# BMO S&P/TSX Laddered Preferred Share Index ETF



## fatcat (Nov 11, 2009)

do any of you preferred share experts out there have any thoughts on this new etf ?

i am a big fan of bmo etf's in general since they tend to equal weight insted of cap weight for most of their products

i have owned ZUT and ZEO and ZEB

i own CPD and the difference between the two etf's is that the bmo product is 5-year laddered (which appeals to me since rates at low points) though the credit quality is slightly less desirable

yields are about the same and mer's are the same .45

i tend to think it's not worth switching but would appreciate other opinions


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## InvestingForMe (Sep 6, 2012)

Hi, fatcat.
Their laddering concept for preferred shares is a bit different from the one they use for the bonds. Unlike for bonds (which have fixed maturity dates) it appears BMO is going to purchase rate-reset preferred shares with dividend reset dates laddered in 5 'buckets' (1 thru 5 years). As each preferred share dividend rate is reset, the shares will automatically move from the 1-year bucket to the 5-year bucket - nothing is sold or purchased. In their literature they state this approach minimizes the risk of redemption that comes with Rate-Reset preferred shares. (Especially if they come with overly healthy reset formulas. For example, dividend reset to a rate that equals the sum of the 5-year Government of Canada Bond Rate (GCAN5YR) plus 4.6%).
Keep in mind the laddering structure for preferred shares does not work the same as it does for the bonds. Laddering preferred shares by their rate-reset dates does not eliminate and maybe not even minimize the redemption risks associated with Rate-Reset preferred shares. (I am not sure that laddering preferred shares is a profitable strategy or a new marketing angle?? I admit it is a novel approach to investing in preferred shares)

Also keep in mind, that preferred share ETFs and mutual funds will still be purchasing rate-reset preferreds in the market, so the unit holder's market risk might also be higher. ie buying BMO.PR.P at $27.25 today and risk redemption at $25.00 in February 2015 or have the dividend reset to a rate that equals GCAN5YR (currently @ 1.48%) plus 2.41%. So if rates remain at current levels right up to Feb. 2015 this preferred share's dividend rate would be reset from its current $1.35/share to $0.9725/share it would automatically be shifted from the 1-year bucket into the 5-year bucket and the share's price would certainly fall from $27.25 to say.... maybe $25.20. (If rates go up from here the redemption risk might decrease, but the market price risk might be the same)

A final thought: By automatically holding onto rate-reset preferreds and simply accepting the new 5-year reset dividend yield BMO might be 'robbing' unit holders of an important feature imbedded in most rate-reset preferred shares - the option to convert into a floating rate preferred share, which can be switched back into a 5-year fixed rate preferred share 5-years hence.

As you pointed out this is a new ETF, but I think it is also the only ETF that uses a laddering structure for preferred shares by Rate-Reset dates. I maybe wrong.

Regards

P.S. If you like their strategy, why not just build your own laddered rate-reset preferred share 'ETF" using 4 or 5 preferreds? You would retain control/flexibility and save the annual 0.45% Management fee plus ETF operating expenses. Just a thought.


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## fatcat (Nov 11, 2009)

hey thanks for that helpful answer
i had never heard of such a laddering approach
i tend to like bmo etf's and they have done well mostly against ishares products
they tend to offer products that you don't see from other companies
equal weighting vs. cap weighting is one of their specialities and their funds show the value of the concept

i would never buy individual preferreds, i do own CPD
i wondered whether this laddering strategy would provide better protection against rising rates which is what they claim
since CPD has more perpetual preferred's in it it will be more sensitive to interest rate rises

i plan to allocate to preferred's again in may or june and i think i will go with this fund

thanks for the reply


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## InvestingForMe (Sep 6, 2012)

Hi fatcat
Disclosure: I have not invested in preferred share ETFs (personal bias toward owning/holding individual issues) so keep in mind I am somewhat biased. However, I also understand that ETF's can be a great investment vehicles for individual investors and accept my bias could well be proven faulty with time. 

I always think of preferred shares as part of my long-term, fixed income, investments. Particularly my perpetual preferred shares - they pay a fixed, regular income, typically no retraction features, and have a long, long maturity date (perpetuity). So for me, CPD would not fit. The ETF's Portfolio Turnover Ratio is just too high. For example, the ratio was 30.50% in 2011, 64.37% in 2010, 50.15% in 2009 and 50.42% in 2008. This ETF has a very high Turnover Ratio with almost half of the preferred shares held being bought and sold every year. For me, preferred shares are an income investment better suited to a buy and hold investment strategy, not a trading strategy (which appears to be used by this ETF). In my mind, a high Portfolio Turnover Ratio seems counter to the logic of owning preferred shares. The ETF also holds 165 individual preferred shares, so I suspect it's holdings is slowly creeping toward dominance by Rate-Reset Preferred shares. (This might be a good thing, I do not know.)

P.S. - The other part I personally struggle with are the distribution policies of ETFs. In the growing competition to attract investors, a greater number of ETFs are quietly augmenting their distributions with a Return Of Investor's Capital (ROC). The CPD for example. paid out $0.828/per share in 2011, (2012 tax info has not been released) which included $0.13416 (or 16.2% of the distribution) which was a return of the investor's own capital. The ROC for CPD has been as high as 32.6% in 2009 and 42.5% in 2007. Using ROC in distributions is making it harder for investors to compare ETF distributions of similar funds. So for 2012, CPD had a 12-month trailing yield of 4.67%, but how much of that is a return of the investor's own capital? (Sorry, this is more of a personal rant and not very helpful to your original question.)


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## gibor365 (Apr 1, 2011)

I was thinking for last couple of month to buy one of the Preferred shares ETFs... which one would you prefer ZRP, XPF or CPD?
XPF has the highest yield 5.4% , but more volatile than CPD with 4.4%.
ZRP just got released and unknown how it would perform comparing to other 2.....

Any other similar ETF worth looking at?


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## InvestingForMe (Sep 6, 2012)

Hi, gibor.
As you mentioned ZRP is new so no track record to go by - Portfolio Turnover Ratio, actual MERs, Distributions and Return of Capital, etc. I tend to like looking at what an investment _does  and not what it says - so personally ZRP is not an option.

XPF = is North American so it hold U.S. preferred shares, which as you probably already know, is not the best for us Canadians - after-tax. In 2011, XPF paid distributions of $1.04113/share (after paying foreign taxes) and of that $0.55512 was Foreign  income and $0.08143 was a Return of the investors' own Capital. Only $0.4464 were Cdn dividends. (I guess irrelevant if the shares are held within a registered account) It's Portfolio Turnover Ratio is not bad at 30.46% in 2011 and 12.67% in 2010 (2012 data not currently available). The ETF currently holds 446 individual shares, so this would held to explain the U.S. dominance (I think in Canada there are only something like 275 or so preferred shares issued.). It's MER of 0.49% (2011) seems reasonable and it's overall performance, capital appreciation is probably in line with the declining interest rate and income hungry investment climate.

Sorry gibor, I am not much help in finding an easy answer to your question. Preferred share ETFs are relatively new and we just do not have a lot to choose from. Even the underlying preferred share indices are fairly new, so we do not really know how they will fair if interest rates or credit concerns (like fall of 2008) were to increase. Maybe I am unable to give you an answer because I just like to know what I am owning and I wrestle with preferred share ETFs because of this. 
Sorry I can not be more helpful.

Regards_


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## gibor365 (Apr 1, 2011)

InvestingForMe said:


> is not the best for us Canadians - after-tax. In 2011, XPF paid distributions of $1.04113/share (after paying foreign taxes) and of that $0.55512 was _Foreign  income and $0.08143 was a Return of the investors' own Capital. Only $0.4464 were Cdn dividends. (I guess irrelevant if the shares are held within a registered account) _


_
I'm pretty sure that it's irrelevant in RRSP/LIRA, ... I want to buy it for TFSA and think it's also irrelevant (but not sure 100%)....do you know

How can I check Portfolio Turnover Ratio for specific ETF?

btw, volume for those preferred ETFs , surprisingly pretty decent comparing with other Canadian ETFs (exclude the big one like XIU), CPD daily avg volume is 75K, XPF - 10K, and ZPR - 19K (pretty high for completely new ETF)_


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## InvestingForMe (Sep 6, 2012)

Hi, gibor
Sorry for the delay in responding. 
Yes, the tax benefit of Canadian dividends is kind of irrelevant for TFSAs and registered accounts. 
Finding Portfolio Turnover Ratio (PTR) for some ETFs, like iShares, is easy. They post it on their websites. For some, like BMO & Vanguard, they do not disclose the ratio at all. And sometimes it is buried inside the ETF's prospectus or more likely inside the Managements Discussion documents. 
We think the PTR can be important is assessing the ETF/mutual funds investment style (active or passive), how closely the ETF is matching its underlying index and how relevant comparison analysis is to the investment decision. (ie. Comparing Bond ETF Yield To Maturity (YTM) between funds. The YTM is almost irrelevant if the bond ETF has a high PTR - because with a high PTR, the manager will not be holding the same bonds six or 12 months down the road making YTM useless.)

Hope this is of some help.


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## andrewf (Mar 1, 2010)

Canadian prefs still benefit from the lack of withholding taxes vs US prefs, EXCEPT when US prefs are held in an RRSP either directly or through a US-listed fund.


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