Best in show: How to find and invest in market leaders - MoneySense (2024)

Image by pressfoto on Freepik

Canadians approach retirement planning in many different ways, but there’s one thing we can all benefit from: a strategy to save enough to retire comfortably and even generate income after we stop working.

But many of us don’t feel financially ready to stop working. According to a 2022 survey by the National Institute on Ageing (NIA) at Toronto Metropolitan University, only one-third of Canadians aged 50-plus say they have the financial capacity to retire when they hope to do so. A survey by investment firm Edward Jones, also published in 2022, found that Canadians preparing for retirement have significant worries about future expenses, including health-care costs (59%), unexpected expenses (58%), economic downturns (42%) and inflation (41%).

These findings may sound grim, but there is also good news in the data points: Many people are enjoying retirement with a reasonable sense of personal and financial well-being. Regardless of where individuals fall on the retirement-savings spectrum, all share the need for a solid strategy to ensure they don’t outlast their money. And with so many options, how does a person choose?

What is a market leader?

One approach that’s proven successful over time is to focus investments on industry leaders, or market leaders, as they’re called in the world of finance. These are companies that hold significant market share, often the largest share, in their sectors—think household names like PepsiCo, Visa and UPS. You can gain exposure to these firms via the Harvest Brand Leaders Plus Income ETF (HBF), for example.

Market leaders offer attributes such as consumer loyalty, resilience, a long operating history, marketing capacity, the ability to invest in innovation and, often, a track record of raising dividends. Combined with a market leader’s size and reach, these features help the company to shape the direction and competitive characteristics of its sector.

Which sectors should investors focus on?

Choosing strong companies is only part of the equation, notes Michael Kovacs, president and CEO of Harvest ETFs, which uses a leaders strategy for several of its ETF offerings. The key is to home in on leaders in sectors where structural economic forces and “megatrends”—that is, rapid macro-level changes in the social and economic landscape driven by factors such as technology and demographics—create opportunities for exceptional growth.

“We focus on these businesses because they have historically led growth industries and megatrends,” Kovacs says. “They have also been the key to the creation and preservation of wealth over time.”

Examples of sectors meeting the criteria for high-growth potential these days include technology, health care and utilities. Identifying promising sectors is the first step; the next step is choosing the individual companies that will make up your portfolio.

Harvest, for example, constructs its ETFs with shares in 20 to 30 leader companies in high-potential sectors. Some might argue a basket of a couple dozen stocks is not sufficiently diverse to achieve desired results.

But Paul MacDonald, Harvest ETFs’ chief investment officer and portfolio manager, disagrees. “Twenty to 30 stocks is not a random number,” he says. “When we select stocks we want an ETF to hold, our goal is to create concentrated portfolios, but with large enough capitalization and wide enough diversity of business styles and operations that we can give investors broad diversified exposure to a single sector or industry.”

By way of example, MacDonald notes that the 20 stocks in the Harvest Healthcare Leaders Income ETF (HHL) are equal to more than 2.5 times the market capitalization of the TSX. “These are huge companies, each with their own diversified lines of business,” he says. “They have scale and liquidity that’s unmatched in the Canadian markets.”

Market-leader ETFs that generate income

A leaders strategy can be very helpful in the wealth-building phase of saving and investing for retirement. But at some point, that foundation will need to generate income—and it’s hard to overstate the importance of this. According to the NIA’s 2022 survey, income adequacy is one of the core determinants of happiness in retirement, especially when it comes to health, an active social life and relationship satisfaction.

Harvest’s signature approach to meeting this need is the covered-call option strategy. Here’s how it works: When an investor or fund manager sells a covered-call option, they sell the right to a buyer to purchase a block of shares on a future date for a pre-determined amount, known as the “strike price.”

If the shares are trading above the strike price on the transaction date, the buyer acquires them, taking advantage of a discounted price to sell them for a profit. The seller, meanwhile, pockets the premium paid for the right to buy the shares. If the shares are trading below the strike price, the buyer has no incentive to complete the transaction. So, the seller keeps the shares—as well as the premium paid by the buyer of the option.

Some critics say covered-call option investors pay a price in lost long-term capital appreciation for a near-term gain. To limit this trade-off, Harvest ETFs limits its options writing to a maximum level of 33% of portfolio holdings.

Moreover, it dovetails with a focused industry-leaders strategy. An investment manager overseeing a portfolio based on 20 or 30 leading stocks in growth sectors is in a prime position to identify the best opportunities for writing covered-call options compared to, say, a manager who has simply bought an entire sector. “When you have active management of a covered-call strategy, familiarity with the sector and the stocks you hold is crucial,” MacDonald says.

In other words, market leaders can deliver results, especially when it comes to generating a reliable income after you stop working. And if you choose to focus on a carefully curated selection of stocks, there’s no reason not to pick the best in class.

Read more about investing:

• Get paid to wait—is now an opportunity to invest in tech stocks?
• 3 ways to recession-proof your RRIF
• What are call options? Why should retirees care about them?
• What do rising interest rates mean for retirement savings?
• We’re living longer—here are two ways to boost retirements savings and income