James Learmonth, CFA
Senior Portfolio Manager
Mike Dragosits, CFA
Published by Harvest ETFs
(Managed by Harvest Portfolios Group Inc.)
As the world economy looks beyond the pandemic to a slow and uneven recovery, sectors that have been overlooked this year may be places to look for opportunity in the coming year.
These include U.S. banks and global utilities, both of which have lagged broader markets since the March sell off. Both sectors are dominated by large, well-financed players who offer predictable, non-cyclical income streams and a defensive element for portfolio holdings.
As prices have declined dividend yields have climbed for those seeking income. When Harvest Portfolios Group overlays this with its covered call strategy, the yields are even more attractive.
That was the message delivered by two Harvest Portfolio Group portfolio managers in a recent webinar for advisors. Senior Portfolio Manager James Learmonth talked about the challenges and energizers driving the U.S. banking sector and the philosophy behind the Harvest US Bank Leaders Income ETF. Portfolio manager Mike Dragosits talked about the challenges and prospects for the global utilities sector and the thinking behind the Harvest Equal Weight Global Utilities Income ETF. The session was introduced by David Wysocki, vice president of national sales at Harvest.
Mr. Learmonth said U.S bank stocks have rallied following a sharp drop in the spring but have failed to keep up with performance of the S&P 500 index.
He said Harvest views American banks as a way to compliment Canadian bank holdings because they add depth and diversity. The Harvest US Bank Leaders Income ETF is an equally weighted portfolio of 15 financial services companies with a minimum 75% allocated to the banking industry. It captures the banking industry leaders at the national and regional levels.
“We don’t think the key decision is whether you own Canadian or US banks,” Mr. Learmonth said. “Instead we see it as an opportunity to diversify by having both,”
He noted that U.S. banks are much better capitalized than they were in 2008 and have aggressively set aside funds against pandemic loan losses. These losses may rise in 2021, but if the downturn is less severe than expected, the excess amounts can be added back into earnings.
“These provisions have a negative impact as they’re accounted for, but if actual losses are lower than the provisions, they later provide a boost to earnings,” he said.
On the other side of the ledger, bank lending has been weak. Banks have seen a significant rise in deposits on the back of federal stimulus payments and the U.S. paycheck Protection Program and hoarding by consumers and businesses in an uncertain time.
Early in the pandemic lending surged as businesses rushed to secure liquidity by opening credit lines and drawing down existing lines. But that was short lived. On the consumer side mortgages and auto loans have continued to grow as consumers lock in large purchases at favourable rates. This has been offset by declines in credit card debt and home equity lines. So longer term, rising rates will make banks more profitable.
“The banking industry faces a tremendous amount of uncertainty,” Mr Learmonth said. “However, dividend yields are attractive, capital positions are strong and a rise in net margins are potential catalysts. That could lead to better performance for bank shares.”
Mr. Dragosits said the Harvest Equal Weight Global Utilities Income ETF outperformed early in 2020, but has lagged the broad stock market since. While utilities tend to be a cushion in a recessionary environment, COVID-19 has been unique.
“What gets me really excited is there’s an opportunity for multiples to catch up to lower rates,” he said. “They have a much easier path to normalization.”
The ETF holds 30 large utility, telecom and pipeline names evenly split between North America and Europe. About 55% are utilities, 33% are telecoms and 12% on the pipelines. Mr Dragosits said the holdings are infrastructure-type critical assets, often monopolies or quasi monopolies. They are stable in terms of cash flow and earnings offering modest capital appreciation.
The current prices are creating higher yields which become more attractive going forward as investors look for secure sources of income. While pipelines are out of favour, the level of pessimism is such that it may not take much to return to higher valuations.
“Oil and gas is still a necessity,” he said.
Mr. Dragosits concludes by saying while investors wait for the sector to rebalance, they can collect high yield dividends. The payments “remain very attractive” when compared with less than 1% on a 10 year bond, he said.
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