One of the coolest Canadian ETF releases recently (at least in my opinion) was Purpose Investment's suite of yield shares. For those out of the loop, these are Canada's first single-stock ETFs, and the first yield-focused single-stock ETFs in the world.
These new ETFs are complex to say the least, combining options overlays, leverage, and single-stock exposure. They're also only found on the NEO Exchange, which speaks volumes to the latter's willingness to pioneer and host innovative ETFs.
For all the Canadian investors out there eyeing these new ETFs, this article will give you a primer on how these funds work and the use cases. Let's dive deep into the new NEO-listed Purpose Yield Shares.
Single-Stock ETFs: How they work
Currently, Purpose Investments has a total of five different Yield Shares ETFs on the market that charge a management fee of 0.40%:
- Alphabet (NASDAQ:GOOGL) Yield Shares Purpose ETF (YGOG)
- Amazon (NASDAQ:AMZN) Yield Shares Purpose ETF (YAMZ)
- Apple (NASDAQ:AAPL) Yield Shares Purpose ETF (APLY)
- Berkshire Hathaway (NYSE:BRKa) Yield Shares Purpose ETF (BRKY)
- Tesla (NASDAQ:TSLA) Yield Shares Purpose ETF (YTSL)
As their name suggests, each of these ETFs has a single holding – the stock of its reference company. These ETFs essentially act as "wrappers" for a particular U.S. stock.
But that's not all – the yield shares also make use of a covered call overlay. According to Purpose, the ETFs will sell covered calls on up to 50% of the portfolio in a systematic manner. The calls sold will generally be at-the-money (ATM) or up to 5% out-of-the-money (OTM).
Finally, the last component of the Yield Shares ETF is the use of modest 25% (1.25x) leverage to enhance both returns and yield. Unlike most leveraged ETFs, this exposure is not reset daily nor high (2x), making the Yield Shares ETFs more suitable as a long-term hold.
Therefore, by buying a yield shares ETF, investors receive exposure to the price movements of the underlying stock (hedged to the Canadian dollar) in addition to monthly income from the covered calls.
Single-Stock ETFs: Use cases
Many of the U.S. stocks tracked by Yield Shares either pay no dividends (GOOGL, AMZN, BRK.B, TSLA) or pay small dividends (AAPL). By adding a covered call overlay, the Purpose Yield Shares allow investors to hold their desired U.S. stock while receiving regular income. In Canada, proceeds from covered call strategies are taxed at the more efficient capital gains rate.
The use of an options overlay also allows the Yield Shares to harness volatility in the underlying stock to produce higher yields. This is because the size of options premiums is affected by changes in implied volatility. This is likely why as of March 3rd YTSL currently has a distribution yield of 15.14%, compared to 5.99% for BRKY - the underlying TSLA shares are much more volatile than BRK.B.
We also need to consider the difficulty and capital-intensive nature of running a covered call strategy without these ETFs. For example, if I wanted to sell one TSLA covered call, I would need to buy 100 shares of TSLA stock for collateral. Currently, TSLA trades at around $190 USD per share. I would need to convert currency and cough up $19,000 USD.
Alternatively, I could buy YTSL for around $22 CAD per share and benefit from a professionally managed covered call strategy without needing to buy 100 shares of TSLA and sell calls myself. The 1.25x leverage provided by the ETF also saves me the need to margin a TSLA position on my own, which isn't allowed in a TFSA or RRSP. Thus, the Yield Shares provide convenience and capital efficiency.
As with most covered call / modestly leveraged ETFs, the usual risks to watch out for are market, leverage, and derivative risk. If the underlying stock does poorly, the corresponding Yield Shares will as well, perhaps to a higher degree due to the leverage used. In addition, the options overlay is subject to a myriad of factors that could influence its performance and make the size of premiums fluctuate.
This content was originally published by our partners at the Canadian ETF Marketplace.