SMSF investors can expand their income by using covered call exchange-traded funds (ETF) due to their ability to provide an added premium above returns from dividends and franking credits, according to an investment manager.
Global X product and investment strategist Marc Jocum suggested ETFs were ideal vehicles to seek income-yielding investments and the release of covered call strategies among these offerings has boosted that ability in sidewards or downwards moving markets.
“ETFs are a great vehicle when it comes to income because there is the growth side of the returns and the income side of the returns and there are around 100 funds in the Australian market that focus purely on generating income,” Jocum told smstrusteenews.
“A covered call ETF is quite simple and does two things simultaneously: it holds a basket of shares and sells a call option on that.
“This call option gives the buyer the rights but not the obligation to buy something at a future point in time. For that right they compensate the seller by giving them a payment known as a premium, which within the covered call strategy helps generate that income.
“With the dividends and the franking credits, this adds another layer and we have seen the option premium add about 3 to 4 per cent per year in returns.”
He noted the covered call strategy offered some capital protection in downwards, sidewards or volatile markets.
“The reason for that is if markets fall, the price of the underlying basket of shares will also fall, but the premium acts as a buffer and is able to cushion the return given you are getting a payment for it,” he said.
“It’s not a new strategy. It’s been proven over decades, but now we have introduced it in an ETF wrapper, but investors need to understand that during upward markets covered call strategies are not going to outperform.
“They do really well during sideways and down markets, which is why covered call ETFs outperformed the broader ASX 200, but more recently as the ASX (Australian Securities Exchange) has approached new highs, the covered call strategies have underperformed.
“However, it is the type of strategy where you can set and forget because the benefit of it is you can blend it with the normal ETF or you hold it as a stand-alone investment.”
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