Five years on, what does the popularity of leveraged options ETFs tell advisors?
Who’s buying leveraged options ETFs?
Sommerville explains that his firm noticed the market for covered call ETFs in the wake of the COVID-19 pandemic. Originally a financial sector specialist firm, they saw the Canadian banks as attractively priced and noticed that many of the advisors they worked with had an appetite for income. Once their covered call products had gained some traction, they looked for ways to improve on the issue that all covered call strategies have: they cap upside potential in exchange for income. The addition of 25 per cent leverage, Sommerville says, allowed Hamilton to add to the ETFs’ yield while mitigating some of that capped upside.
These products, he says, have timed well with the mass retirement of the baby boomer generation. A larger per centage of investors are looking for retirement income, and they’re attracted to the tax efficiency of covered call options as their income is paid as capital gains. Sommerville says that in his firm’s experience, there has been a balance between the advisor and DIY channels in terms of their appetites for these ETFs. Where that interest starts to diverge, Sommerville says, is when we look at ETFs with yields in the low 20s. Those ETFs, which tend to come with higher levels of leverage or more volatile or concentrated underlying holdings, tend to be more popular among DIY investors.
The role of a bull market
Sommerville acknowledges that these ETFs have benefitted from strong bull markets, which has likely buoyed their popularity. With the exception of 2022, annualized returns on US and Canadian equity markets have been incredibly strong since HDIV was first launched. That strength has meant the leverage has worked and many of these products have seen significant NAV growth in addition to their income payouts. Moreover, the market dips and corrections that have taken place over the past half-decade have tended to be followed by sharp moves upwards.
“I think investors have been trained to buy the dip since COVID,” Sommerville says.
Despite this strong performance, ongoing investor confidence, and narratives around market backstops like the Fed put, Sommerville acknowledges that this bull market could still end and markets could move in the other direction. When that happens, the leverage in these ETFs will accelerate the downside just as it contributed to the upside. Sommerville argues that this dynamic makes the underlying holdings of a leveraged ETF essential to understand. He says that blue-chip companies held in diversified baskets should be able to better withstand a market downturn.
