Four New ETFs and an Invitation

BMO has announced it’s launching four new ETFs, which will start trading on Tuesday, November 20:

  • BMO S&P 500 (ZSP/ZSP.U)
  • BMO S&P/TSX Laddered Preferred Share (ZPR)
  • BMO S&P/TSX Equal Weight Industrials (ZIN)
  • BMO S&P/TSX Equal Weight Global Gold (ZGD)

Let’s look at the two most interesting ETFs in this lineup. Investors seem to be falling out of love with currency hedging, which causes a long-term drag on returns for Canadians who invest in US equities, and ETF providers are responding. Less than three weeks after the launch of the unhedged Vanguard S&P 500 (VFV), BMO has a competitor. Back in September, BMO changed the benchmark for its US equity ETF from a Dow Jones index to the better-known S&P 500, but that fund retained its currency hedging. The new BMO S&P 500 (ZSP), however, is unhedged and its management fee is identical to Vanguard’s at just 0.15%.

What’s interesting is that BMO has also created a version that trades in US dollars (ZSP.U). If you want a USD-denominated ETF that tracks the S&P 500 it generally makes more sense to go with one of the New York-listed funds from iShares, SPDR or Vanguard because of their enormous liquidity and lower fees. But the BMO fund has one advantage: as a Canadian-domiciled fund, it would be exempt from US estate taxes, which can be a major concern for wealthy Canadians with lots of greenbacks to invest. (The two versions might also be useful for using Norbert’s gambit to exchange currencies.)

A ladder of preferreds

Preferred shares are extremely popular with taxable investors, because have little price volatility except when interest rates move (which makes them similar to corporate bonds), and because their distributions are eligible for the dividend tax credit. There are several preferred share ETFs in Canada, the largest of which is the iShares S&P/TSX Canadian Preferred Share (CPD), which at almost $1.3 billion in assets is the 10th largest in the country. (Yes, I was surprised by that, too.)

The BMO Laddered Preferred Share (ZPR) is unique because all of its holdings are what are called rate reset preferreds. These have a specific call date, usually every five years, on which the holder can choose to lock in a new dividend at current rates, or convert to a floating rate that will change monthly or quarterly based on a reference rate. By contrast, CPD is about one third perpetual preferreds, which have no maturity date and pay the same fixed dividend as long as they are outstanding.

So what’s the difference? Rate resets will be similar to short-term corporate bonds in the way they respond to interest rate changes. If rates rise, they will fall in price, but not as much as perpetuals, which behave more like long-term bonds. With many investors worried about the prospect of rising rates, a ladder of short-term issues has obvious appeal. Think of ZPR as a tax-advantaged complement to the iShares 1-5 Year Laddered Corporate Bond (CBO).

Spend Saturday with the spud

This Saturday, November 24, I will be participating in an Introduction to ETFs for Investors, presented by TMX and iShares. I’ll be part of a panel that includes fellow financial journalist Caroline Cakebread and Pat Chiefalo of National Bank Financial. The keynote speaker will be Bruce Sellery, author of Moolala, and all attendees will receive a copy of his book. Rumour has it my own MoneySense Guide to the Perfect Portfolio will also be part of the swag bag.

The event runs from 8 a.m. until noon at the AllStream Centre at Exhibition Place in Toronto. We would love for you to join us: you can register online here. The cost is $25, but Canadian Couch Potato readers can enter the promo code ETF13b and get $10 off. If you attend, make sure you stop by to say hello.

29 Responses to Four New ETFs and an Invitation

  1. Canadian Capitalist November 19, 2012 at 10:09 am #

    It’s nice to see unhedged ETFs getting launched. Hope to see one tracking developed markets ex. US with reasonable MERs.

  2. Mandy @MoneyMasterMom November 19, 2012 at 10:14 am #

    I had better not tell Derek about your presentation this Saturday. If I do, he’ll be especially annoyed that he’s spending the day celebrating Christmas with my extended family. :) Hope your presentation goes well!

  3. Derek @ Free at 33 November 19, 2012 at 6:09 pm #

    Learning more about ETF’s would be 100X more enjoyable then my wife’s family Christmas. Alas, happy wife, happy life.

  4. Nathan November 19, 2012 at 6:41 pm #

    One thing to be aware of is that preferreds in general take on quiet a bit more equity-like risk than corporate bonds, so I expect that ZPR will be significantly riskier than CBO. In-depth analysis here: http://www.financialwebring.org/forum/viewtopic.php?f=29&t=115428

  5. André November 21, 2012 at 5:19 am #

    Hello Dan,
    Is VFV a canadian-domiciled fund (as ZSP)?
    If so, what are the +/- over non-domiciled funds for canadian investors?
    Thanks

  6. Danno November 21, 2012 at 9:05 am #

    I am also curious as to the answer to André’s question.

    So I could invest in (1) ZSP (which is Canadian-domiciled, trades in Canadian dollars, but is unhedged so offers US currency exposure), or (2) ZSP.U, which is the same, except trades in US dollars. Or I could invest in (3) a fund listed/domiciled on a US exchange.

    All else being equal (assuming the holdings & MERs are similar between 1/2 and 3 – which they probably are not, and so maybe that is the answer), what are the advantages/disadvantages between 2 & 3 especially?

  7. Canadian Couch Potato November 21, 2012 at 9:35 am #

    @André and Danno: Yes, VFV and ZSP/ZSP.U are Canadian-domiciled funds. Here are the pros and cons:

    – VFV and ZSP allow Canadians to get unhedged exposure to the S&P 500 while buying and selling in Canadian dollars and therefore avoiding currency exchange costs. This was previously impossible with ETFs.

    – As Canadian-domiciled funds, VFV and ZSP/ZSP.U are not subject to U.S. estate taxes, though this is really only relevant to very wealthy investors.

    – One disadvantage with VFV and ZSP is the slightly higher management fee compared with US-listed funds such as VOO, IVV or SPY. But we’re talking about just a few basis points, and the advantage of trading in Canadian dollars will outweigh the fee difference for most investors.

    – Other than to avoid estate tax issues, I cannot think of any reason one would use ZSP.U rather than a US-listed fund.

    Hope this clears things up.

  8. Danno November 21, 2012 at 9:50 am #

    Thanks again for the quick reply. That does help a lot. Assume we are speaking here generally about an unregistered account. In an RRSP, my understanding is that holding VOO or IVV or whatever directly, is still the best option due to the foreign withholding tax issue? So (among the S&P indecies) the best US holding in an RRSP may be VOO, an unregistered account may be VFV, and a TFSA probably VFV as well?

  9. Canadian Couch Potato November 21, 2012 at 9:57 am #

    @Danno: You are correct that in an RRSP or RRIF, holding a US-listed ETF exempts you from withholding taxes. Sorry, I should have included that in the list above.

    In a non-registered account, you will pay the withholding tax if you use VFV or ZSP but you can reclaim it. In a TFSA, you will pay the withholding tax and cannot reclaim it. The same would be true is you held US-listed ETFs in these accounts, so the only issue becomes whether you want to trade in US or Canadian dollars.

  10. ZB November 21, 2012 at 10:04 am #

    Is ZPR a better choice than XPF in your yield hungry portfolio?

    If not this one, are any BMO ETFs good alternatives to the iShares options in this portfolio to lower MERs or take advantage of DRIP?

  11. Canadian Couch Potato November 21, 2012 at 10:11 am #

    @ZB: I originally chose XPF because I feel the Canadian preferred share market is very narrow and having US exposure helped provide better diversification. The generally higher yield on US preferreds compensated for much of the additional tax (at least it did at the time: not sure if that has changed).

    DRIPs are largely irrelevant to ETF choices: brokerages allow you to DRIP pretty much any Canadian ETF these days.

  12. CCP Fan November 21, 2012 at 11:24 am #

    By reading this blog and a few others, I’ve learned about two distinct problems with US-listed ETFs for Canadian investors:
    1- the US estate tax issues (including the uncertainty of future changes to the tax treaty and IRS rules), and
    2- the Canadian Revenue Agency’s reporting obligations and stiff penalties related to form T1135.
    I’m far from wealthy enough to worry about the current exemptions levels of US estate taxes, but I am willing to pay the few basis points penalty to eliminate the risk of future exposure to estate taxes through future wealth (investment success!) or exemption level changes.
    For my taxable investment account, the hassle of tracking currency exchange rates (establishing cost basis and capital gains in C$ for tax reporting), and the threat of stiff penalties in case I was late to file my taxes, keeps me buying canadian-based ETFs. Unfortunately, this forces me to hold a hedged EAFE ETF. I’d prefer holding an unhedged one.

  13. Craig November 21, 2012 at 8:53 pm #

    Dan,
    Do you see any signs of Vanguard or BMO having a Canadian (unhedged) equivalent to VTI? I would enjoy not having to pay for 2 currency exchanges but it would appear that VZV is not a good enough equivalent.

    PS: Any thoughts on the new VRE capped REIT? It has a decently lower MER than ZRE but I can’t find anything about holdings other than it uses the FTSE (?cap-weighted) index. It also seems like a bit of a risk allowing up to 25% to be a single REIT.

    Thanks as always for your blog. I’m enjoying these new competitive ETF products but I haven’t been tempted to modify your complete portfolio yet for these new entries.

  14. Canadian Couch Potato November 21, 2012 at 9:06 pm #

    @Craig: I too have been hoping for an unhedged VTI (and an unhedged international equity ETF, too) and I suspect one will arrive eventually, though I have not heard anything specific. As you may know, ETF providers rarely tip their hand about what products are in the pipeline.

    Regarding the new Vanguard REIT ETF, I’m reserving judgement until the holdings are published and we have a little track record. FTSE has published a document about the index, and it does include a list of the top holdings as of October 31:
    http://www.ftse.com/Indices/FTSE_Canada_All_Cap_Sectors_Capped_Index_Series/Downloads/GPVAN022.pdf

    I agree the 25% cap is probably too high, although it is the same as in XRE. That’s the reason I tend to prefer the equal-weighted ZRE.

  15. KK November 22, 2012 at 1:31 pm #

    So which of the Preferred Shares ETF or Corporate Bond ETF do you recommend for a (1) registered account (TFSA or RESP) (2) for a non-registered account … I have some cash in both accounts that I want to invest.

    THANKS

  16. Canadian Couch Potato November 22, 2012 at 1:39 pm #

    @KK: I can’t make specific ETF recommendations for individuals, sorry. In general, I can say that preferred shares have a tax advantage over bonds (the dividend tax credit), so they can be a better choice in a taxable account. Bond ETFs are very tax-inefficient and should be kept in a registered account whenever possible.

  17. Mazhar November 22, 2012 at 1:47 pm #

    The ETF13b code actually gave me $20, so the seminar is almost free!

  18. Canadian Couch Potato November 22, 2012 at 1:52 pm #

    @Mazhar: Another reader mentioned the same thing to be, though when I tried it, I got $10 off. Maybe it varies with your location?

  19. Mazhar November 22, 2012 at 2:56 pm #

    oh interesting, not sure. Anyway, just wanted to say it could be cheaper to attend than you think. I had actually used a URL from iShares’ twitter feed, not sure if they have an extra discount embedded there somehow. I’m located in Toronto FYI.

    See you on Saturday hopefully!

  20. Canadian Couch Potato November 22, 2012 at 3:03 pm #

    @Mazhar: You bet. I will stick around after the panel discussion to chat with anyone who wants to. See you then.

  21. Mazhar November 27, 2012 at 2:04 am #

    Had the pleasure of meeting Dan over the weekend at the seminar.

    Dan: You probably had the longest lineup of fans during the meet and greet! :). In fact, I had to line up twice to talk to you!! Thanks for sticking around.

  22. Canadian Couch Potato November 27, 2012 at 9:11 am #

    @Mazhar: Thanks for your patience: it was great to meet you. Good luck with the new blog.

  23. Oldie December 4, 2012 at 1:01 am #

    @CCC: I have followed the post and subsequent discussion with interest. After several re-reads, it just occurred to me there might be another advantage for Canadians to hold ZSP.U rather than a corresponding USA-based index fund tracking the S&P500. If ZSP.U is a Canadian based fund, even though the underlying stocks that its index tracks are US-domiciled, does that not mean that dividends issued (if the fund held in a taxable account) will be taxed on a favourable basis compared to dividends flowing out of a US based fund?

  24. Canadian Couch Potato December 4, 2012 at 1:04 am #

    @Oldie: No, dividends from US companies are foreign dividends, period, and they’re taxed accordingly. It doesn’t matter where the fund itself is domiciled.

  25. Oldie January 2, 2013 at 12:44 am #

    @CCP: Hmm — my professional association’s RRSP does not allow for holding US dollars; so if in the RRSP I held ZSP for my US equity category, would the US originating dividends be subjected to withholding tax or would it be excused because of the RRSP agreement, just like a regular US traded ETF?

  26. Canadian Couch Potato January 2, 2013 at 8:49 am #

    @Oldie: ZSP is subject to withholding taxes in an RRSP and there is no way to recover them. Consider this a small price to pay (about 0.30%) for a large diversification benefit compared with holding Canadian equities only.

  27. Oldie January 26, 2014 at 1:51 pm #

    @CCP: This is a question with respect to the difference in behaviour of CPD and ZPR: In a large non-registered account with the intent of generating tax advantaged Canadian dividend income (as well as the potential for capital growth, with acceptance of the market fluctuation risk exposure) suppose one starts with 40% in VCE and 30% in Interest bearing Cash/GIC’s (and say 30% in foreign equities, which we will not change). Suppose one were to reduce the VCE component to 30%, and the Cash component to 20% and consider filling in the resultant 20% gap with preferred shares, would it be reasonable to choose 10% CPD and 10% ZPR (assuming the account is large enough to make a 10% an efficient component, and assuming there is also an existing RRSP with a considerable bond weighting for acceptable balance, and that the investment horizon is more than 12 years away)?

    What I am getting at is whether the behaviour of CPD and ZPR is expected to be different enough in an era immediately following historically falling interest rates to be worthwhile trying to balance the expected divergent outcomes against each other, no matter whether rates go up, down or remain the same. Is there any merit in this line of thinking? Or is there very little diversification gain for whatever effort is required to set-up this split portion of preferred shares.

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