ZUT - Utilities ETF

[bloschuk]

BMO Equal Weight Utilities Index ETF. Thinking about adding this to my portfolio to have more exposure to utilities. Does anyone know how the distributions would be taxed? Wondering if this should go into my non-registered (if dividends) or RRSP/TFSA.

[FrugalTrader]

This ETF will likely distribute very similarly to 2010: dividends, return of capital and other income.

http://www.etfs.bmo.com/bmo-etfs/distribution?fundId=75756

[james4beach]

Some calculations that may be relevant as the market becomes more concerned about dividend payout sustainability (https://docs.google.com/spreadsheet/ccc?key=0AsTuy4YR2D5TdFM1eDhhc3V0MFRjMVozTnlaR2JOZ 2c&usp=sharing) (click for spreadsheet; you can download it too)

ZUT's weighted average payout ratio (of underlying stocks) is 64%. That's not horrible but it's on the high side (paying out over 50% of generated cash gets iffy)

66% of fund's assets in stocks with payout ratio > 0.5
39% of fund's assets in stocks with payout ratio > 0.75
23% of fund's assets in stocks with payout ratio > 0.9

The last stat is the biggest worry. It means nearly one quarter of the fund's investments are in danger of an imminent dividend cut, and could take steep losses with the ensuing share selloff. Such cuts have been resulting in share price declines in the neighbourhood of -50%.

It's going to be hard to predict the effect of such distribution cuts, but the relevant shares will definitely plummet. I'm not sure what the overall effect on the ETF will be, but basically there's going to be a chronic drag on ZUT share price so long as distribution cuts are happening. How big that drag is, I don't know. The market seems not very efficient, in that it's not seeing the dividend cuts coming.

The stocks suffering cuts have traded right up to the cut as if nothing is wrong (Mr. Market is not being very smart). Then they sharply crash when the cut happens... even though the payout ratio signaled the problem. What this tells me is that many of ZUT's holdings -- and thus ZUT itself -- are overpriced and the price we see today is not reflecting the high probability distribution cuts. e.g. the charts of NPI ($18.67) and INE ($9.95) look like all is OK, but I don't think the price reflects the rather strong chance of rate cut. This would result in a very sharp drop if the dividend gets cut.

I think there are technical reasons why the market is being inefficient. Normally investment banks and hedge funds would short stocks like this, but market conditions (quantitative easing & ZIRP) make short selling really unattractive currently. Also utility stocks are not widely held in Canada, e.g. utilities are under 2% of the TSX Composite, so there's not much institutional involvement in these names. The market caps aren't very big, and the trading volumes are low... an institution wouldn't bother with them.

Basically I'm worried that holdings like NPI and INE are overvalued due to the market not properly considering their risks; resulting in ZUT being overvalued.

[My Own Advisor]

TA has been touch-and-go for a dividend cut for at least a year. A few others, like FTS, EMA, CU, not too worried about.

I'd like to say other Utility ETFs are better, but XUT is not and that one only has 11 holdings. Those three companies above comprise 50% of the ETF holdings.

Based on how many ETFs provide distributions (FrugalTrader provided the link) I would suggest to put most of them in TFSA or RRSP. This way, you avoid any tax headaches.

[Belguy]

I once invested in some sector ETF's but, in the interest of keeping the management of my portfolio simple and keeping my trading costs to a minimum, I have largely eliminated them in favour of sticking with just a handful of the lowest fee, broadest based ETF's.

It works for me.

[james4beach]

The reason I like investing in utilities is that the broad indexes have so little of them. It's less than 2% of the TSX Composite, so if you do standard Canadian investment, you hardly get any utilities. Even though ZUT may be overvalued currently, I'm still watching it closely with the intention to buy.

[gibor]

james, I agree with you , but not sure if ZUT is really overvalued now.... current P/E = 16 , not so high (however, I couldn't find waht is historic P/E for ZUT) and it trading just 1.8% off 52 weeks low... yield also not bad , above 5%. What i don't like - is unpredictability of dividends, in last 12 months it ranges from 0.06 to 0.07 (even though cannot tell that it constantly declining ). yes, there is some danger "23% of fund's assets in stocks with payout ratio > 0.9" , but w/o danger ETF price would be much higher and imho Utilities are not banks or automakers, so Payout is a little less important . I would think that low 15's (about 1-1.5% down from current price) is a reasonable entry point.
What do you think?

[Belguy]

Have you considered either of Canadian MoneySaver's top rated dividend ETF's?

They are CDZ which is 11% utilities and ZDV which is 15% utilities.

[james4beach]

gibor: generally I agree with your points, except that "w/o danger ETF price would be much higher". This is the part I'm concerned about, I don't think it's true. I'm not sure the price accurately reflects the risk.

belguy: I don't like CDZ due to its very high MER, but ZDV is one I'm watching. Except that ZDV also has very high dividend payout ratios :)

[Belguy]

"CDZ is an excellent and consistent performer, CDZ is a veteran in this category and has delivered for its unitholders. Yield is on the low side, and MER on the high side. Sector diversification is the best of the dividend ETF's and tax efficiency is OK."

"ZDV is a solid first-year performer and has the second lowest MER of the group. A great yield and respectable sector diversification and excellent tax efficiency are other considerations but we only have one year to go on."

--Canadian MoneySaver, June 2013

[gibor]

Belguy, i was mentining it before...I don`t like CDZ top holding, payout is too high.... I`m tracking my mini-CDZ (extract of CDZ with reasonable P/E and Payout ) and it`s doing much better than CDZ.
XDV I just don`t need as many holdings I hold as invividual stocks, so why to pay MER

[larry81]

The reason I like investing in utilities is that the broad indexes have so little of them. It's less than 2% of the TSX Composite, so if you do standard Canadian investment, you hardly get any utilities. Even though ZUT may be overvalued currently, I'm still watching it closely with the intention to buy.

I also own some ZUT, ZWU.

I consider utilities as another slice of my fixed income allocation, they compliments bonds very well and are less correlated to equities than dividends ETF like CDZ.

[Belguy]

It comes back to the question of how many individual investments a Couch Potato investor needs in his portfolio.

In other words, how much slicing and dicing should you do in order to achieve sufficient diversification before it leads to diworsification?

I have seen some portfolios that are put under the scrutiny of a so-called 'expert' who often returns with the criticism that the investor has too many funds in his portfolio.

After all, most ETF's already invest in hundreds and sometimes thousands of stocks and so do you really need more than four or five ETF's to provide for adequate diversification? One S&P 500 ETF alone is pretty well diversified.

Just discussin'.

[gibor]

Belguy, VTI is even more diversified.
Just 2 ETFs VTI + VXUS covering almost all world.

[larry81]

Belguy, VTI is even more diversified.
Just 2 ETFs VTI + VXUS covering almost all world.

VTI+VXUS = best combo

But for folks with larger portfolio and "special situation" (ex: small biz owner, non-reg investor, etc.) sometime it make sense to slice and dice. Adding assets classed like utilities, REIT, US REIT, and international bonds can be justified.

[Belguy]

Belguy, VTI is even more diversified.
Just 2 ETFs VTI + VXUS covering almost all world.

Didn't CC recently suggest that this was not a viable way to invest? I don't recall his reasoning.

[gibor]

I don`t really know.... I have some ETFs like VTI, PRF, XIU ..... but majority of my holdings are dividend stocks.... I just want to build stream of sividends that will be enough for early retirement

[larry81]

Didn't CC recently suggest that this was not a viable way to invest? I don't recall his reasoning.

any reference ? I would like to hear the reasoning