By Caroline Grimont
I had wanted to start my column today with a quote from Warren Buffett, the one that talks about how you should only invest in what you know. As I was searching for the exact quote, I ended up reading Buffett’s 1996 letter to Berkshire Hathway shareholders. I found that what he said is of far greater importance to the point I was trying to make. Here is what Buffett wrote, emphasis mine:
“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.
Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy. What an investor needs is the ability to correctly evaluate selected businesses. Note that word “selected”: You don’t have to be an expert on every company, or even many. You only have to be able to evaluate companies within your circle of competence. The size of that circle is not very important; knowing its boundaries, however, is vital.”
Buffett then goes on to add that, to invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. What you do need is two well-taught courses: How to Value a Business, and How to Think About Market Prices.
“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the
temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”
The original point I was trying to make is that investors should buy the things that they know and understand. Buffett explains this through an idea he terms the “Circle of Competence.”
What is a Circle of Competence, and Why it Matters
The ‘Circle of Competence’ is a way to think about investing. Picture all the things you know, and understand and draw a circle around them. That becomes your circle of competence. Now, when you think about what companies or stocks you’d like to buy, shop within your circle of competence. For example, if you’re a doctor, chances are you’d know the best healthcare equipment companies. If you’re a tradesperson, you’d know which company manufactures the safest and best used equipment. That’s your circle of competence.
However, as Buffett points out, the size of the circle does not matter, but it is vital that you know its boundaries. For example, would you approach a brain surgeon, even the best brain surgeon in the world, to paint your house? Or even to set your bones, or to replace your knees? Of course not. Because that is outside a brain surgeon’s circle of competence. But if you were to ask her anything related to the occipital lobe, you’re in the right place.
Your circle of competence could be determined by any number of things – what you do for a living, the stuff you use, your hobbies, your friend groups, anything. If you stay within your circle of competence, you benefit from knowing how things work, and equally, knowing what doesn’t work, or what just isn’t available. Think about it like this – would you go to McDonald’s and ask for butter chicken? Or would you stick to fries, which is within McDonalds’ circle of competence?
The problem is that once you step outside that circle, you increase risks, especially because you don’t know as much. And you have to know what you don’t know. Put another way, understanding your circle of competence requires self-awareness, because if you don’t, but think you do, overconfidence could lead to poor decisions, and losses.
Don’t Know Where to Invest? An ETF Could Help
So, invest in what you know. But then again, just because you use a laptop, does that mean you know if Microsoft is a good investment? Though you’ve probably eaten at both, can you tell if Tim Horton’s is better than McDonald’s as an investment?
I know that I can’t. Which is why, again, I turned to Buffett, and the start of his quote, which provides the answer:
“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”
As an investor, if you’re looking for a fund that is managed by award winning portfolio managers, invests in an equally weighted portfolio of 20 large companies selected from the world’s Top 100 Brands, and offers monthly income alongside an opportunity for capital appreciation, you could consider the Harvest Brand Leaders Plus Income ETF, (TSX: HBF).
What is HBF?
Harvest Brand Leaders Plus Income ETF is an equally weighted portfolio of 20 large companies selected from the world’s Top 100 Brands. It consists of a core U.S. large cap portfolio, and is filled with stocks of companies that investors could easily recognize, including Microsoft, Coca-Cola, Apple, Walmart, Amazon, Visa, and McDonald’s.
Through this fund investors get access to a wide range of companies, all of which are household names that have been operational for decades.
Will I Get Income with HBF?
In a nutshell, yes. Investors in HBF can look forward to dividends for income, along with capital appreciation. Additionally, HBF utilizes a covered call strategy to enhance portfolio income potential and lower portfolio volatility. The fund writes covered call on 33% of the portfolio securities, which helps to lower the volatility of the fund’s return and provides monthly cash flows. With a write level of 33%, there is still enough exposure to capture the potential upside.
As Harvest ETFs explains it: “Covered call option writing is about striking the right balance. At its most basic level, when you write a covered call option, you gain premiums but can miss some market upside.” You can find out more about covered calls here.
As my colleague Ambrose O’Callaghan recently wrote: “Harvest ETFs has built a reputation for generating consistent monthly income through this active covered call writing strategy throughout its over 15-year history. It is one of the largest investment fund companies engaged in call option strategies in Canada. The investment team is one of the most knowledgeable in option writing and equity investing, possessing many decades of experience. To date, Harvest has generated nearly $1.5 billion in total monthly cash distributions.”
From a tax standpoint, it is important for Canadian investors to remember that this income received from covered calls is considered capital gains and is not considered interest income. This is important, because 50% of income from capital gains (up to $250,000) is generally tax free, while the remainder is taxed at your marginal rate. However, interest income is taxed as ordinary income.
How Much Does HBF Cost?
The management expense ratio and trading expenses ratio together of HBF are 1.01%. For this price, investors get a carefully curated and regularly reviewed portfolio of 20 high value, large-cap U.S. stocks, along with covered call options written on a portion of the portfolio to ensure monthly income.
How to Buy HBF?
Investors can buy HBF via online discount brokerages, or through brokers. The ETF may be held both in registered accounts such as an RRSP, RESP or TFSA, or in non-registered accounts.
What is the Risk Rating of HBF?
Investors should remember that this is a fund that invests in stocks and so its value can either rise or fall. What this means is that investors could lose money, depending on when they buy and sell this ETF.
As Harvest ETFs explains in HBF’s documentation, “One way to gauge risk is to look at how much the ETF’s returns change over time. This is called ‘volatility’. In general, ETFs with higher volatility will have returns that change more over time. They typically have a greater chance of losing money and may have a greater chance of higher returns. ETFs with lower volatility tend to have returns that change less over time. They typically have lower returns and may have a lower chance of losing money.”
Harvest has rated the volatility of this ETF as medium.
Who is HBF For?
HBF is appropriate for investors who are looking for exposure to U.S equities and income, want a medium to long-term investment, and can handle the ups and downs of stock markets.
So if you want to invest in companies that you know, recognize, understand, and maybe love, but also want income, and want award-winning professionals tracking your portfolio for you, you could consider the Harvest Brand Leaders Plus Income ETF, (TSX: HBF).
Disclaimer
The content in this article should not be construed as investment advice. Please read the relevant prospectus before investing. Commissions, management fees and expenses all may be associated with investing in Harvest Exchange Traded Funds or Harvest High Income Shares ETFs, managed by Harvest Portfolios Group Inc. (the “Funds” or a “Fund”). The Funds are not guaranteed, their values change frequently, and past performance may not be repeated. Tax investment and all other decisions should be made with guidance from a qualified professional.
