# Is there still value in CDN banks/financials? XFN, ZEB?



## favelle75 (Feb 6, 2013)

Looking for another solid long-term ETF for my TFSA and I keep coming back to the banks. Are they overvalued and due for a drop or at best flatlined growth? Thoughts?


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## doctrine (Sep 30, 2011)

In my opinion, yes. I own shares in most of the banks. National Bank is still my favorite, yield at 4.7% with 10% dividend growth in the last year (40% since 2010).


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## favelle75 (Feb 6, 2013)

doctrine said:


> In my opinion, yes. I own shares in most of the banks. National Bank is still my favorite, yield at 4.7% with 10% dividend growth in the last year (40% since 2010).


Thanks Doctrine...so do you suggest the individual stocks outright or is there an ETF that also looks good from your vantage point?


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## favelle75 (Feb 6, 2013)

I was thinking possibly VCE as well.


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## doctrine (Sep 30, 2011)

ZEB is good; if you have under $10k to invest in the banks then it's probably okay, that works out to $55 a year in fees which is probably 5 trades a year for most (10 at Questrade though). XFN is fairly highly weighted to Royal and TD although it has a few other holdings, but it'll probably be okay. Again, under $10k. Anything more than that and you should be looking at holding shares. As with anything, you shouldn't overinvest in this sector (I would say less than 25%), but the valuation and dividends are quite good, so I have a healthy weighting.


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## fatcat (Nov 11, 2009)

doctrine said:


> ZEB is good; if you have under $10k to invest in the banks then it's probably okay, that works out to $55 a year in fees which is probably 5 trades a year for most (10 at Questrade though). XFN is fairly highly weighted to Royal and TD although it has a few other holdings, but it'll probably be okay. Again, under $10k. Anything more than that and you should be looking at holding shares. As with anything, you shouldn't overinvest in this sector (I would say less than 25%), but the valuation and dividends are quite good, so I have a healthy weighting.


i used to have ZEB and then decided that since i wanted to hold canadian banks essentially forever, decided to buy 5 banks directly ... i now have 4 and plan to get down to 3 .... though i agree ZEB makes owning the banks very easy, one trade and you get all 5 of the biggies


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## favelle75 (Feb 6, 2013)

Nice! Thanks guys. I would want to throw SunLife and ManuLife in there as well. Total would be about $8K, so I should definitely look at an ETF.


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## dotnet_nerd (Jul 1, 2009)

ZWB is also worth looking at. It's the BMO Covered Call fund for the Canadian banks.

http://www.etfs.bmo.com/bmo-etfs/glance?fundId=83031

The option premiums boosts the yield a bit, it's at about 6.95% at the moment


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## favelle75 (Feb 6, 2013)

dotnet_nerd said:


> ZWB is also worth looking at. It's the BMO Covered Call fund for the Canadian banks.
> 
> http://www.etfs.bmo.com/bmo-etfs/glance?fundId=83031
> 
> The option premiums boosts the yield a bit, it's at about 6.95% at the moment


Thanks dotnet. That's a huge yield! So less risky but higher payouts? What's the catch!


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## james4beach (Nov 15, 2012)

favelle75 said:


> Thanks dotnet. That's a huge yield! So less risky but higher payouts? What's the catch!


The catch is that ZWB doesn't really yield 6.95%. It _distributes_ 6.95% and a lot of that is return of capital. See 'distribution' section of their web site and look at 2012 tax characteristics, and especially look at the annual report page 5, under "DISTRIBUTIONS TO UNITHOLDERS FROM"

When you look at actual earnings -- dividends & interest the fund earns -- that makes up only about 45% of the total distribution. The other 55% is return of capital.

This lets us estimate the actual yield of ZWB at 45% x 6.95% = *3.13% ZWB yield* which sounds sensible.

So what does this mean ... say you buy $10,000 of ZWB and it distributes 6.95% = $695 in a year. That distribution is composed of:
$313 earned income
$382 return of capital

The $382 comes out of the $10,000 capital ... everything else being equal, your investment drops to $9,618. Every year, your capital drops further. It's important that you realize that the fund is only earning the 3.13%

To give you another example, I could create a fund that holds $10,000 in a savings account. Perhaps it earns 2% interest, and I return another 3% return-of-capital (ROC). Now you have a 5% distribution and everyone would be wetting themselves with excitement about a super safe savings account that distributes 5%.


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## doctrine (Sep 30, 2011)

> Thanks dotnet. That's a huge yield! So less risky but higher payouts? What's the catch!


Last time I checked, ZWB was slightly underperforming ZEB. That means despite a higher yield, the capital value of the ETF has decreased by slightly more than the extra yield you received. I'd rather just own the banks directly rather than trying to extract more income. 4.5-5% is already a pretty good yield for a large bank, especially with 5-10% growth per year.


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## My Own Advisor (Sep 24, 2012)

I with doctrine, NA has a bunch of upside IMO.

Own the other 5 banks. Not selling.  Collect my money and reinvest.


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## dotnet_nerd (Jul 1, 2009)

james4beach said:


> See 'distribution' section of their web site and look at 2012 tax characteristics


I don't care about the tax implications, it's in my TFSA



james4beach said:


> To give you another example, I could create a fund that holds $10,000 in a savings account. Perhaps it earns 2% interest, and I return another 3% return-of-capital (ROC). Now you have a 5% distribution and everyone would be wetting themselves with excitement about a super safe savings account that distributes 5%.


No, that's not a good example. The value of the fund would continue shrinking until the $10,000 is depleted. Then the stock price of your fund would sink to 0.

All I know is, I bought 500 shares of ZWB about a year and a half ago at around $14.20. I receive between $35 to $44 each month in "distributions" or whatever you want to call it. But's it's real money, a rose by any other name. And the stock price has gone up not down. 

I've received 16 payments so far totaling $674 over 16 months.
674/(14.2*500) =* 7.1% annualized yield*
And I still have my $14.20 in fact I could dump it for a profit.

That's good enough for me.


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## james4beach (Nov 15, 2012)

dotnet_nerd said:


> I receive between $35 to $44 each month in "distributions" or whatever you want to call it. But's it's real money, a rose by any other name


It's real money, but some of it is just your own money handed back to you. Why pay a fund manager extra MER % just to hand your own money back to you?

I pointed to the tax implications only because that's where it tells you how much of the distribution is return of capital.

Many of these ETFs with high RoC are giving high distributions at the expense of long term capital appreciation. That's what dipping into ROC does... Higher monthly distributions, yes, but a lower ending price. It's just a question of where the money comes from at what point in time. A trade-off.

For example, I see nearly identical total returns on both ZWB and ZEB for the last 1 and 2 years. Yet ZWB's distribution and yield far exceeds ZEB's. It's an illustration of that trade-off... you end up in the same place, with the same return. So it's not a disaster by any means. *However* you're paying 10 basis points more in fees for ZWB.

I agree this ZEB vs ZWB isn't a very big deal, but I get upset when a higher MER fund attracts buyers using misleadingly high distribution yields... they are implying an investor will make more money with the 'higher yield'. In the end, it always turns out to be a wash, with worse long-term performance in the high-MER and high-complexity fund (such as covered call ETF).


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## james4beach (Nov 15, 2012)

doctrine said:


> Last time I checked, ZWB was slightly underperforming ZEB. That means despite a higher yield, the capital value of the ETF has decreased by slightly more than the extra yield you received.


Yes see my last post. It's a direct tradeoff. ZWB has a higher distribution consisting of significant ROC, which erodes the share price. So you end up in the same place.


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## Jaberwock (Aug 22, 2012)

If you invest in ZWB, you will gain some income from the writing of covered calls, but you will lose some of the potential upside capital gain if the bank shares rise. This article from money sense explains it all very clearly:

http://www.moneysense.ca/2012/09/14/the-income-illusion/


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## HaroldCrump (Jun 10, 2009)

dotnet_nerd said:


> All I know is, I bought 500 shares of ZWB about a year and a half ago at around $14.20. I receive between $35 to $44 each month in "distributions" or whatever you want to call it. But's it's real money, a rose by any other name. And the stock price has gone up not down.


But please look at the trading range of ZWB over the last couple of years.
_You_ may have just happened to buy at $14.20, but many other investors would have bought anywhere between $15 - $16.50.
The security traded between $15 and $16.40 for most of 2011.

It seems you are looking only at the yield of this security, and not its underlying strategy and its implications.
You could just as easily have bought this at $16 instead of $14.20.


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## Eclectic12 (Oct 20, 2010)

dotnet_nerd said:


> I don't care about the tax implications, it's in my TFSA.


james4beach is pointing out the breakdown of the distribution - not the tax implications. Unless the RoC is coming from a REIT or other from a short list of exceptions, RoC usually means the investor's cash is being paid back to them.

http://howtoinvestonline.blogspot.ca/2010/07/return-of-capital-separating-good-from.html





dotnet_nerd said:


> The value of the fund would continue shrinking until the $10,000 is depleted. Then the stock price of your fund would sink to 0 ... All I know is, <details of investment> ... That's good enough for me.


You are assuming nothing is changing when in reality, more investors are buying & selling to give the fund cash flows to invest or distribute as RoC. The changing number of units as well as investors assuming extra yield is 100% from options so that the assets are not being eroded (which may not be the case) can keep the unit price higher than it should be. 

The unit price should be close to the asset value but as a long list of company share prices can tell you (ex. BreX, Nortel, Enron etc.), the trading price is not always right. 




james4beach said:


> It's real money, but some of it is just your own money handed back to you. Why pay a fund manager extra MER % just to hand your own money back to you?
> 
> I pointed to the tax implications only because that's where it tells you how much of the distribution is return of capital ...


+1 .. though I don't believe you were pointing at the tax implications but the capital appreciation implications. Since RoC is usually looked at from a tax perspective and is reported that way, taxes are really a sidebar, IMO.


Cheers


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## james4beach (Nov 15, 2012)

Eclectic12, you're right, taxes are a sidebar and I was just peeking at them for the RoC info.

I should also mention that it's very hard to figure out exactly where RoC comes from (see Eclectic12's link to see what a mess it is). We're speculating here that it's some degree of your own money being handed back, or some unrealized capital gains maybe, but it doesn't really matter. Just look at the total return figures and you'll see that ZWB performs about the same as ZEB... this says definitively that, one way or another, ZWB's higher payouts are coming at the expense of long term capital appreciation.

Jaberwock thanks for the including the link to "The income illusion" article. That's a great article and changed my whole perspective. Here's a quote regarding covered call strategies:



> Hallett doesn’t recommend call-writing strategies. “You’re saying you will take the cash now and give up some upside but in the fullness of time, on a total-return basis, I don’t see how that works in your favour. If history is any indication—admittedly, it might not be for your investment horizon—you’re probably giving up more than you’re getting.”


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