long have covered call ETFs been around? They seemed to have performed relatively well over the last year in comparison to a lot of other things.

A: Covered Call ETFs: Are They for You? This is the title of an excellent piece written nearly 11 years ago by Tom Bradley, Chair and Co-Founder of Steadyhand. I will draw from his article as I could not say this better myself. According to Bradley's blog (in 2012, but he's still posting today!), "A long-standing investment strategy is back in vogue. "Covered call writing" is designed to generate income from a stock by selling a call option against it (the right to buy the stock at a set price in the future). While the strategy has been around forever, what's new is covered call ETFs, which now total over $1.5-billion."

So covered call ETFs have been around since at least 2012. What are these funds all about?

Bradley: "Well, first and foremost, they're actively managed equity funds. ZWB owns the six major banks, while HEX holds 30 of the largest stocks in Canada. In both cases, the positions are equally weighted (in HEX, RBC is the same size as Silver Wheaton) and don't change very much. The active part relates to writing call options on each stock. The premiums received from selling these options, along with any dividends, are paid out to the unitholders on a monthly basis. The brilliant thing about these funds is that option premiums are considered capital gains, so the distributions are tax efficient."

What is the downside?

Bradley: "The strategy demands that managers trade a lot, and the cost of trading is high. In its first ten months of operation, HEX's trading costs were 1.2 per cent of assets, which exceeded the fund's management expense ratio of 0.8 per cent (BMO doesn't disclose ZWB's cost of trading options). Also, with the growth of these funds and a relatively thin options market in Canada, there will be times when managers have to pay up for liquidity. As one hedge fund manager told me, "The bid/ask spreads are not insignificant. "

Who are covered call ETFs appropriate for?

Bradley: "These funds are only appropriate for investors who are in need of tax-effective income. They're not a replacement for a core fixed-income strategy (Guaranteed Investment Certificates (GICs), bonds or preferred shares), but rather an enhancement. They belong firmly in a portfolio's equity bucket."

Q: I no longer want to manage my own money, so I am about to start interviewing potential investment advisors. What are the key skills that I should be looking for?

A: The highest level of qualifications: The investment industry tends to employ people with great personalities: make sure they also have the highest level of qualifications. If you are effectively outsourcing the management of your portfolio, look for a CFA Charterholder or someone with a Master of Finance. A Chartered Financial Analyst (CFA®) designation is given to those who have completed the CFA® Program and completed acceptable work experience requirements. Advisors with this designation are qualified to manage portfolios on a discretionary basis (e.g. to make trading decisions on behalf of clients).

#2: Ability to communicate: Look for someone with the ability to communicate on investment issues, but also on other topics. This means they will talk with you in simple English so that you clearly understand the point(s) they are trying to convey, but also that they can communicate with you as your needs change over time. Test this out in the interview! Ask them to explain an investment concept or two that you genuinely want to understand better. For example, "I am confused…interest rates went up, but my bond prices went down." Do they talk in jargon, or do they offer you a well-thought-out example of exactly how this works?

#3: Big picture focus: Work with someone who has a big-picture focus. Your advisor needs to understand your overall life objectives as well as your financial objectives.

Erin O'Brien, CFA, is a Partner and Portfolio Manager with Cumberland Private Wealth Management in Toronto: "How will I know when I have enough money to retire? This is a pressing question in many people's minds and can only be answered by doing a comprehensive financial plan. This plan needs to be revisited on a regular basis to see how you are progressing toward your goals to determine if any adjustments to the plan need to be made over time. This involves forecasting your monthly retirement budget and reviewing your pension income, current assets, and savings requirements against the backdrop of an achievable rate of return projection. This process will guide you in determining how much you need to save and for how long in order to have enough funds to support you through your retirement years. It is never too early or too late to start this process."

#4: Empathetic nature: In my experience, there are two main reasons that advisors need to have an empathetic nature.

The first reason is that they will end up in meetings with clients or potential clients that have suddenly become single. I wrote about this concept in an article for CFA Institute: "My calculation is that 90% of married women will end up needing to manage their own finances at some point due to divorce or widowhood. About half of all U.S. marriages fail, and 11 million of the 13 million widowed spouses in the United States are women. That's more than 80%. So, the odds are pretty good that even a married woman will find herself single one day. Then we need to add in those women who will be "virtually single" due to incapacity in their partner, with 10% of all Americans over 65 having diagnosed Alzheimer's."

The second reason is that when advisors/clients develop a strong connection and a bond of trust, there is a high likelihood that the client will feel comfortable confiding in the advisor about something deeply personal. Other times a client might just need someone to talk to or a shoulder to cry on. Jacqueline Ruedin Rüsch is the Founder of Privilège Ventures in Zurich. She shared: "I will never forget a performance review in which a client who I was not particularly close with suddenly started to tell me about his best friend's recent suicide. I was really surprised at the way he was talking with me: it was as if he was with his psychoanalyst. Initially, I thought he just wanted to share because of the shock, but he ended up in tears, talking about very confidential details for over an hour with me. I have to admit it was a bit difficult to manage, but I felt very humbled that he wanted to share such a personal story with me."

What happens if, down the road, you have a change in marital status or you experience a shock of some sort? Check your gut feeling about where your potential advisor fits on the empathy and communication scale.

 Barbara Stewart, CFA

Do you have questions about your own investment portfolio? I have recently set up The Rich Thinking® Financial Advice Hotline. This will be a win/win: you get a free 30-minute confidential Zoom chat offering an independent, unbiased perspective on your financial situation with no sales pitch! In exchange, I get to use the anonymized data that will come from these conversations to make my Rich Thinking research even better. Email me to book your Zoom discussion: