My attention was drawn to a piece by David Berman of the G&M, in which he touted the virtues of ZEB, BMO Equal Weight Banks Index ETF. I took issue with one rather careless line in the analysis, but was fascinated by one of the reader comments:
I own bank stocks and have done so for many years with great results.
But recently a friend introduced me to BK which is an ETF doing covered calls on the Canadian banks. Pays 15% annual dividends distributed monthly. Trying to figure out the downside on this.
Any opinions are appreciated.
My interest was piqued because I recently contributed to a FWF thread titled Covered Call ETF’s – Why? in which the pro-CC forces did battle with battalions of the anti-CC stripe. Also because, as we all know, BK is a SplitShare Corporation that, like most (all?) of the others, regularly touts its covered call programme:
. To generate additional returns above the dividend income earned on the portfolio, The Company engages in a selective covered call writing program.
So I responded:
BK is the Capital Units of a SplitShare Corporation and therefore has special risks all of its own. For starters, it’s leveraged. The capital units will stop paying dividends if the Whole Unit NAV falls below $15, which is another wrinkle often missed.
Hardly a thesis, but there’s enough there to tell the questioner where to begin asking questions about this wonderful investment that pays 15% annual dividends due in part to the magical powers of Covered Calls.
And that got me wondering: just what is the performance of BK/BK.PR.A Whole Units vs. ZEB?
There’s performance data, of a sort, in the 2024 BK Annual Report and the ZEB Web Page (where you can show Annualized Performance as of 2024-11-30 after a bit of fiddling).
| Issue | One Year |
Three Year |
Five Year |
Ten Year |
| ZEB | +39.76% | +9.68% | +11.92% | +9.89% |
| BK Whole Units |
+34.31% | +12.14% | +11.96% | +9.21% |
So ZEB has done a little better over the ten year period than the BK Whole Units, but given the volatility of the relative returns as imperfectly reflected in these data, nothing to really write home about.
Now, zealots of the Covered Call faith will be quick to dismiss such heterodox notions and point out that the banks have been on fire for the past ten years. And the only coherent defence of their religion I have ever seen cheerfully admits that a covered call strategy will underperform in good times (because occasionally you have positions called away and replaced at higher prices; or you have to buy back your options before this happens, again at higher prices) but that this is compensated for by corresponding outperformance in bad times. This may not achieve much, net, over a cycle but it does reduce your volatility for those who care about such things. So we’ll wait for some banking bad times and see what happens.
That coherent defence of Covered Callism? It was some time ago I read it, but I think it was on the CBOE website. Those of you with a prediliction for archaelogical librarianism might wish to find it and post a link in the comments, because I got stuck!
I just hope that earnest inquirer in the Globe comments sees my response and does some checking, because there’s no way 15% is sustainable. As DBRS said in their most recent confirmation of BK.PR.A:
Without giving consideration to capital appreciation potential or any source of income other than the dividends earned by the Portfolio, the Preferred Share distributions together with the current distributions on the Class A Shares will create a projected grind on the NAV of the Portfolio of approximately 9.3% per year over the next 5 years.
… and while it might be tempting to think there is a huge population of option buyers out there, eager to overpay for call options so they can underwrite excess performance for sleazy CC salesmen, I’m not convinced that call option buyers are that dumb.
See the sections Sequence of Returns Risk and The effect of Cash Income on Sequence of Returns in my discussion of SplitShare credit quality to learn more about cash grind.
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0747 % | 2,478.2 |
| FixedFloater | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.0747 % | 4,699.1 |
| Floater | 5.81 % | 6.06 % | 57,680 | 13.78 | 3 | 0.0747 % | 2,708.1 |
| OpRet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.0629 % | 3,669.0 |
| SplitShare | 4.76 % | 4.58 % | 86,321 | 3.04 | 5 | -0.0629 % | 4,381.6 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.0629 % | 3,418.7 |
| Perpetual-Premium | 5.67 % | 5.57 % | 565,856 | 6.78 | 7 | -0.0906 % | 3,078.2 |
| Perpetual-Discount | 5.56 % | 5.62 % | 51,479 | 14.44 | 27 | 0.1388 % | 3,406.2 |
| FixedReset Disc | 5.94 % | 6.00 % | 113,182 | 13.75 | 28 | -0.0953 % | 3,173.9 |
| Insurance Straight | 5.46 % | 5.55 % | 65,787 | 14.51 | 22 | 0.0217 % | 3,330.2 |
| FloatingReset | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.0953 % | 3,775.7 |
| FixedReset Prem | 5.97 % | 4.33 % | 84,902 | 2.53 | 20 | 0.0691 % | 2,657.5 |
| FixedReset Bank Non | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.0953 % | 3,244.3 |
| FixedReset Ins Non | 5.28 % | 5.49 % | 77,138 | 14.46 | 14 | 0.0859 % | 3,133.2 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| ENB.PR.N | FixedReset Disc | -1.81 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 23.17 Evaluated at bid price : 24.37 Bid-YTW : 6.02 % |
| GWO.PR.H | Insurance Straight | -1.36 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 21.51 Evaluated at bid price : 21.77 Bid-YTW : 5.63 % |
| PWF.PF.A | Perpetual-Discount | -1.09 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 20.05 Evaluated at bid price : 20.05 Bid-YTW : 5.66 % |
| CU.PR.G | Perpetual-Discount | 1.03 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 20.68 Evaluated at bid price : 20.68 Bid-YTW : 5.45 % |
| FFH.PR.K | FixedReset Prem | 1.14 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2027-03-31 Maturity Price : 25.00 Evaluated at bid price : 25.65 Bid-YTW : 3.21 % |
| IFC.PR.A | FixedReset Ins Non | 1.15 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 21.60 Evaluated at bid price : 22.00 Bid-YTW : 5.37 % |
| CU.PR.D | Perpetual-Discount | 1.23 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 22.05 Evaluated at bid price : 22.28 Bid-YTW : 5.50 % |
| MFC.PR.F | FixedReset Ins Non | 1.23 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 18.88 Evaluated at bid price : 18.88 Bid-YTW : 5.76 % |
| IFC.PR.K | Insurance Straight | 2.49 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 23.39 Evaluated at bid price : 23.85 Bid-YTW : 5.55 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| FTS.PR.M | FixedReset Disc | 215,493 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 23.13 Evaluated at bid price : 24.62 Bid-YTW : 5.55 % |
| SLF.PR.H | FixedReset Ins Non | 102,000 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 21.95 Evaluated at bid price : 22.50 Bid-YTW : 5.60 % |
| ENB.PR.Y | FixedReset Disc | 88,096 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 21.51 Evaluated at bid price : 21.51 Bid-YTW : 6.31 % |
| BN.PF.F | FixedReset Disc | 70,647 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 23.20 Evaluated at bid price : 24.75 Bid-YTW : 5.87 % |
| MFC.PR.Q | FixedReset Ins Non | 64,228 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 23.61 Evaluated at bid price : 25.32 Bid-YTW : 5.49 % |
| FTS.PR.K | FixedReset Disc | 57,340 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2056-02-06 Maturity Price : 22.79 Evaluated at bid price : 23.65 Bid-YTW : 5.43 % |
| There were 15 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| See TMX DataLinx: ‘Last’ != ‘Close’ and the posts linked therein for an idea of why these quotes are so horrible. | ||
| Issue | Index | Quote Data and Yield Notes |
| ENB.PR.N | FixedReset Disc | Quote: 24.37 – 25.03 Spot Rate : 0.6600 Average : 0.4291 YTW SCENARIO |
| GWO.PR.M | Insurance Straight | Quote: 25.33 – 25.92 Spot Rate : 0.5900 Average : 0.3962 YTW SCENARIO |
| POW.PR.B | Perpetual-Discount | Quote: 24.00 – 24.50 Spot Rate : 0.5000 Average : 0.3267 YTW SCENARIO |
| GWO.PR.H | Insurance Straight | Quote: 21.77 – 22.30 Spot Rate : 0.5300 Average : 0.3734 YTW SCENARIO |
| BN.PF.A | FixedReset Prem | Quote: 25.65 – 26.11 Spot Rate : 0.4600 Average : 0.3083 YTW SCENARIO |
| PWF.PR.E | Perpetual-Discount | Quote: 24.30 – 24.88 Spot Rate : 0.5800 Average : 0.4631 YTW SCENARIO |