Before being bought by BlackRock early in 2012, Claymore Investments pioneered many new services and unconventional products. One of these was its so-called Advantaged ETFs, which used a complicated structure to convert fully taxable bond interest and foreign income into tax-favoured return of capital and capital gains.
Barely a year after these funds joined the iShares family, the 2013 federal budget took aim at this sleight of hand. While the government is grandfathering contracts already in force, it won’t allow new ones, which means the eventual end of the tax break promised by the Advantaged ETFs. A couple of weeks after the budget, iShares stopped accepting new subscriptions for these funds until they decided how to handle the situation.
The ETFs are open for business again, but several have new names and all have new strategies. Here’s a summary:
The iShares Global Monthly Advantaged Dividend has become the Global Monthly Dividend Index ETF (CYH). The tax-favoured structure is gone, but the investment strategy is largely the same: the fund is about half US and half international dividend stocks. However, the older version used two US-listed Guggenheim ETFs as its underlying holdings. Today the fund tracks a different index—the Dow Jones Global Select Dividend Composite—and holds its 300-odd stocks directly.
The iShares Advantaged Canadian Bond is now the High Quality Canadian Bond Index ETF (CAB). It’s a plain-vanilla bond fund tracking the same index as before, with a fixed target of 60% government and 40% corporate bonds, all investment grade. That compares with about 70% government bonds in the iShares DEX Universe Bond (XBB) and about 80% in the Vanguard Canadian Aggregate Bond (VAB). The average maturity (8.5 years) and duration (6.1 years) of CAB are both slightly lower than those of XBB and VAB.
The iShares Advantaged Convertible Bond has changed its name to the Convertible Bond Index ETF (CVD) and now holds its securities directly, which eliminates its former tax advantage. The underlying index remains unchanged.
A hybrid approach
While the above three funds no longer have any tax advantages, the iShares Advantaged High Yield Bond (CHB) and iShares Advantaged Short Duration High Income (CSD) have both retained their names and—at least temporarily, it seems—some of tax benefits. Both now use what BlackRock calls a “hybrid strategy,” whereby the current portfolio is covered by grandfathered contracts, but new inflows will be invested directly in the underlying bonds. According to BlackRock:
The Hybrid Strategy is intended to allow for the preservation of any tax benefits associated with the forward agreement until its expiration or earlier termination, while also allowing the fund to realize the benefits of accepting new subscriptions while respecting the growth limits for forward agreements set out in certain proposed new tax rules. BlackRock expects that these tax benefits will diminish over time as the fund accepts new subscriptions and the tax benefit is spread over the fund’s larger asset base.
What does it mean for investors?
ETF providers are loath to close funds because it would mean giving up hundreds of millions in assets under management. They’re relying on investors to fall prey to inertia and simply go on holding these ETFs long after they have outlived their usefulness. But if you own any of the former Advantaged funds you need to consider whether they still make sense.
Remember, unless you bought the ETFs for the wrong reason in the first place, you’ll be holding them in non-registered accounts. And once the forward agreements no longer apply, most these asset classes (especially high-yield bonds) don’t belong in taxable accounts. Like any other ETF filled with premium bonds, a fund like CAB belongs in a tax-sheltered account—assuming it has any place in your portfolio at all when comparable bond ETFs are cheaper. If you need to hold fixed income in a taxable account, consider a GIC ladder.
The only ETF that might retain some usefulness in a taxable account is CYH. Although its dividends are now fully taxable, that’s true of any foreign equity ETF, and because the fund now holds its stocks directly, rather than via an underlying US-listed ETF. That means there is an opportunity to recover international withholding taxes in a non-registered account. (For the details, see our recent white paper on this subject: CYH would offer similar advantages to what we’ve called Type F funds.) However this has to be balanced against its high MER of 0.68%.