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Benefiting from higher implied volatility

Synchronised global growth along with subdued inflationary pressures continue to provide a positive environment for equities and bonds. However, the revived inflationary threats and the possibility of higher interest rates could erode corporate profitability and lead to further bursts of volatility. In this environment, we favour investment strategies that allow investors to cautiously participate in market upside, either by selecting quality assets or managing portfolios to enhance yield and limit interest rate risk.

The rise of expected volatility results in a higher premium for investors selling call options on their equity holdings, namely implementing covered call, sometimes called ‘buy-write’, strategies. In our covered call strategies included in the BMO Enhanced Income Equity ETFs, we have increased the mid-term option yield target from 2 to 3% per annum across all regions – UK, US and Europe. What’s more, the current outlook of stable to slightly rising equity markets is positive for our covered call strategies as investors can benefit from positive market performance while also receiving an additional premium from selling index call options against 50% of the portfolio. Typically, steadily rising markets allow our ETF portfolio managers to gradually adjust the ‘moneyness’ of the call options to minimise the risk of the options being exercised while allowing upside participation.

Overall, we expect to enhance the current net dividend yield of 3.8% for the FTSE 100 Index, 3.1% for the Euro Stoxx 50 Index and 1.5% for the S&P 500 index (as at 31 July 2018), by 3% per annum over the medium-term, to a total estimated annualised portfolio yield of 6.8% in the UK, 6.1% in Europe and 4.5% in the US.

This article was provided by BMO Global Asset Management and does not necessarily reflect the views of Citywire

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