Time for investors to plant seeds in these underappreciated sectors

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Like many of those who grew up in the Prairies, I come from a family with strong farming roots, so I know that having patience is ingrained in a farmer’s makeup, which is something that we investors can certainly learn from.

As famed French botanist Henri Alain Liogier said: “Life on a farm is a school of patience; you can’t hurry the crops or make an ox in two days.” No doubt, having patience is much easier said than done, especially when it seems like storm clouds are gathering on the distant horizon.

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But, like farmers, we also believe in the importance of being good stewards and seeing things through uncertain times. Today’s environment is no doubt a bit of a unique one, with many investors choosing to find safety in the herd, while those stepping out have underperformed.

This isn’t stopping us from doing our own thing. Despite higher interest rates and heightened volatility, we’re finding some excellent opportunities to eventually harvest what we think will be a bumper crop in both earnings and cash flow.

There are essentially two ways to make money: growth and income, and we are leaning towards the latter today. We simply think there is too much uncertainty around growth given the high cost of capital, so we prefer owning those segments with strong front-end cash flows. Or, as the saying goes, “A bird in the hand is worth two in the bush.”

We’re doing this via option overlays and structured notes in energy, utilities and financials, three sectors that are boasting annual yields as high as nine to 15 per cent.

In energy, the capped energy index is trading at only six times earnings, yet many companies are generating so much cash flow that they can buy back all their stock and debt in just five to seven years if oil prices remain anywhere near current levels.

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One of the ways we’re playing this sector is via the Horizons Canadian Oil And Gas Equity Covered Call ETF. It owns high-cash-flowing companies such as Arc Resources Ltd., Tourmaline Oil Corp., Keyera Corp., Canadian Natural Resources Ltd. and Cenovus Energy Inc. Because of the sector’s volatility, it is generating some great call premiums that when added to dividends give off a whopping yield of 14.5 per cent.

We’ve also recently purchased structured notes in the sector, including a recent one on Canadian Natural Resources, Suncor Energy Inc. and Cenovus that will pay an annualized 12-per-cent coupon monthly as long as these stocks don’t fall more than 30 per cent. The nice thing is that the note has a geared downside buffer should it not get called away before its seven-year maturity date.

Another segment of the market that we like is utilities, which has borne its share of selling. The performance gap between the Nasdaq and the Dow Jones utility index is now the widest it’s been on record, according to Bespoke Investment Group LLC.

We currently own the BMO Covered Call Utilities ETF, which has been beaten down 10.5 per cent this year. As a result, it is yielding more than eight per cent, which is quite high considering the lower risk nature of the underlying holdings.

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We have also purchased structured notes in the sector, including one recently on the Solactive Canada Utilities Index that will pay an annualized 10.65-per-cent coupon monthly if it doesn’t fall more than 30 per cent. It also has a 12-month, rather than a six-month, call feature with a 110-per-cent strike, so that means a greater probability of getting paid for longer.

Finally, there is the financials sector, where the outlook seems fairly flat given the sensitivity of its customers to higher mortgage costs, but the selloff this year reflects this risk. In this case, we like the Horizons Equal Weight Canadian Bank Covered Call ETF, which has a yield of nearly 13 per cent.

We also own structured notes in the sector, including one that will pay an annualized 8.31-per-cent coupon monthly as long as these stocks don’t fall more than 40 per cent. The nice thing is it also has a geared downside buffer should it not get called away before its seven-year maturity date.

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The other one we did recently was an autocallable, meaning if bank stock gains are above zero per cent or higher in six months, the note will get called away at par and pay a 14-per-cent coupon.

As you can see, there are plenty of birds in the tree; you simply need to shake the branches to catch them before they eat all the seeds in your field.

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.

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