ZPR Hires New Benchmark Provider

Bank of Montreal has announced:

BMO Asset Management Inc. (BMO AM) today announced a change (ZPR Index Change) to the underlying index of BMO S&P/TSX Laddered Preferred Share Index ETF (Ticker: ZPR).

Currently, ZPR tracks the performance of the S&P/TSX Preferred Share Laddered Index. Effective on or about October 19, 2015, ZPR will start tracking the performance of the Solactive Canadian Preferred Share Index (Successor Index). An amendment to the offering documents of ZPR has been filed with the securities regulatory authorities, for which a receipt has been issued.

As a result of the ZPR Index Change, the current name of ZPR will change to BMO Laddered Preferred Share Index ETF.

In addition, the index provider will change to Solactive AG.The Solactive Canadian Preferred Share Index will provide investors with substantially the same exposure to the asset class to which ZPR is currently exposed. Since its creation in 2007, Solactive AG has become one of the key players in the indexing space. Solactive AG currently calculates indices for 175 clients in Europe, America and Asia with approximately USD$ 25 billion invested in products linked to its indices.

The ZPR Index Change is intended to provide investors of ZPR with substantially the same index exposure as the current index. The Successor Index aligns with the current investment objectives and strategy of ZPR. One notable but slight difference between the current index and Successor Index is the S&P/TSX Preferred Share Laddered Index is rebalanced on a quarterly basis while the Solactive Canadian Preferred Share Index is rebalanced on a monthly basis.

Solactive has been mentioned on PrefBlog once before, in connection with the now defunct CNPF:

The Solactive Canada Preferred Stock Index is admirably transparent. The indexing agent is Structured Solutions AG, which is based in Frankfurt. My, aren’t we getting international! They appear to do a lot of business with Global X, a New York based firm that has a hatful of thinly sliced ETFs.

The Solactive Laddered Canadian Preferred Share Index is similarly transparent making public a complete list of constituents together with the number of shares held in the index to six decimal places. Regrettably, they use Bloomberg symbols in their listing, presumably because brain-dead bank employees have no idea that information about anything is available anywhere else, but it’s no big deal. Hit yourself on the head with a hammer a few times, mumble something positive about ‘respect inna workplace’ and you’ll be able to translate the symbols to your preferred convention pretty easily. Mind you, there are no less than eight constituents with the symbol “ENBCN 4 12/31/49”, so you’ll have to do some guessing!

The Solactive Guideline describes index construction:

On each Adjustment Day each Index Component of the Solactive Laddered Canadian Preferred Share Index is weighted according to the Market Capitalization of the respective preferred share within the term buckets. The weights are capped twofold on a Selection day, whereas a cap on an issuer basis is applied of 12.5% per issuer on a selection day as well as a Cap of 20% per Maturity Bucket.

So the caps are a little higher than the 10% previously used.

“Solactive Laddered Canadian Preferred Share Index Universe” in respect of a Selection Day are instruments that fulfill the following criteria:
a) Defined as Preferred Share
b) Listed on the Toronto Stock Exchange
c) Incorporated in Canada
d) Trading in CAD
e) Only rate reset securities are eligible, which have rate reset dates frequency of five years or less
f) Floating Rate instruments are explicitly excluded
g) For instruments that are currently part of the Solactive Laddered Canadian Preferred Share Index a minimum Total Market capitalization of 50 m CAD. For instruments that are not part of the current composition of the Solactive Laddered Canadian Preferred Share Index a minimum Total Market capitalization of 100 m CAD is required
h) For instruments that are currently part of the Solactive Laddered Canadian Preferred Share Index a minimum Average daily value traded over the last 3 month of 50,000 CAD is required. For instruments that are not part of the current composition of the Solactive Laddered Canadian Preferred Share Index a minimum Average daily value traded over the last 3 month 100,000 CAD is required
i) Minimum ration of DBRS or S&P is P3 (low) or a minimum ration of Moodys above Baa3. If more than one of the rating agencies has issued a rating on the stock, the highest rating is used
j) Time to maturity of up to 6 years.

Looks like a bit of a rush job on the guideline. Ration?

Anyway, two of these elements confused me: first, I’m not sure what they mean by “Floating Rate instruments”. Does this include the BCE FixedFloaters and RatchetRates? (The answer is ‘no’; the constituent list includes “BCECN 3.11 12/31/49”, which is BCE.PR.F, a FixedFloater). Does it include FloatingResets? The term is not defined. Second, I am baffled by the stipulation that the Time to maturity is up to 6 years. The best guess I can come up with is that they mean Time to Next Exchange Date, which, since reset frequency is stipulated as being five years or less, means they just want to eliminate new issues with a long first-call-lockout-period.

There’s a bit of ambiguity in section “3.4 Dividends and other distributions” as well. The formula they provide makes sense if dividends are reinvested on the ex-date, but this is not made explicitly clear. This is not as pedantic a point as one might think: a lot of people simply can’t reinvest on the ex-date because they won’t get the money until a month later. Therefore, if they want to match the index exactly, they’ll have to borrow it and incur interest costs that will not be reflected in the index; this represents a bias against active managers. Not the biggest deal in the world, to be sure, but it’s there.

And finally we arrive at the interesting question of why BMO has changed index providers. It seems likely that Solactive is cheaper than S&P and it also seems likely that “BMO” is a much better name to use when selling a Canadian ETF than “S&P”. If I was running an index fund, I’d basically have to go with S&P to get the credibility, but BMO doesn’t have that problem. So, I’ll bet a nickel that part of the answer is short and sweet: it’s about the money.

A much more interesting possibility, however, is reporting vs. their benchmark. The fund is currently reporting its performance for past periods against the S&P index and detailed quantitative analysis by PrefBlog’s crack team of analysts has determined that performance, in absolute terms, since the inception date of Nov 14, 2012, has not been at levels that will help persuade granny to invest some of the old hard-earned. We also note from the guideline that:

The Index is based on 1000 at the close of trading on the start date, September 15th 2015

Historical figures have not been calculated and I’m not sure BMO would be allowed to use hypothetical, back-dated index calculations even if they were available. So while I have every confidence that BMO will comply with every jot, tittle and comma of the regulations regarding fund performance reporting, I also suspect that having a benchmark that only starts on September 15, 2015, will not only allow them to de-emphasize the results of the preceding three years, but that there is a pretty good chance that results measured from index inception are going to be pretty good.

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