There’s been a summer surge of single-stock ETFs, with three independent companies — Harvest Portfolios Group Inc., Ninepoint Partners LP and Purpose Investments Inc. — each launching 10 new leveraged offerings in late August and expanding this unusual concept to Canadian stocks. All three companies plan further expansion of their single-stock suites.
One of the key attractions of these niche products is a lower price per ETF unit, relative to the share price of the underlying stock. Shares of Royal Bank of Canada, for instance, fetched $200 in early September. At the same time, the single-stock ETFs based on RBC ranged between $10.43 and $12.72 at the three issuers.
These low per-unit prices make options strategies more accessible to fund managers, since options are priced in board lots of 100 shares. However, a highly liquid options market is required for these strategies to be effective.
In terms of investor comfort, it also helps that the underlying stocks are large-cap companies that are leaders in their industries and, in many instances, household names.
But the more meaningful difference between these ETFs and the single stocks that they hold is how portfolio managers create differentiated returns through the use of covered calls and relatively modest leverage. An attractive feature is tax-efficient income, since the options premiums that the ETFs collect are capital gains, which are only 50% taxable.
“The outcome at the end of the day is going to be a smoother, more income-oriented return profile, more steady distributions and potential downside mitigation,” said Karl Cheong, executive vice-president and Ninepoint’s head of ETFs. The Toronto-based firm is the newest entrant in single-stock ETFs with its all-Canadian starting lineup.
Ninepoint is looking, in part, to gain market share with aggressive pricing. Its management fee is 29 basis points, versus 40 basis points for Harvest and Purpose. Also, Ninepoint’s management fee is being waived until the end of February.
Harvest, known for its focus on equity income strategies, entered the single-stock market in August 2024 and now has 21 ETFs based on U.S. stocks, along with the 10 newly launched Canadian ones. Most of them, including all the Canadian ETFs, employ 25% leverage.
An ‘income-generation engine’
Purpose pioneered single-stock ETFs in December 2022 with its first five, each based on a U.S. stock. By February of this year it had 15. The 10 Canadian single-stock ETFs bring Purpose’s total to 25.
“Our core thesis here is really making volatility work for you instead of against you by turning it into an income-generation engine,” said Purpose portfolio manager Nick Mersch, who co-manages Purpose’s suite of Yield Shares.
Purpose aims to accomplish its goal through a complex option-writing strategy combined with 25% leverage. At any one time, 10 to 20 different covered calls are being held on each ETF.
Holding covered calls with a variety of different maturities and strike prices is designed to lessen the impact of a rising stock being called away. “What this really allows us to do is ultimately participate much more meaningfully in a long-term growth upside of the underlying security,” Mersch said.
There are generally dramatic differences between the distribution yields of the underlying stock and those of the leveraged single-stock ETFs. At Harvest, annualized yields generally range between 10% and 40% of net asset value, said Chris Heakes, senior portfolio manager with Oakville, Ont.-based Harvest.
“The biggest factor in option pricing is the implied volatility, which is just in a sense, a number representing how risky a stock [is], or what the demand is for options on that name,” Heakes said.
Higher-growth companies tend to be more volatile, and that translates into higher yields for single-stock ETFs. Among the highest yielding is Harvest MicroStrategy Enhanced High Income Shares ETF. Its annualized distribution yield was recently about 45%. The underlying stock, renamed Strategy Inc. in August and paying no dividends, describes itself as the world’s largest bitcoin treasury company.
The use of 25% leverage doesn’t dramatically change the risk profile of a single-stock ETF versus the underlying stock, said Cheong. “The intent there for us is not to take on hedge-fund style risk, but really to give investors a slight yield enhancement.”
For every $100 invested, the ETF can hold about $125 worth of stock, which means there are more shares generating dividends and option premiums. In rising markets, leverage will boost returns. “But in falling markets, it can magnify losses, so we’re transparent about that trade-off,” Cheong said.
The combination of covered calls and modest leverage, which generally tend to offset each other in terms of the ETF’s risk profile, works better in some types of markets than others. Because of options premiums, “these type of strategies tend to perform really well in sideways markets,” Cheong said.
In strong bull markets, however, the strategies might lag the performance of the underlying stock, since there’s a greater likelihood that the call options will be exercised, limiting the ETF’s capital growth.
Wrap-style portfolios
Single-stock ETFs are an oddity, in that they lack the diversification of holdings that is the hallmark of most investment funds. Recognizing that the normal expectation of ETF investors is to obtain exposure to multiple securities, the three single-stock issuers have created wrap-style portfolios as part of their High Income, HighShares and Yield Shares product suites.
With $830 million in assets, Harvest Diversified High Income Shares ETF is much larger than any of the U.S. single-stock ETFs that it holds. “That’s been one of the runaway (sales) successes in the lineup,” Heakes said. Harvest Canadian High Income Shares ETF, holding a portfolio of single-stock Canadian ETFs, was added to the suite in August.
Meanwhile, Ninepoint Enhanced Canadian HighShares ETF holds all 10 of the firm’s recently launched single-stock ETFs. The holdings are tilted in favour of the highest yielding single-stock ETFs, subject to a 15% cap for any one holding.
Purpose takes a different multi-stock strategy. Tech Innovators Yield Shares Purpose ETF, launched in February, offers a thematic approach by holding technology-related single-stock ETFs. Look for Purpose to expand its offerings in the near future with additional multi-stock yield-share ETFs that target different growth or income objectives.