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Covered Call ETFs: A Disconnected Investment Choice

Strategic Insights

— 1 min read

As interest rates and dividend yields decline, investors seek alternative ways to generate income, but they may be met with resistance from financial planners and advisers, who prefer more traditional methods. Covered call ETFs, which use options strategies to produce income from a portfolio of stocks, may seem like an attractive option, but experts have raised concerns about their high fees, lower total returns, and tax implications. A recent example highlights the gap between covered call ETFs and traditional dividend-paying stocks.

Key Takeaways:

  • Covered call ETFs use an options strategy to generate income from a portfolio of stocks, but this approach limits investor participation in gains and potentially offers less downside in fast-falling markets.
  • The distribution yield on the $3.1-billion BMO Covered Call Canadian Banks ETF (ZWB) is 6.5%, compared to 3.9% for the $4.2-billion BMO Equal Weight Banks Index ETF (ZEB).
  • Despite the higher yield, ZWB delivered annualized one- and three-year total returns of 19.9% and 6.3%, respectively, compared to ZEB's 27.4% and 9.8% over the same periods.
  • The wider management expense ratio of ZWB (0.71%) compared to ZEB (0.28%) contributes to the difference in total returns.
  • Advisers object to covered call ETFs due to high fees, lesser total returns, and tax issues, including a mix of dividends, capital gains, and a return of capital that reduces the adjusted cost base.
  • Covered call ETFs are more complex than owning traditional dividend-paying stocks, and investors should carefully consider the trade-offs before investing.

Statistics:

  • Distribution yield on ZWB: 6.5%
  • Distribution yield on ZEB: 3.9%
  • ZWB's annualized 1-year total return (May 31): 19.9%
  • ZWB's annualized 3-year total return (May 31): 6.3%
  • ZEB's 1-year total return (May 31): 27.4%
  • ZEB's 3-year total return (May 31): 9.8%
  • ZWB's management expense ratio: 0.71%
  • ZEB's management expense ratio: 0.28%

Sources:

BMO Covered Call Canadian Banks ETF, Investment Reporter, Globe and Mail

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