This Monthly Income ETF Yields 12% — and it Deserves a Closer Look

The growth in Canadian income exchange-traded funds (ETFs) has really hit a crescendo lately. It feels like every week, there is another covered call ETF launching. Some layer on 1.25 times leverage. Others focus entirely on single stocks, which, personally, is not a structure I’m particularly fond of, given the added concentration risk.

Still, one ETF that has quietly slipped under the radar for many investors is Moat Active Premium Yield ETF (TSX:MOAT). With just $4.13 million in assets under management, the ETF has largely languished in obscurity. But the strategy itself is actually fairly unique compared to many of the income products currently flooding the market.

This is not simply another covered call ETF. For income investors willing to explore something a bit more sophisticated, MOAT may deserve a closer look, especially considering it currently pays a 12.07% annualized yield as of May 13 based on monthly distributions. That said, this is a fairly complex ETF, so let’s break down how it actually works.

What is MOAT?

There are really two components investors need to understand here, starting with the stock selection process itself. MOAT is actively managed, meaning it does not simply track an index.

Instead, portfolio manager Chris Thom currently selects a concentrated portfolio of just under 50 Canadian and U.S. companies. As the name suggests, the focus is on businesses with economic moats.

In investing, a moat refers to a durable competitive advantage that helps a company fend off competitors over long periods of time. These advantages can come from strong brands, network effects, intellectual property, cost advantages, regulatory barriers, or high switching costs that make it difficult for customers to leave.

Think about companies where competitors struggle to meaningfully chip away at market share even after years of trying. Those are typically the types of businesses moat investors look for.

Importantly, though, even a great company can become a bad investment if you overpay for the stock. That becomes important once you understand how MOAT actually generates its income.

How MOAT generates a 12% yield

A cash-secured put is essentially an agreement where the ETF sets aside enough cash to potentially buy 100 shares of a stock at a predetermined strike price. In exchange for taking on that obligation, the ETF immediately receives an option premium.

If the stock price remains above the strike price by expiry, the option expires worthless, and MOAT simply keeps the premium as income. If the stock falls below the strike price, the ETF may be required to purchase the shares at that agreed-upon price. Chris Thom actively selects strike prices and expiry dates based on factors such as implied volatility and the attractiveness of option premiums.

In practice, this strategy can be thought of as getting paid to potentially buy high-quality companies at valuations the manager already considers attractive. That is why the moat-focused stock selection process matters so much. The ETF is attempting to generate income while opportunistically gaining exposure to durable businesses at lower entry prices.

Meanwhile, the cash being held to secure these put options is not simply sitting idle. That capital is typically invested in cash equivalents and short-term instruments that generate additional interest income for the ETF. Combined together, the option premiums and interest income are what help support the fund’s current annualized yield of 12.07%, based on the latest monthly distribution of $0.20 per share.

Of course, investors should understand that distributions can fluctuate over time, and principal losses remain possible. This is still an options-based strategy with meaningful complexity and risk. The 0.75% management fee is also higher than your average index ETF.

The post This Monthly Income ETF Yields 12% — and it Deserves a Closer Look appeared first on The Motley Fool Canada.

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Fool contributor Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.