BMO launched its Covered Call Canadian Banks ETF (TSX: ZWB) in January 2011. The ETF immediately started attracting investor attraction. Investors were mesmerized by the initial annualized yield of 10% and piled money into the fund: among ETFs launched in 2011, ZWB ranked first by Assets under Management by a wide margin. Interestingly, the second most popular among ETFs launched in 2011 is another covered call product: the Horizons Enhanced Income Equity ETF (TSX: HEX). Investors had clearly developed a preference for income products.
It appears that many investors thought (or at least hoped) the higher yield from ZWB compared to a plain vanilla product like the BMO S&P/TSX Equal Weight Banks Index ETF (TSX: ZEB) would translate into higher total returns. Now that ZWB has a 2 year track record under its belt, we can analyze how ZWB’s returns stacks up against ZEB’s.
Performance for the 2-year period ending Jan. 31, 2013
BMO Covered Call Canadian Banks ETF (ZWB): 8.10%
BMO S&P/TSX Equal Weight Banks Index ETF (ZEB): 8.92%
We find that the Covered Call ETF under performs the Bank ETF by an annualized 0.82 percent over a two year period even though it is just 0.10 percent more expensive than the plain-vanilla ETF. In the following graphic, we break down the total returns from the two ETFs into income and capital gains.
The one year performance (for the period ending Jan. 31) of the Covered Call Banks ETF (ZWB) is compared with that of the Equal Weight Banks ETF (ZEB) in the following table:
If we look at the income generated by these two ETFs as a percentage of starting NAV, we get:
Income generated for the 1-year period ending Jan. 31, 2012
BMO Covered Call Canadian Banks ETF (ZWB): 9.2%
BMO S&P/TSX Equal Weight Banks Index ETF (ZEB): 3.5%
Income generated for the 1-year period ending Jan. 31, 2013
BMO Covered Call Canadian Banks ETF (ZWB): 6.8%
BMO S&P/TSX Equal Weight Banks Index ETF (ZEB): 3.6%
In other words, though an investor earned a significantly higher current income with ZWB, she would have earned lower total returns compared to an investment in ZEB over the past two years. Also, the income an investor receives from the covered call ETF has been dropping: the fund started off with an annualized yield of 10 percent but two years later, the yield is just 5.6 percent. Granted, a two year time frame is too short to make a fair comparison of ZWB and ZEB but the early results show that just as we initially suspected, there is no free lunch here.
NB: This post was initially published on Feb 20, 2012. It was updated on Feb 5, 2013.