# ZFH BMO Floating Rate High Yield ETF



## liquidfinance (Jan 28, 2011)

http://www.etfs.bmo.com/bmo-etfs/glance?fundId=97636/

This caught my eye when BMO first released it ealier in the year. At this time it had a tiny NAV and quite a wide spread so I didn't look into it any more. Now the spread is a lot better and the fund is bigger. Has anyone here had a close look at this to determine just how much risk is really involved? 

Would it be a dangerous place to park dividend cash? 

Duration 0.26
YTM 4.08
Cash Yield currently 4.0%


----------



## doctrine (Sep 30, 2011)

Are the holdings accurate? It is only listing federal floating rate bonds on the webpage, but also says it has 92.4% exposure to non-investment grade corporate bonds. I would at least like to see if its Canadian companies or something else..20% CCC "or below", who are they?


----------



## andrewf (Mar 1, 2010)

correct link:

http://www.etfs.bmo.com/bmo-etfs/glance?fundId=97636

It holds short term government bonds plus a basket of credit default swaps on high yield issuers in the US. Given the somewhat checkered past of CDS, I'm not entirely comfortable with this for a yield of 4.08%. Compare to HFR which has a yield of 2.08%, but with much better credit ratings, almost all BBB and up.


----------



## james4beach (Nov 15, 2012)

At the highest level, this fund fails test #1: "what does it hold?". It's very difficult to tell what it holds.

This is kind-of-but-not-really a junk bond fund. Not only that, but it doesn't hold any bonds: it holds a single index derivative for junk bonds. And not just an index of bonds, but rather a derivative of a derivative of bonds.

The holdings page is misleading, because it actually holds a single index derivative (see summary of investment portfolio), Markit's CDX High Yield index. This is a leveraged instrument, kind of like a futures contract. As a result funds will hold plenty of cash and t-bills to pad the account, otherwise you would have a massively leveraged position. This is why it looks like it holds so much cash. The same is true for funds that hold commodity futures, for instance.

The holding: what the hell is this exactly? Trust me, very few people actually know. This is an exotic instrument. It's a Credit Default Swap of an index of junk bonds. Because the index itself is a derivative, that's why I'm pointing out this is a derivative of a derivative.

If this was actually a junk bond fund, I would say maybe. But if you buy this, you are so many levels removed from a real market instrument, that it can't possibly be a good idea. These CDX index instruments trade on the exchanges as if they have a life of their own. People buy and sell them, more or less disconnected from the reality of the underlying. On top of that there is probably a boat-load of counterparty credit risk... not just the junk bonds, but the institutions who insure the junk bonds.

I'll go as far as to say that this may be the current market's version of the past crisis's toxic paper. Back then it was derivatives upon derivatives of mortgage and asset backed securities, removed by several layers, along with counterparty risk and all kinds of opaque goodies. This is more or less the same thing, but in this case the fundamental underlying security is a junk bond.

So here we are with more or less the same turds, 7 years later. If we get another credit crisis, everyone will tell me again that we could have never seen this coming and banksters are too smart and sophisticated to knowingly do such stupid things. (Rolls eyes).

If it was possible to do so, I would actually consider shorting this.


----------



## james4beach (Nov 15, 2012)

I'm going to contact BMO about this. I can't believe this fund is legal in Canada, it's far too exotic. It takes a lot of knowledge and experience to understand WHAT this even is; this is not suitable for retail investors.

Please god... tell me widows aren't buying this.

For anyone who does decide to do this. Please, first call BMO and talk to someone in their ETF team. Write down their name and make a recording of the phone call. Keep it for the class action lawsuit in 5 or 10 years.


----------



## liquidfinance (Jan 28, 2011)

james4beach said:


> I'm going to contact BMO about this. I can't believe this fund is legal in Canada, it's far too exotic. It takes a lot of knowledge and experience to understand WHAT this even is; this is not suitable for retail investors.
> 
> Please god... tell me widows aren't buying this.
> 
> For anyone who does decide to do this. Please, first call BMO and talk to someone in their ETF team. Write down their name and make a recording of the phone call. Keep it for the class action lawsuit in 5 or 10 years.


This is what I got from an email I sent to them in March



> Good afternoon Mr. Thomas,
> 
> 
> 
> ...


----------



## liquidfinance (Jan 28, 2011)

james4beach said:


> At the highest level, this fund fails test #1: "what does it hold?". It's very difficult to tell what it holds.
> 
> This is kind-of-but-not-really a junk bond fund. Not only that, but it doesn't hold any bonds: it holds a single index derivative for junk bonds.


James that part is not true

What are these then?

Canada Govt Tb Jan 29 15	26.68%
CANADA GOVT TB NOV 06 14	25.75%
Canada Govt Tb Sep 11 14	25.08%
CANADA GOVT TB DEC 04 14	20.51%

Surely this should protect that capital? The risk of the CDS the provides the yield.

Why I have stayed away is because I just do not understand how severe the loss could be from the CDS if it all goes 2007 again.


----------



## HaroldCrump (Jun 10, 2009)

liquidfinance said:


> This is what I got from an email I sent to them in March


This is just regurgitated gobbledygook from the fund prospectus.
This individual has simply copied and pasted the official text.

There is no "regulatory oversight" on CDS, and neither is there "pricing transparency".
The whole thing is an OTC market. How can there be pricing transparency.


----------



## HaroldCrump (Jun 10, 2009)

liquidfinance said:


> Why I have stayed away is because I just do not understand how sever the loss could be from the CDS if it all goes 2007 again.


CDS is an insurance policy against the default of high risk assets.
There won't be a loss from the CDS per se.
The risk with a CDS is that if/when the insurance protection is required, the counterparty may not be able to meet its side of the bargain.
In other words, there is counterparty risk.

It is similar to your auto insurance company not able to (or refusing to) pay for damages in the event of an accident.
So you lose the asset, _and_ don't get the insurance claim.

To calculate your true exposure in this case, you should add up the assets being protected by the CDS (coverage is usually 80% to 90% of par value), plus the coverage premium itself (say 10%), less the possible recovery (say 15c. on the $, because bonds seldom default 100%).
That is the true exposure.


----------



## gibor365 (Apr 1, 2011)

_Compare to HFR which has a yield of 2.08%, but with much better credit ratings, almost all BBB and up. _ with such yield and MER about 0.5 , GIC looks much more attractive


----------



## HaroldCrump (Jun 10, 2009)

The underlying is a total return swap as well, not an ETF.
You have to go 3 levels deep before you actually get to the real holdings.

This seems like the movie _*Inception*_ - in this case, the risk compounds exponentially as you go down each level.

I agree with James4B that this is a derivative of a derivative of a derivative of a....

Buy a 5 year GIC ladder, go sit on the porch, and drink beer.


----------



## liquidfinance (Jan 28, 2011)

HaroldCrump said:


> The underlying is a total return swap as well, not an ETF.
> You have to go 3 levels deep before you actually get to the real holdings.
> 
> This seems like the movie _*Inception*_ - in this case, the risk compounds exponentially as you go down each level.
> ...



I agree with the Buy a GIC part but I was looking at this as a fund to mop up excess dividends in the TFSA.


----------



## liquidfinance (Jan 28, 2011)

gibor said:


> _Compare to HFR which has a yield of 2.08%, but with much better credit ratings, almost all BBB and up. _ with such yield and MER about 0.5 , GIC looks much more attractive


GIBOR 

This fund has its uses. GIC's are not always practical and are relatively illiquid. For what I have used it for this fund has served me well.


----------



## HaroldCrump (Jun 10, 2009)

liquidfinance said:


> I agree with the Buy a GIC part but I was looking at this as a fund to mop up excess dividends in the TFSA.


There was a thread on here about brokerage specific money market funds for storing temporary cash reserves.
Usually there are no trading commissions for buying those funds, whereas in this case, you will have to pay in/out commissions.


----------



## gibor365 (Apr 1, 2011)

HaroldCrump said:


> Buy a 5 year GIC ladder, go sit on the porch, and drink beer.


Don't think it's a good idea to start 5 y ladder right now.... it's very likely that rates will go up in 2015... 
I have kinda 1 year GIC ladder in Peoples Trust at 2.4% , trying to open 1 y GIC every couple of months, so it's becomes much more liquid 
In my discount brokerage account rates are much worse.... keep it mostly in ATL5000 for 1.25%, have some GICs (but rates are worse), actually today bought 3 year GIC 2.15% from LB


----------



## liquidfinance (Jan 28, 2011)

HaroldCrump said:


> There was a thread on here about brokerage specific money market funds for storing temporary cash reserves.
> Usually there are no trading commissions for buying those funds, whereas in this case, you will have to pay in/out commissions.


I don't think there was anything for Questrade and with them there is no buy commission. Only a sell. So depending on time frame / amount invested it can be worth while.


----------



## james4beach (Nov 15, 2012)

Oh boy, BMO is being extremely misleading about the risk exposure of this ETF. Keep that email, you may end up showing it in court!



liquidfinance said:


> BMO: "We currently have 6.91% CDX position that represents the margin posted to gain the high yield credit exposure."


You need futures experiences to understand this ETF. What they're telling you above is that the position only looks like 6.91% because it's the overnight margin requirement on the position. *Their effective exposure is much more than 6.91%*, probably closer to 100% of the fund value. Derivatives like this are intrinsically leveraged. From what I gather, the ICE futures generally have something like 10:1 to 14:1 leverage.

Say I held an index future (that's a 10:1 instrument) in my own account. My account balance is $100 net value. Of that, the futures position may only be $10 (the maintenance margin) plus $90 cash. So it looks like tiny 10% exposure -- but it's not. In reality my exposure with that instrument is still 100%, because the $10 shown in my account -- like the 6.91% shown in BMO's -- is only the margin.

In other words, a futures investor who is 100% invested in an index future will have an account that only shows a 10% futures position. It looks small, but it's a damned lot bigger in reality.



> What are these then?
> 
> Canada Govt Tb Jan 29 15 26.68%
> CANADA GOVT TB NOV 06 14 25.75%
> ...


Those are the cash portions of the account, see my example above with how a futures position works. They pad the cash because having just the CDS instrument alone would be insanely high leverage. If their CDS position is 6.91% of the NAV, assuming 10:1 leverage their CDS exposure is more like 69% of the account. If this is a 14:1 instrument, then it's virtually 100% CDS exposure.



> Surely this should protect that capital? The risk of the CDS the provides the yield.


All the cash is not as impressive as it looks. From what I can tell, they're betwen 70% to 100% exposed to the junk bond CDS index. How risky is that CDS index itself? I don't know, you have to be a "distressed credit derivatives" expert to figure that out.



> You have to go 3 levels deep before you actually get to the real holdings.


I actually agree. On second examination of this I figure there's at least 3 levels of indirection from the ultimate underlying assets.



> GIC's are not always practical and are relatively illiquid


This thing, ZFH, is a whole different beast from a GIC. As far as types of assets they're worlds apart. People _will buy_ this to "chase yield" without having a clue what they're buying. But if you learned any lessons at all from 2007-2008, you would say: no, I won't buy exotic opaque instruments just for yield especially when there are clues that the underlying are some bizarre unexplainable derivative soup.


----------



## liquidfinance (Jan 28, 2011)

Thanks James I appreciate your time to post this. 

I like HFR and was wondering where this fits into the mix. Looking at it from the explanations provided, by Harold and yourself, it seems far too exotic for the reward. As I clearly don't have a sound understanding of the risks involved I will not be putting any money into it. 

What I wanted to understand was if the worst was to happen could you actually lose everything with this fund or is there a cap to the downside.


----------



## RBull (Jan 20, 2013)

HaroldCrump said:


> The underlying is a total return swap as well, not an ETF.
> You have to go 3 levels deep before you actually get to the real holdings.
> 
> This seems like the movie _*Inception*_ - in this case, the risk compounds exponentially as you go down each level.
> ...


This is what I'm doing. Had to take a pill first due to the rates but retirement changes a lot of things.


----------



## james4beach (Nov 15, 2012)

liquidfinance said:


> I like HFR and was wondering where this fits into the mix. Looking at it from the explanations provided, by Harold and yourself, it seems far too exotic for the reward. As I clearly don't have a sound understanding of the risks involved I will not be putting any money into it.
> 
> What I wanted to understand was if the worst was to happen could you actually lose everything with this fund or is there a cap to the downside.


Risk tolerances are relative  Compared to this thread topic (ZFH), the Horizons HFR is less risky and more straightforward: it actually just holds a portfolio of bonds and a few interest rate derivatives. Nothing too exotic. It's not horribly risky, I just don't think it's worth the tradeoff it offers between risk and reward.

With HFR, worst case is that low grade corporate bonds crash and become illiquid. I would guess a worst case price decline of maybe -20% to -30% (just illiquidity of corp bonds in the last crisis alone resulted in -10% discounts to NAV). The reward you're getting is 2.1% yield and myself, I don't think that's worth the -20% to -30% decline risk. For me, 2% yield pretty much rounds down to zero anyway. At that point you might as well take 1.8% yield on cash at a credit union!


----------



## HaroldCrump (Jun 10, 2009)

gibor said:


> Don't think it's a good idea to start 5 y ladder right now.... it's very likely that rates will go up in 2015...


But that is the whole point of ladders, isn't it?
You don't have to speculate on the timing of interest rate increases/decreases.

What do you mean _very likely_?
You don't have the foggiest idea.
I mean that with all due respect.

No one knows.
Not even the BOC governor Poloz can tell you that.

We have been hearing _interest rates are going up next year_ since 2010.


----------



## gibor365 (Apr 1, 2011)

_Not even the BOC governor Poloz can tell you that._ 
Sure, because he will raise rates exactly when Yellen does  
I've heard that Canada just twice in the history changed rates not in line with US and both times it was failure as per Benjamin Tal 's (the Deputy Chief Economist of CIBC World Markets Inc) speech.... 
The best rate I can get in my discount brokerage for 5 y GIC is 2.46% , I prefer to buy 1 year 2.4% in Peoples Trust and wait ....
Somebody likes "long ladders" , but I like a short ones


----------



## andrewf (Mar 1, 2010)

james4beach said:


> Risk tolerances are relative  Compared to this thread topic (ZFH), the Horizons HFR is less risky and more straightforward: it actually just holds a portfolio of bonds and a few interest rate derivatives. Nothing too exotic. It's not horribly risky, I just don't think it's worth the tradeoff it offers between risk and reward.
> 
> With HFR, worst case is that low grade corporate bonds crash and become illiquid. I would guess a worst case price decline of maybe -20% to -30% (just illiquidity of corp bonds in the last crisis alone resulted in -10% discounts to NAV). The reward you're getting is 2.1% yield and myself, I don't think that's worth the -20% to -30% decline risk. For me, 2% yield pretty much rounds down to zero anyway. At that point you might as well take 1.8% yield on cash at a credit union!


I wouldn't advocate putting a lot of money in out of province credit unions. That is highly concentrated risk, and many of those credit unions have excessive exposure to real estate in markets with stretched valuations. If you brush off this risk, you might as well go all the way and buy pref shares in those CUs and enjoy higher yields.


----------



## james4beach (Nov 15, 2012)

Back onto the thread topic. I really don't recommend this fund, ZFH.

I'm concerned that it's inappropriate and too dangerous for retail. It's an exotic fund, containing junk bond derivatives. It contains opaque exotic instruments. Additionally the junk bond market has been falling rather sharply; if this continues, it will destabilize high-risk credit and derivatives.

Personally I see a parallel between subprime/mortgage bonds of the last crisis, and junk bonds in the current market. These days, junk bonds are very popular and people have piled into them while chasing yield. And just like subprime, there are lots of derivatives and exotic instruments that are now pitched to retail -- like ZFH


----------



## My Own Advisor (Sep 24, 2012)

HaroldCrump said:


> We have been hearing _interest rates are going up next year_ since 2010.


I got a fixed-rate mortgage because of believing and "trusting" folks who thought they knew. Never again. Nobody knows.


----------



## james4beach (Nov 15, 2012)

Now that the junk bond bubble is bursting, it's probably very bad idea to hold ZFH.

I mean, it was always a bad idea, but now it's downright dangerous.


----------



## Twixer (Nov 25, 2015)

HaroldCrump said:


> We have been hearing _interest rates are going up next year_ since 2010.


I think it has become increasingly hard to rise rates and we will be in low-rate environment for long time. It is an effect of globalization.

The main driver of inflation are wage increases. If wages increase in one country, companies are able to quickly move jobs to cheaper place. Unemployment rises, suppress inflation and rates stay low.


----------



## james4beach (Nov 15, 2012)

ZFH holds a derivative instrument, credit default swaps, that make ZFH assume the risk of junk bond defaults.

ZFH _insures_ junk bonds from default. So as junk bonds continue to crash day after day, and the risk of default rises, ZFH is assuming this risk. For this risk, you the investor get a slight boost to your yield.

I hope some lawyers are reading this thread. BMO may have misrepresented what this fund is. They definitely do not portray the risks properly. I recommend that anyone who has communicated with BMO about their investment in this keeps all notes & records of your interactions with BMO.


----------



## james4beach (Nov 15, 2012)

This thing is still intriguing to me because it's so weird and exotic. The fund has grown quite a bit ($480 million assets under management). It holds a proprietary, leveraged derivative. The main risk is that the underlying junk bonds could default, which is more likely to happen during a recession.

I still can't believe BMO is allowed to sell this ETF to retail investors. This is nearly half a billion $ invested in very weird derivatives... and they really don't disclose the risks very well. I think BMO is being irresponsible with this thing and I feel like they're misrepresenting it.

In fact, I'm pretty sure that people have put half a billion $ into this due to inadequate or misleading descriptions from BMO about what's in it. Even the Management Report of Fund Performance, for example, completely dances around the extreme complexity of what the fund contains and does not once mention the CDX index it holds or default risks. Same goes for the web page and holdings list... all of which are misleading.

Proshares had created a similar ETF (TYTE) but shut theirs down after 2 years due to lack of investment interest. It was pretty heavily blasted when it came out. Here's one article on it: Credit Default Swap ETFs Are Not Worth The Risk

As far as I can tell, ZFH is pretty similar to the now defunct TYTE except that BMO has slightly diluted the junk bond CDS to reduce the risk very slightly. This article is one of the best explanations I've found of what it invests in. Just imagine "ZFH" where you see TYTE because it's essentially the same investment:



> It is highly unlikely that a significant number of the 100 companies in the CDX would simultaneously default (independently). However, extreme situations, such as the financial crisis, can create a self-fulfilling prophecy where an unwillingness to extend credit leads to defaults, which makes it harder to obtain credit. If another crisis of that magnitude occurs, TYTE would see significant losses . . . Overall, TYTE and WYDE are not worth the trouble of dealing with their complexity.


ZFH has performed quite well so far, because these have been good times to be long CDS and selling insurance on junk bonds (so far). So yes, it's provided a high yield and pretty stable value. However it could all turn south in a recession or junk bond crisis. Perhaps if one believes there is no recession on the horizon, and believes junk bond default rates will remain low, it could be a decent investment... but should not be considered safe or recession-proof!


----------



## james4beach (Nov 15, 2012)

I think it's now time to get out of ZFH. The fund has become more risky now that US corporate credit is deteriorating and the junk bond market is getting some stress. The perceived default risk of low grade issuers is rising, as a few big corporations (Sears, GE) are in trouble.

This does not mean that ZFH will necessarily crash, but as I wrote above, it's hard to evaluate the risk. I've been posting these messages hoping that a unit holder will stumble across this thread.


----------



## james4beach (Nov 15, 2012)

Ah, and here we go. ZFH finally cracked today, down 1.6% in a single day. More like an equity movement rather than a "safe" fixed income. This is an indication of junk credit finally deteriorating and/or CDS plummeting.

I feel bad for all the investors BMO mislead into this investment.


----------



## Jimmy (May 19, 2017)

james4beach said:


> I think it's now time to get out of ZFH. The fund has become more risky now that US corporate credit is deteriorating and the junk bond market is getting some stress. The perceived default risk of low grade issuers is rising, as a few big corporations (Sears, GE) are in trouble.
> 
> This does not mean that ZFH will necessarily crash, but as I wrote above, it's hard to evaluate the risk. I've been posting these messages hoping that a unit holder will stumble across this thread.


I always saw these as not worth the risk. They may yield 2+ % more than an IG bond fund but the default risk counters this so just stay w IG. Eg Default risk for BBB is 4.6%. ( recovery rate say 50%) so loss is 2.3%.


----------



## james4beach (Nov 15, 2012)

Jimmy said:


> I always saw these as not worth the risk. They may yield 2+ % more than an IG bond fund but the default risk counters this so just stay w IG. Eg Default risk for BBB is 4.6%. ( recovery rate say 50%) so loss is 2.3%.


I agree, not worth the risk. By the way ZFH is now down 5.7% from its peak in September. Imagine believing BMO's marketing, that this is low risk fixed income, and then having a 5.7% decline -- wow!

Investors are fleeing this ETF. Before the decline, it had $480 million AUM and is now down to $370 million. My guess is that all money will leave it and the ETF will shut down eventually.


----------



## james4beach (Nov 15, 2012)

ZFH briefly and sharply crashed in Thursday's trading. TMX trading history shows over 1,000 shares traded at 13.36 and several thousand more shares at 13.52 - 13.57. That was a 13% drop from the peak price, just brutal.

This has started unravelling.


----------



## Jimmy (May 19, 2017)

Similarly I am a little worried about HPR and preferreds. It is down on price 18 %. It has fallen more than the market which is troubling as it is supposed to be less risky. Seems it is very correlated to the 5 yr BOC yields which has fallen by a similar amount. 

Not worried because interest rates are going up, yields will rebound and these reset to these higher yields every 5 yrs. Just baffling but still these types of swings are unnerving. James Hymas just thinks it makes no sense too. Just some loss selling before YE and noise.


----------



## hfp75 (Mar 15, 2018)

Interesting thread - thoughts on HYI ?

Not trying to derail vs ZFH....


----------



## james4beach (Nov 15, 2012)

Sorry I don't know anything about other floating rate funds.

An update: money has been pulled out of ZFH, and its asset under management has shrank by about $150 million over about four months.

The fund is now down to $339 million AUM. It might be a bearish sign when _one third_ of the invested money has been pulled out in a short time span.


----------



## l1quidfinance (Mar 17, 2017)

hfp75 said:


> Interesting thread - thoughts on HYI ?
> 
> Not trying to derail vs ZFH....


HYI should be considered a junk bond fund. Use it to boost yield but be sure to understand the risks. Certainly not a place to keep cash safe.


----------



## james4beach (Nov 15, 2012)

james4beach said:


> Investors are fleeing this ETF. Before the decline, it had $480 million AUM and is now down to $370 million. My guess is that all money will leave it and the ETF will shut down eventually.


In just 6 months, assets under management has dropped from $480 million down to $153 million today. Money is steadily leaving ZFH. If anyone is still in this, you should probably get out. I wonder if the ETF will survive until the end of this year.


----------

