BMO Canadian ETF Dashboard

— as of August 31, 2019 —

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Canadian Bank Yields: Value Hidden in Plain Sight

Chris Heakes

Canadian Bank Yields: Value Hidden in Plain Sight

Snapshot
With the market consumed by headlines, tweets, and trade wars, one sector that presents a simple and compelling story is Canadian banks. Despite the noise, the fact is Canadian banks are in good health, remain highly profitable, and having experienced some short-term weakness present an excellent valuation opportunity with yields on the underlying banks at 4.5%. Investors can access the Canadian bank sector through ZWB and ZEB, in order to:

  • Leverage the buying opportunity. There is a strong correlation between bank yields and the forward return on ZEB. Yields above 4% tend to foreshadow a strong year, and with the fundamentals remaining strong, banks are also near 10-year lows in price-to-earnings.
  • Enhance their income through call options (ZWB only). In addition to dividend yields, ZWB collects premiums by writing out-of-the-money call options on select assets, increasing the distribution yield to 5.8%,
  • Balance their exposure to the sector. Rather than relying on market cap weighting in its asset allocation, ZEB takes an equal weight approach to provide balanced exposure to the sector.

Details
BMO Covered Call Canadian Banks ETF (Ticker: ZWB)
BMO Equal Weight Banks Index ETF (Ticker: ZEB)

Benefits
Solid fundamentals. Attractive valuation. Tax-efficient structure. Enhanced income through call options writing.

Trade Idea – Domestic Banks with an Options Layer
Despite ongoing tariffs and trade wars, investors should take note: Canadian banks, after the recent earnings cycle, delivered a strong 7% earnings per share (EPS) growth and 15% return on equity (ROE), while offering a 4.5% dividend yield.1 Yet even with strong underlying growth, valuations remain modest. Caution has driven price-to-earnings multiples near 10-year lows, and while the market has flattened the yield curve, the potential for yield curves to steepen, which tend to benefit banks, is more likely at this time.  

As seen in the chart below, looking at the ZEB returns since inception,2 there is a strong correlation between bank yields and the forward return of ZEB. When yields have been in excess of 4% on underlying banks, this has historically led to strong 12 months performance on the underlying banks.

Forward Returns Based on Dividend Yield

Dividend Yield # of Months Avg. Forward 12-Month Return
3.50 9 -4.0%
3.75 33 5.4%
4.00 34 13.7%
4.25 26 18.4%
4.50 2 32.6%

Source: Bloomberg. Data since December 2009; ZEB NAV returns.

We believe these factors create a discount opportunity – whereby investors can access a robust banking sector with a long history of dividend growth through low-cost ETF solutions, such as ZWB and ZEB. And from an income perspective, it’s important to consider the lack of suitable alternatives for yield-seeking investors, especially given that the ratio of bank, bank yields relative to government of Canada bond yields are at a 50-year peak.

bmo-etfs_10chart7_848px_2019-08-29_ENG.jpg#asset:3122

Investors seeking additional income should look to ZWB, which collects premiums from writing out-of-the-money call options. The covered call strategy adds income, and can add a benefit should banks trade sideways. As an additional benefit, the option income is tax-efficient, helping investors preserve their returns as the market becomes more challenging.   

Outlook
Though an end to trade wars would be an adrenaline shot for markets, the cycle is clearly shifting and investors need be more selective with asset allocation. We continue to believe high-quality assets with a strong history of dividend growth can provide superior returns for investors, while also keeping their portfolios insulated from extreme levels of volatility. Canadian banks continue to enjoy strong profitability, sustainable dividends, and we believe current levels present a very attractive buying opportunity on ZWB and ZEB.

 

 

1 Bloomberg, as at August 27, 2019.
2 October 20, 2009.

Chris Heakes

Canadian Bank Yields: Value Hidden in Plain Sight

Snapshot
With the market consumed by headlines, tweets, and trade wars, one sector that presents a simple and compelling story is Canadian banks. Despite the noise, the fact is Canadian banks are in good health, remain highly profitable, and having experienced some short-term weakness present an excellent valuation opportunity with yields on the underlying banks at 4.5%. Investors can access the Canadian bank sector through ZWB and ZEB, in order to:

  • Leverage the buying opportunity. There is a strong correlation between bank yields and the forward return on ZEB. Yields above 4% tend to foreshadow a strong year, and with the fundamentals remaining strong, banks are also near 10-year lows in price-to-earnings.
  • Enhance their income through call options (ZWB only). In addition to dividend yields, ZWB collects premiums by writing out-of-the-money call options on select assets, increasing the distribution yield to 5.8%,
  • Balance their exposure to the sector. Rather than relying on market cap weighting in its asset allocation, ZEB takes an equal weight approach to provide balanced exposure to the sector.

Details
BMO Covered Call Canadian Banks ETF (Ticker: ZWB)
BMO Equal Weight Banks Index ETF (Ticker: ZEB)

Benefits
Solid fundamentals. Attractive valuation. Tax-efficient structure. Enhanced income through call options writing.

Trade Idea – Domestic Banks with an Options Layer
Despite ongoing tariffs and trade wars, investors should take note: Canadian banks, after the recent earnings cycle, delivered a strong 7% earnings per share (EPS) growth and 15% return on equity (ROE), while offering a 4.5% dividend yield.1 Yet even with strong underlying growth, valuations remain modest. Caution has driven price-to-earnings multiples near 10-year lows, and while the market has flattened the yield curve, the potential for yield curves to steepen, which tend to benefit banks, is more likely at this time.  

As seen in the chart below, looking at the ZEB returns since inception,2 there is a strong correlation between bank yields and the forward return of ZEB. When yields have been in excess of 4% on underlying banks, this has historically led to strong 12 months performance on the underlying banks.

Forward Returns Based on Dividend Yield

Dividend Yield # of Months Avg. Forward 12-Month Return
3.50 9 -4.0%
3.75 33 5.4%
4.00 34 13.7%
4.25 26 18.4%
4.50 2 32.6%

Source: Bloomberg. Data since December 2009; ZEB NAV returns.

We believe these factors create a discount opportunity – whereby investors can access a robust banking sector with a long history of dividend growth through low-cost ETF solutions, such as ZWB and ZEB. And from an income perspective, it’s important to consider the lack of suitable alternatives for yield-seeking investors, especially given that the ratio of bank, bank yields relative to government of Canada bond yields are at a 50-year peak.

bmo-etfs_10chart7_848px_2019-08-29_ENG.jpg#asset:3122

Investors seeking additional income should look to ZWB, which collects premiums from writing out-of-the-money call options. The covered call strategy adds income, and can add a benefit should banks trade sideways. As an additional benefit, the option income is tax-efficient, helping investors preserve their returns as the market becomes more challenging.   

Outlook
Though an end to trade wars would be an adrenaline shot for markets, the cycle is clearly shifting and investors need be more selective with asset allocation. We continue to believe high-quality assets with a strong history of dividend growth can provide superior returns for investors, while also keeping their portfolios insulated from extreme levels of volatility. Canadian banks continue to enjoy strong profitability, sustainable dividends, and we believe current levels present a very attractive buying opportunity on ZWB and ZEB.

 

 

1 Bloomberg, as at August 27, 2019.
2 October 20, 2009.