Unique Opportunity in Fixed Income to Complement Your GICs with BMO’s Canadian Mortgage Backed Securities Index ETF

For investors seeking exposure to a unique asset class typically reserved for institutional investors, BMO Canadian MBS Index ETF (Ticker: ZMBS) offers easy access to an attractive yield pick up relative to federal bonds, enhancing portfolio income.

Why ZMBS as a Complement to GIC

• Yield pick- up over federal bonds while maintaining a AAA rating. ZMBS has a 3.69% YTM¹ and a duration of 1.84 years. This means that the investor is being paid almost 58 basis points more by ZMBS. BMO Short Federal Bond Index ETF (Ticker: ZFS) currently features a weighted average yield to maturity of 3.11%, with a weighted average duration of 2.61 years.² Both ETFs have an equivalent average credit rating of AAA.
• CMHC-insured mortgages to give added protection. NHA Mortgage-Backed Securities (MBS) are fully guaranteed by the Canadian Mortgage and Housing Corp. (CMHC) a Crown corporation, protecting principal and interest payments.³ Canada has strict regulations in place to guard against riskier mortgage lending practices, which was not the case in the run up to the U.S. housing crisis in 2008.
• Liquid and easy access. For retail investors, ZMBS offers simplified access to mortgage-backed securities through its ETF structure, providing greater liquidity. For institutional investors, ZMBS eliminates the logistics and administration required with MBS pools.
• Tax-efficient returns. The current interest rate environment makes this an opportune time to consider ZMBS. With a weighted average yield to maturity (YTM) of 3.69%, it holds lower rate mortgages that are trading at a discount. As they reach face value at maturity, a larger portion of the return is taxed as capital gains. The capital gains component is likely to diminish as the mortgage securities in the basket are replaced by higher-rate mortgages.

Relative to GICs for taxable investors, the after-tax difference can be substantial for high-net-worth investors, creating an opportunity for advisors to add value.⁴

Tax Breakdown Using BMO Canadian MBS Index ETF (Ticker: ZMBS)

One Year GIC: BMO Guaranteed Investment Certificate 1-year non-redeemable rate as of September 30, 2024, compounded annually.) Capital gains tax scenario only applies to amounts under $250,000, over $250,000 after tax returns can vary.

Using a one-year time horizon with an investment of $100, a capital inclusion rate of 50% with no changes to interest rates or credit spreads, an investor can generate a higher after-tax expected return (approximately +26%), due to the higher portion of returns coming from capital gains in ZMBS.⁵

Performance

Source: BMO GAM, September 30, 2024.

¹ As of June 24, 2024. Yield to Maturity: The total expected return from a bond when it is held until maturity – including all interest, coupon payments, and premium or discount adjustments.

² Duration: sensitivity of the price of a debt instrument to a change in interest rates.

³ Relative to GICs, ZMBS price return can be negative in a rising interest rate scenario.

⁴ ZMBS comparison to GIC: ZMBS - Tax Calculation

Interest Income

• 1.87% Coupon x $100 Initial Investment = $1.87 Pre Tax Interest Income
• $1.87 Income Before Tax x (1- Marginal Tax Rate⁶) = $0.87 After Tax Interest Income

Capital Gain

• (3.69% YTM - 1.87% Coupon) x $100 Initial Investment = $1.82 Pre Tax Capital Gains realized at maturity
• Capital Gains before Tax x (1 - Capital Gains Inclusion Rate) + [ Capital Gains Before Tax x (1 - Capital Gains Inclusion Rate) x (1 - Marginal Tax Rate) ] = $1.33 After Tax Capital Gains

Total Return

• $1.87 Interest Income + $1.82 Capital Gains = $3.69 Pre-Tax Return
• $0.87 Interest Income + $1.33 Capital Gains = $2.20 After Tax Return

GIC

Interest Income

• 3.75% Coupon x $100 Initial Investment = $3.75 Pre-Tax Interest Income Earned
• $3.75 Coupon x (1 - Marginal Tax Rate) = $1.74 After Tax Return

^* Initial investment of $1,000 – holding period 1 year (assumes that the investor sells the ZMBS at 1 year) YTM is calculated gross of fees. Assuming the tax rate is 53.53. Top marginal tax bracket will differ depending on province of residence. Capital gains scenario assumes amount under $250,000, amounts over $250,000 after tax returns can vary.

^*Yields and Bond Prices are inversely related. A rise in yields will decrease the bond price and a fall in yields will increase the bond price.

^*Yield to Maturity: The total expected return from a bond when it is held until maturity – including all interest, coupon payments, and premium or discount adjustments.

⁵ Assuming the tax rate is 53.53. Top marginal tax bracket will differ depending on province of residence. Individuals will be allowed a $250,000 threshold below which the capital gains inclusion rate will remain at its current rate. This threshold will not be prorated for 2024 and will only apply in respect of net capital gains realized on or after the effective date of June 25, 2024. As anticipated, the release noted that Graduated Rate Estates (GREs) and Qualified Disability Trusts (QDTs) would also now be eligible for the $250,000 threshold available to individuals in respect of capital gains that are not allocated to a beneficiary in the year, reflecting that these trusts are subject to the same progressive personal income tax rate structure. Many individuals (and GREs, QDTs) will be able to avoid the proposed higher inclusion rate by timing their dispositions to remain below this threshold annually. Capital Gains Tax Update: What You Need to Know Now - BMO Private Wealth