Bond yields have been rising sharply lately by bond market standards, but the net effect on income-hungry investors is negligible.
So we should expect interest to remain strong in one of the ETF world’s most interesting products, the iShares Canadian Financial Monthly Income ETF (FIE-T). This exchange-traded fund has been around for more than 11 years – eons by ETF industry standards – and has attracted an impressive $944.7-million.
The fee for investors who own FIE is 0.82 per cent, which for this type of ETF is at the outer reaches of bloated. A competing product, the BMO Equal Weight Banks Index ETF (ZEB-T), recently had its management expense ratio lowered to a comparatively svelte 0.28 per cent.
What gives with FIE? My theory is the yield, which shows up at 5.8 per cent on Globeinvestor. With five-year Government of Canada bond yields around 1.3 per cent, that’s huge. Also, FIE has produced some strong total returns – 39.6 per cent for the 12 months to Sept. 30 and 9.7 per cent on an annualized basis over the past 10 years.
FIE is a play on a favourite sector of investors – financials. Banks make up about 48 per cent of the portfolio, insurance companies represent another 26 per cent and much of the rest are diversified financial companies and even a couple of real estate investment trusts.
How, you have to ask yourself, does FIE produce income yielding almost 6 per cent with this mix of investments? You’ll find answers if you check its online profile and dig into the data on distributions. In 2020, FIE paid out 48 cents in total distributions per unit, as it has since 2011. This ETF has been dead reliable.
However, only 28 cents per unit was accounted for as dividends in 2020. The rest was a return of capital, which in non-registered accounts is not taxed each year. Instead, the RoC amount is subtracted from your adjusted cost base, thereby accentuating your capital gain when you sell or easing a capital loss.
RoC can be an issue if a fund consistently pays out more than it takes in via dividends, bond interest and capital gains from securities it has sold at a profit. Over time, the fund’s unit value could get ground down. This doesn’t seem to be a problem with FIE, but investors using non-registered accounts should know what they’re dealing with here. There is work to be done in keeping track of your adjusted cost base over the years.
The big issue with FIE is the weighty cost. Sure, returns are fine. But there’s no getting around the fact that you’re paying almost triple what a similar product, ZEB, charges. Holding only banks, ZEB has produced a one-year return of 49.4 per cent and a 10-year annualized return of 12.1 per cent. The yield is 3.2 per cent, based mostly on dividends. The RoC portion in recent years has been negligible.
-- Rob Carrick, personal finance columnist
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Globe Advisor
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Ask Globe Investor
Question: I’m five to 10 years away from retirement and because of the rapid rise in equity prices, my portfolio is weighted about 80% in stocks and only 20% in bonds. That’s a lot more equity exposure than I envisioned at this point in my life. But with the outlook for bonds so poor (not only are yields tiny, but bond prices are sure to fall as interest rates eventually go up) I’m not convinced I should rebalance into something more like the classic 60/40 portfolio.
What is your advice for portfolio balancing at this juncture, and are there any bond alternatives that you recommend? Thanks, Mort
Answer: Often the rule of thumb to help set a guideline for asset mix for a person’s portfolio is 100 less your age is your equity exposure. This is just a guideline. Over the past several years I as a portfolio manager have strayed from this guideline, primarily because of the exceptionally low interest rate environment we have had. The Bank of Canada has a target inflation rate of 2%. Any investment that does not yield that or more, I am effectively losing you money as an investment manager.
Now, there are often exceptions to the rule. The need for capital preservation is the primary one of course. As long as the investor is aware that there is a loss of buying power of those funds then I’m okay with it. One has to be reminded that yields impact the market price of fixed income products such as bonds, except for GICs. GIC prices do not change from purchase to maturity but they do not provide easy liquidity.
I am not surprised that your asset mix has gradually increased the equity exposure over time. It was probably your reluctance to invest your money with a less than 1% yield in bonds. As long as the quality of your equity is high (example banks and utilities) and well diversified across sectors, then I don’t think your portfolio is inappropriate for your current timeframe.
It may even be suitable once you retire because of the income it provides. It might even be more appropriate than getting paid interest income because dividends are taxed at a lower rate than interest, which is 100% taxable. Canadian-sourced dividends even have the benefit of a tax credit.
In these ever changing times, you as an investor need to be willing to adapt to the current investing environment. If it means having a higher than expected equity weighting then it may actually be the right thing for you. Have a discussion with your financial advisor regularly to make sure that your asset mix, objectives and more importantly, your risk tolerance is being met.
--Nancy Woods, Vice President, Portfolio Manager and Investment Adviser with RBC Dominion Securities Inc.
What’s up in the days ahead
Several central banks have started hiking interest rates - and expectations are accelerating that the U.S. Federal Reserve and Bank of Canada aren’t far from pulling the trigger as well. Can this powerful bull market be sustained in the face of monetary tightening. David Berman, Scott Barlow and Darcy Keith will have an indepth look.
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Compiled by Globe Investor Staff