Buy this preferred share ETF for attractive income

Preferred shares have continued to struggle to recoup the losses incurred earlier this year. So far this quarter, the S&P/TSX Preferred Share Index has gained 1.6 per cent, though it’s still down 5.4 per cent year to date. At their depressed level, preferred shares offer excellent value compared to fixed-income investments.

One way to invest in preferred shares is through exchange-traded funds (ETFs) that try to duplicate the performance of a particular market index. A key advantage of such funds is their very low management expenses.

Here’s a preferred share exchange-traded fund to buy for income:

BMO Laddered Preferred Share Index ETF (TSX─ZPR) tries to match the return of the Solactive Laddered Canadian Preferred Share Index. This index uses a five-year laddered structure that evenly divides the portfolio by calendar years, or annual buckets. Each bucket consists of a number of rate-reset preferred shares that will reset in the same year. Every year, the issues in one of the buckets will reset their dividend according to prevailing interest rates. In this way, the portfolio resembles a laddered portfolio of bonds or GICs.

The fund’s top holdings include three issues by Royal Bank. Together, they make up about 4.8 per cent of the portfolio. Also included is the Series 12 issue of TD Bank, which accounts for 1.7 per cent. Three Enbridge issues account for 4.4 per cent. And issues by Canadian Utilities and Manulife Financial account for 1.4 and 1.3 per cent, respectively. Altogether there are 160 issues in the portfolio.

The fund’s industry breakdown is as follows: diversified banks, 29.0 per cent; oil and gas storage and transportation, 22.8 per cent; life and health insurance, 10.8 per cent; others, 10.2 per cent; real estate, 7.1 per cent; telecommunications, 5.2 per cent; independent power producers and energy, 4.4 per cent; electric utilities, 4.3 per cent; multi-line insurance, 2.6 per cent; multi-utilities, 2.1 per cent; and integrated oil and gas, 1.4 per cent.

More than two-thirds of the portfolio is considered to be of satisfactory or superior credit quality according to the Dominion Bond Rating Service. The remaining nearly one-third is considered to be of adequate credit quality.

BMO Laddered Preferred Share Index ETF was launched on Nov. 12, 2012. Returns have been disappointing, reflecting overall weakness in the preferred share market. Since inception, the ETF’s net asset value (NAV) has suffered a compound annual loss of 7.4 per cent. Returns for the past one- and three-year periods have also been a disappointment.

Rate-reset preferred shares, after all, have been highly sensitive to lower government bond yields. But yields are expected to gradually rise in coming years as the economy strengthens. This should at least provide support for the prices of rate-reset preferreds.

Meanwhile, the ETF’s low expense ratio of 0.50 per cent will help performance. And its annualized distribution yield of 5.6 per cent is attractive.

BMO Laddered Preferred Share Index ETF is a buy if you want mostly income and you can tolerate medium investment risk in the form of volatility.

Look at volatility

One way to measure the volatility of a fund is through its standard deviation. This measures how much a fund could move up and down based on how much the fund has moved up and down in the past.

Keep this in mind when considering the BMO Laddered Preferred Share ETF. Its three-year standard deviation of 14.08 per cent is well above the iShares S&P/TSX Canadian Preferred Share Index ETF’s (TSX─CPD) 11.04 per cent. If you don’t like a lot of volatility, you might prefer the iShares ETF, but you will have to accept a lower yield.


Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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