Quite unexpectedly, some of the biggest big tech companies posted stronger-than-expected earnings last quarter, including Alphabet, Amazon, and Microsoft. And after the shake-ups in the U.S. banking sector earlier this year, with JPMorgan’s purchase of First Republic Bank in May, there is optimism that America’s banking sector is once again stabilizing.1
All this has been good news for markets, which have benefitted from these surprisingly positive results. Despite the buoyancy of stock markets, however, the risk of a recession in North America within the next 12 months remains elevated according to many market watchers.2
That’s why now is a great time to consider your options for broad-based equity investing as a way to diversify your portfolio and help mitigate risk.
What is broad-based investing?
Broad-based investing is a strategy that provides investors with convenient, cost-effective access to the broader stock market as well as risk mitigation in the event of a market downturn.
The easiest way for most investors to implement a broad-based investing strategy is through index funds that track the performance of a large group of stocks or even the overall market. Investing through index funds offers investors the opportunity to diversify their portfolios, gain exposure to various sectors, and access the overall market’s performance.3
Index funds tend to provide cost-effective access to the broader stock market because they replicate the holdings of the underlying index and are an affordable way for investors to buy access to a variety of stocks in a convenient single index. If the average investor sought to buy shares of the dozens or hundreds of companies held in an index fund it would quickly prove cost-prohibitive.
And with so many stocks in an index fund, investors benefit from risk mitigation in the event of a market downturn. Because index fund holdings are so diversified, investors are less likely to experience significant losses due to the poor performance of one or two companies in the fund.
The cost-effectiveness and risk mitigation provided by broad-based index funds also makes them an attractive option for long-term investing.4
Which index funds are available?
The good news for investors is that there is a wide range of broad-based indices to choose from, depending on your goals and preferences as an investor.
Consider the S&P 500 as an example. The broad market represented by the S&P 500, comprised of the 500 leading U.S. companies, has actually risen an average of 1% during all recessionary periods since 1945. During the February 2020 to April 2020 recession caused by the pandemic, the S&P 500 initially fell 1.4% but rebounded to close the year up over 16% higher.5
So is it any wonder that one of the most popular indexes is the S&P 500 Index? The S&P 500 Index allows investors to gain exposure to a variety of sectors and industries by tracking the performance of the top 500 companies in the U.S. economy. Investors can access this index through investment vehicles like an exchange-traded fund (ETF).
For Canadian equity exposure, investors might choose an investment that tracks the S&P/TSX 60 Index. The S&P/TSX 60 Index is composed of the 60 largest companies listed on the Toronto Stock Exchange and offers investors exposure to nine different industries, including banking, basic materials, consumer goods, energy, and information technology.6
Why you should consider a covered call strategy?
While broad-based index funds offer some element of risk mitigation due to their diversification, investors looking for an additional strategy to protect their investments should also consider covered calls. Covered calls are all about lowering the volatility in your investments, which is particularly useful in the event of a market downturn. By adopting a covered call strategy, investors can generate yield from an equity index versus through sector- or stock-specific investing, while also benefitting from some downside protection.
In a covered call, investors can sell options on stocks they already own. They receive a premium from a buyer for the option, and if the stock price increases the buyer can purchase the stock at a lower agreed “strike price.” If the stock price decreases or the option expires, however, the seller keeps both the premium and the stock. This arrangement serves as a safeguard, helping to mitigate potential losses.
In such expired option scenarios, the investor can then sell another call option on the stock.
It’s important to note that higher levels of volatility in the market generally result in both increased premiums and greater potential upside for investors.7
One study found that over a 25-year period, covered calls on the S&P 500 outperformed the overall S&P 500, with a return of 830% on covered calls against returns of 807% in the S&P 500.8
Covered call investing with ESPX ETF and ETSX ETF
Looking for an investment solution that will keep you invested in stocks while offering the opportunity to take advantage of market volatility?
The Evolve S&P 500® Enhanced Yield Fund (ESPX ETF) is designed to provide investors with the performance of the S&P 500® Index, with the addition of enhanced yield through active covered call strategies on the underlying securities. This Fund invests primarily in the equity constituents of the S&P 500® Index, while writing covered call options on up to 33% of the portfolio.
Evolve’s S&P/TSX 60 Enhanced Yield Fund (ETSX ETF) is designed to provide investors with the performance of the S&P/TSX 60 Index, with the addition of enhanced yield through active covered call strategies on the underlying securities. This Fund invests primarily in the equity constituents of the S&P/TSX 60 Index, while writing covered call options on up to 33% of the portfolio.
Remember that the covered call options in both funds have the potential to provide extra income and help hedge long stock positions.
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- “FRC: First Republic Bank Taken Over by JP Morgan in Efforts to Stabilize Banking Sector,” TradingView, May 3, 2023; https://www.tradingview.com/news/tradingview:ca5a32b32094b:0/
- Ristovski, D., “Canada is Likely to Come Out on Top, but the Risk of Recession Remains Elevated,” The Conference Board of Canada, April 21, 2023; https://www.conferenceboard.ca/insights/canada-is-likely-to-come-out-on-top-but-risk-of-recession-remains-elevated/
- Kenton, W., “What Is a Broad-Based Index, and What Are Some Broad Index Funds?,” Investopedia, May 17, 2023; https://www.investopedia.com/terms/b/broad-basedindex.asp
- Caplinger, D., “How to Invest in Index Funds,” The Motley Fool, April 21, 2023; https://www.fool.com/investing/how-to-invest/index-funds/
- Klebnikov, S., “How Does The Market Perform During An Economic Recession? You May Be Surprised,” Forbes, June 2, 2022; https://www.forbes.com/sites/sergeiklebnikov/2022/06/02/heres-how-the-stock-market-performs-during-economic-recessions/
- “S&P/TSX 60 Index,” TMX Money, May 19, 2023; https://money.tmx.com/en/quote/%5ETX60
- Griebenow, N., “How to Position Your Income Portfolio For 2023 with Covered Calls,” Advisor Perspectives, December 13, 2022; https://www.advisorperspectives.com/commentaries/2022/12/13/how-to-position-your-income-portfolio-for-2023-with-covered-calls
- “New Study Compares 25-Year Performance of Options Strategy Benchmarks to Traditional Indexes,” Cboe, February 14, 2012; https://ir.cboe.com/news-and-events/2012/02-14-2012/new-study-compares-25-year-performance-options-strategy-benchmarks-traditional-indexes