Fall 2023

Should Investment Counsellors Broaden Portfolio Construction Using Diversified Strategies?

Oct. 18, 2023

Structured notes have long been a popular portfolio diversification and capital protection tool for Investment Counsellors and Multi-Family Offices, but they often require extensive due diligence and monitoring. Mark Webster, Director, Institutional & Advisory, BMO ETFs, outlines the advantages of outsourcing with the new BMO Strategic Equity Yield Fund, which replicates an exposure to a broad basket of autocallable notes.

Multi-Family Offices and Investment Counsellors concentrate on their core competencies to construct portfolios for high-net-worth investors, but there are some areas where they may wish to consider outsourcing expertise.

Discretionary portfolio managers buy public equities or bonds, usually with a North American focus or overweight. They might buy an ETF to broaden international exposure or to accentuate a sector. In some instances, they may also invest in third-party managed private equity or private credit funds to diversify further.

Another tool that could be considered is the structured note, a hybrid instrument with both equity and bond-like characteristics. Currently, all the major Canadian Banks issue notes, providing enormous depth and breadth for boutique firms to access.

What is a structured note?

A structured note is a debt security issued by a financial institution and is typically linked to a reference portfolio of equity securities. Notes typically pay a contingent monthly coupon based on the performance of the underlying portfolio, as well as providing some contingent capital protection. They can be a portfolio diversification tool whose hybrid nature provides monthly payouts based on the performance of equities, while providing some downside risk mitigation like a bond.

One of the most common note structures in Canada is the autocallable note, a yield enhancement strategy providing the potential for above market coupons and contingent downside protection. 

How do autocallable notes work?

Autocallables offer several benefits:

  • Medium-term (typically), with a feature that allows the issuer to call the note
  • Contingent coupon payments
  • Contingent principal protection

The call feature gives the issuer the right to redeem the note at a pre-determined observation date if the underlying reference asset’s level meets or exceeds the autocall level. The notes typically have a coupon that is paid if, on a pre-determined coupon observation date, the underlying reference asset’s level meets or exceeds the coupon threshold. Lastly, autocallable notes offer contingent principal protection. If the note is not called prior to maturity, the invested principal is protected if the underlying reference asset’s level is at or above the protection level at maturity. 

While these are effective tools for Family Offices and Investment Counsellors, they can be a challenge to manage across a broad clientele. Challenges include: 

  • Note terms may change from one issue to the next;
  • Notes require extensive due diligence and monitoring, given the contingency of coupons and capital preservation;
  • Note reference portfolios may be concentrated in one sector or industry, limiting diversification;
  • For proper diversification, it would be necessary to hold a number of notes which could lead to line-item fatigue.”

The BMO Strategic Equity Yield Fund

Recognizing the appeal structured notes have to all investors, BMO Global Asset Management has launched the BMO Strategic Equity Yield Fund, which replicates the exposure of a broad basket of notes — in an 81-102 compliant fund wrapper — to simplify the access to these unique portfolio management tools. 

Bridging the risk and return profiles of traditional asset classes like fixed income and equities, the Strategic Equity Yield Fund provides an appealing yield boost above what is available in core bond holdings. Another appealing feature is the contingent downside protection, which can buffer returns in a declining market.

Using a diversified approach across sectors and geographies, BMO’s experienced team has created a single exposure, which would otherwise require countless hours of due diligence and administration for investment counsel. The result is a cost-effective and scalable investment solution that carries a low-to-medium risk rating, ensuring broad application across a large client swathe.

Much like covered call ETFs, a subject covered extensively in previous editions of The Vault, the Strategic Equity Yield Fund can increase yield, while mitigating risk.

To get the most out of these two types of strategies, it may be best to think about the expected tax treatment of each solution:

  • The Strategic Equity Yield Fund’s return should principally be taxed as income, so may be more suitable for a registered account or as a bond substitute in a taxable account.
  • The return of covered call funds should principally be taxed as capital gains, so may be more suitable for a taxable account. 

Both of these strategies provide Investment Counsellors and Multi-Family Offices with more tools to diversify investor assets. Their ease of use provides expertise and scalability to complement core capabilities within boutique firms, helping to build more robust portfolios for changeable markets.

For more information on the BMO Strategic Equity Yield Fund, reach out to your regional Institutional BMO ETF Specialist.


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