Alternative Income with ESG Virtue

One of the benefits of higher interest rates is that cash instruments are now appealing from a yield standpoint – good news for advisors with large client bases of retirees or those nearing retirement.

Of course, advisors know that the trade-off for cash’s status as a risk-free investment is that there is no opportunity for upside beyond the yield on the underlying instrument. That is to say there’s still demand for alternative income ideas.

Speaking of demand, plenty clients – particularly those in younger demographics – remain enthusiastic about environmental, social and governance investing. That despite last year’s retreat by ESG funds, which was largely the product of weakness in growth stocks. Thing is ESG investors are, broadly speaking, a devoted lot.

Until recently, however, advisors haven’t had many credible choices to offer ESG-enthused clients when it comes to generating income with the ESG overlay. That scenario is changing for the better and exchange traded funds are a big part of that equation.

Covered Calls and ESG? Yes, It’s Possible.

Covered calls, including in fund form, are solid avenues for generating income outside the realms of stocks and bonds.

Covered call strategies are often rewarding in turbulent market settings because options premium move higher, meaning more income to options writers or sellers. Thanks to the recent debuts of the Nasdaq 100 ESG Covered Call ETF (QYLE) and the S&P 500 ESG Covered Call ETF (XYLE), advisors have more options to present to clients that want to access the marriage of ESG and income.

These ETFs are linked to the ESG equivalents of the widely followed Nasdaq-100 (NDX) and S&P 500 indexes, so advisors aren’t presenting income-hungry clients with exotic fare with these funds. Both QYLE’s and XYLE’s benchmark adheres to guidelines set forth by the United Nations (UN) Global Compact compliance, and ESG Controversies.

“The ESG scores utilize a multitude of data points across a company’s business operations including issues such as environmental supply chain, employee management, human rights, board diversity and independence,” according to Global X. “The final score is a reflection of data aggregated across these multiple ESG considerations and controversial business activities may be excluded if they are seen as non-beneficial to society or actively working against climate change.”

Though the ESG covered call ETFs aren’t mirror images of each other, advisors should expect the likes of casino operators, civilian firearms makers, coal producers and other fossil fuel firms, among others, are excluded.

Big Income Potential, Diversification Benefits

Covered call ETFs can deliver big income. For example, a non-ESG fund that follows the Nasdaq-100 sports a trailing 12-month yield of 13.70%.An S&P 500 equivalent has a trailing 12-month distribution yield of 13.55%.

Those are obviously big numbers, but there are more benefits. Covered call strategies are considered alternative investments, meaning they can bring diversification and reduced correlations to portfolios.

“By receiving income by writing calls on an index, income investors can potentially diversify their equity income portfolios to equity sectors that are typically un-aligned with other equity income strategies. One example is that of an ESG equity dividend strategy. These types of dividend-focused strategies tend to have sector leanings towards cyclical and defensive sectors, making them less diversified from this standpoint. Through pairing a strategy like this with an ESG covered call strategy, the higher the diversification opportunity is,” concludes Global X.

Related: (Un)Conventional Wisdom: Investing in the Energy Transition