BMO Canadian ETF Dashboard

— as of November 30, 2019 —

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Alfred Lee

De-Risk Your Fixed Income, Without Giving Up Yield

Snapshot

Whether or not headline risks – tariffs, U.S. 2020 presidential election, Brexit – are positively resolved in the near term, many investors believe the economy is approaching the later stages of the credit cycle.

Alfred Lee

De-Risk Your Fixed Income, Without Giving Up Yield

Snapshot
Whether or not headline risks – tariffs, U.S. 2020 presidential election, Brexit – are positively resolved in the near term, many investors believe the economy is approaching the later stages of the credit cycle. As attention shifts towards quality, US preferred shares and investment grade US corporate bonds represent a sweet spot for growth and safety, which Advisors can use to:

  • Access attractive yields. Investors can earn consistent yield despite the low interest rate environment, in stable asset classes.
  • Reduce risk exposure. Moving to investment grade assets can insulate the portfolio in the event the economy does turn over.   
  • Increase portfolio diversification. Enhance your clients’ portfolios with blue chip U.S. names in a broad range of industries and sectors.

Details
BMO US Preferred Share Index ETF (Ticker: ZUP)
BMO US Preferred Share Index ETF (US Dollar Units) (Ticker: ZUP.U)
BMO US Preferred Share Hedged to CAD Index ETF (Ticker: ZHP)
BMO Mid-Term US IG Corporate Bond Index ETF (Ticker: ZIC)
BMO Mid-Term US IG Corporate Bond Index ETF (US Dollar Units) (Ticker: ZIC.U)
BMO Mid-Term US IG Corporate Bond Hedged to CAD Index ETF (Ticker: ZMU)

Benefits

  • ZIC, ZIC.U, ZMU – Consistent income through a diversified portfolio of mid-term U.S. corporate bonds, with or without U.S. currency exposure
  • ZUP, ZUP.U, ZHP – Increased earning power through high-quality pool of U.S. preferred shares, with or without U.S. currency exposure

Trade Idea – Rethinking the Fixed Income Side of the Portfolio
Despite some progress being made on Brexit and the US-China trade negotiations, there remains a lot of uncertainty on the political landscape. As these events weigh on the economy, interest rates will likely remain low, which would lead investors to continue to stretch for yield in such conditions. Currently, the U.S. Federal Reserve is expected maintain its dovish stance and continue to cut rates in the new year as some indicators suggest the economy has already peaked, and because external factors such as the presidential election may induce further volatility. Even in the event of a positive resolution in all of these events and rates begin to rise, the consensus is that we would still likely remain in a low rate environment, as aging demographics weigh on economic growth.     

To de-risk the fixed income side of their portfolios – while still earning an attractive yield – investors can look to U.S. preferred shares and mid-term U.S. corporate bonds. An increasing number of retired or investors nearing retirement will place ongoing demand on yield coming from stable sources. U.S. preferred shares offer a compelling solution to this end, given the asset class behave more like bonds, given there are no rate-resets and all issues have a fixed coupon, with many issued at a dividend rate between 5%-8%. Moreover, 70% of the universe is investment grade.1

Similarly, if the economy does indeed turn over, high yield assets will likely feel it first, which places further emphasis on a focus of investment-grade assets. Moving to ETFs like ZMU allows investors to access better credit quality while still gaining more yield than government bonds. Investment grade is the sweet spot for later stage economic cycles. Also, a typical Canadian portfolio tends to hold stocks, bonds and preferred shares from major domestic companies, ZMU would offer diversification, given its makeup of blue-chip U.S. issuers, such as Microsoft, Johnson and Johnson, and Proctor and Gamble. We find this approach helps mitigate the risk of owning the same issuers over and over again through different parts of the capital structure.  

Outlook
Given that political uncertainty has been a drag on the near term, satisfactory conclusions on either the U.S.-China trade war or Brexit could push out the late cycle. However, we think the shift towards quality will continue to drive investment decisions for the foreseeable future. 

 

 

1 Bloomberg.

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Bannon Kopko

Better Times Ahead Mean Rising Yields, Focus on Financials

Snapshot

After a prolonged period of outperformance for defensive investing, the skies are starting to clear, and improving sentiment is pushing global bond yields higher. Rising yields are a good thing for cyclical stocks, and the banks are a great way to play that. 

Bannon Kopko

Better Times Ahead Mean Rising Yields, Focus on Financials

Snapshot
After a prolonged period of outperformance for defensive investing, the skies are starting to clear, and improving sentiment is pushing global bond yields higher. Rising yields are a good thing for cyclical stocks, and the banks are a great way to play that.

Details
BMO Equal Weight Banks Index ETF (Ticker: ZEB)
BMO Covered Call US Banks ETF (Ticker: ZWK)

Benefits

  • Highest correlation with rising US 10-year bond yields (see charts below), which we believe could continue
  • Diversified exposure among some of the biggest banks in Canada and the U.S.
  • Reduced volatility and added income through call options writing with ZWK

Trade Idea
Recent trade tensions and Brexit headlines have taken a toll on investors and business confidence. However, it seems that those risks, while still present, could be receding. The U.S. and China are getting closer to ratifying a “phase one” deal, and a friendly divorce in Europe appears more likely than a few months ago. Diminishing uncertainty should positively impact P/E ratios, business confidence and rising interest rates. The financial sector could be one of the sectors set to benefit most from further upside in yields, given it has the highest correlation with the US 10-year Treasury yield.

Why do banks work in periods of rising rates? Think increasing operating margins – when rates rise, bank spreads increase in their lending business (all things equal), and that extra income goes straight to earnings. A rising interest rate environment also historically improves the confidence of business and consumers, driving increased banking activity that also augments the bank’s earnings.  ZEB allows investors to have equal-weighted exposure to the six major Canadian banks. ZWK is invested in a diversified portfolio of U.S. banks, and offers downside protection and reduced volatility through out-of-the-money call options.

ZEB allows investors to have equal-weighted exposure to the six major Canadian banks. ZWK is invested in a diversified portfolio of U.S. banks, and offers downside protection and reduced volatility through out-of-the-money call options.

TSX Sector Correlations to U.S. 10-Year Yields
As of September 30, 2019

Sectors Correlation*
Financials 57%
Energy 25%
Discretionary 7%
Industrials 4%
Healthcare 1%
Technology -21%
Staples -39%
Materials -39%
Real Estate -49%
Telecoms -55%
Utilities -66%

* 5-year rolling correlation; yields vs. monthly outperformance to TSX.
Source: Scotiabank GBM Portfolio Strategy, Bloomberg.

Dec-2019-Bannon-graph.jpg#asset:3509

Source: Bloomberg.

Outlook
Recent market optimism, fuelled by issues like improving U.S.-China trade talks, Brexit progress, and global PMIs bottoming are all starting to push yields higher – and we believe it could continue. If macro data/sentiment improves further, financials have lots of room to outperform, and ETFs are an accessible way for investor investors to add diversified exposure to the sector.