Earn More on Your AAA Credit Holdings with ZMBS
How can Investment Counsellors and Family Offices enhance the return on their clients’ credit holdings while maintaining a AAA credit rating? In this article, Erika Toth, Director, ETF Distribution, Institutional & Advisory, BMO ETFs, outlines a potentially attractive opportunity involving the BMO Canadian MBS Index ETF (ZMBS).
An Attractive Opportunity for Yield Pickup?
For investment counsellors and multi-family offices seeking to enhance the returns on their AAA credit holdings, the BMO Canadian MBS Index ETF (ZMBS) offers a potentially attractive opportunity for yield pickup.
What is ZMBS?
The BMO Canadian MBS Index ETF (ZMBS) is the first and only Canadian ETF with exposure to the FTSE Canada NHA MBS 975 Index (“the index”).
As ZMBS aims to track the performance of the index, it invests in a basket of Canadian mortgage-backed securities (MBS) insured by the Canada Mortgage and Housing Corporation (CMHC). In order to be included in the index, a mortgage must feature:
- An issue amount of at least $200 million
- At least $100 of current outstanding issue
ZMBS is comprised of bonds maturing in more than one year up to a five-year maximum. It is rebalanced monthly to reflect the underlying index, and it is cap-weighted, meaning that holdings are weighted by market capitalization.
Experienced investment professionals will recall mortgage-backed securities’ role in the 2008 Financial Crisis. As such, it is important to note that the mortgage-backed securities held by the ETF are fully guaranteed by the CMHC, both for principal and interest payments. The CMHC is the federal agency responsible for housing.
ZMBS – Three Key Benefits
- Easy access. ZMBS offers simplified access to mortgage-backed securities through its ETF structure, including greater liquidity. It eliminates the logistics and administration required with MBS pools, as well as prepayment risks and uneven cash flows.
- High-quality yield. ZMBS offers a higher yield than Bank of Canada bonds and other government bonds of similar duration — all with a AAA credit rating and an explicit CMHC guarantee.
- Tax-efficient returns. The current interest rate environment makes this an opportune time to consider ZMBS. With an annualized distribution yield1 of 1.44%2 and a weighted average yield to maturity (YTM)1 of 4.57%,2 it holds lower-rate mortgages that are now trading at a discount. As they reach face value at maturity, a larger portion of the return is taxed as capital gains. This capital gains component is likely to diminish in the future as the NHA (National Housing Act) mortgage securities in the basket are replaced by higher-rate mortgages.
Comparison: ZMBS vs. ZFS vs. ZPS
A comparison to the BMO Short Federal Bond Index ETF (ZFS) and the BMO Short Provincial Bond Index ETF (ZPS) may help to put ZMBS’ benefits in perspective.
ZFS currently features an annualized distribution yield of 1.96% and a weighted average yield to maturity of 4.00%, with a weighted average duration of 2.54 years.2 In comparison to ZMBS’ 1.44% distribution yield and 4.57% YTM,2 this means that the investor is being paid almost 60 basis points more by ZMBS with an equivalent (AAA) credit rating.
ZPS, meanwhile, has an annualized distribution yield of 3.00% (for tax purposes, it is treated as interest income), a weighted average yield to maturity of 4.14%, and weighted average duration of 2.61 years.2 However, in comparison to ZMBS and ZFS, it features a lower average credit rating — AA rather than AAA.
| How Do Mortgage-Backed Securities Work? With mortgage-backed securities, the securitization intermediary — the party responsible for packaging assets into interest-bearing securities — are mortgage originators (those who grant mortgages). In Canada, this includes Schedule 1 and Schedule 2 banks and credit unions. These banks and financial institutions aggregate mortgages to create pools of mortgage-backed securities, each comprised of hundreds of mortgages. The CMHC guarantees the MBS’ underlying mortgages, all of which are insured, five-year fixed-rate mortgages. The CMHC benefits from an explicit guarantee from the federal government on existing and future mortgage-backed securities. |
How is Canada Different?
Canada has strict regulations in place to guard against riskier mortgage practices, which was not the case in the U.S. real estate crisis of 2008.
For one, as previously mentioned, all mortgage-backed securities in the NHA MBS market are fully insured by the CMHC (which is backed by a Government of Canada guarantee) for both principal and interest, with no limit on coverage.
Additionally, since before the 2009 credit crisis, Canadian mortgage standards have been stricter than in the U.S. when it comes to sub-prime mortgages. This means that the quality of Canadian mortgage pools tends to be higher.
Annualized Performance
1-Month |
3-Month |
6-Month |
Year-to-Date |
1- |
3- |
5-Year |
10-Year |
Since Inception |
|
ZMBS |
0.42% |
0.33% |
3.27% |
0.33% |
2.98% |
0.13% |
- |
- |
0.93% |
ZFS |
0.41% |
0.03% |
3.61% |
0.03% |
2.20% |
-0.33% |
0.65% |
0.93% |
1.35% |
ZPS |
0.44% |
0.00% |
4.07% |
0.00% |
2.36% |
-0.24% |
0.87% |
1.29% |
1.78% |
Total returns of market close March 31, 2024. Source: Morningstar.
To learn more about ZMBS or receive other trading insights, reach out to your BMO ETF Specialist at their email address.
1 Definitions:
- Annualized Distribution Yield: The most recent regular distribution, or expected distribution, (excluding additional year end distributions) annualized for frequency, divided by current NAV.
- YTM: Yield to Maturity (YTM) is the discount rate that equates the present value of a bond’s cash flows with its market price (including accrued interest). The measure does not include fees and expenses.
2 BMO Global Asset Management, as of March 31, 2024.
Disclosures:
Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.
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