Why accumulating unit ETFs are vital for a modern portfolio

When BMO GAM launched a new short-term bond ‘Accumulating Units’ ETF, it was an important moment for the Canadian investment landscape

Why accumulating unit ETFs are vital for a modern portfolio

When BMO GAM launched a new short-term bond ‘Accumulating Units’ ETF in February 2017, it was an important moment for the Canadian investment landscape.

The new ETF was the first of its kind; an innovative fund structure that solved some of the key issues facing Canadian advisors. In fact, BMO GAM came up with the idea for its accumulating units ETFs after speaking with advisors and discovering that many were being forced into lengthy conversations with clients about the complex reporting of investment returns in a fixed income portfolio.  Advisors also said they were facing another specific challenge: what to do with the income portion of a portfolio when an investor doesn’t rely on their investments for cash flow.

“These accumulating units are exciting because they solve that issue, which was a reoccurring theme for many advisors,” says Erika Toth, VP, Eastern Canada, BMO ETFs. “The reaction from advisor community has been hugely appreciative. The one we have the best feedback on has been ZST.L, the Ultra Short-Term Bond ETF. It is an excellent complement to an overall bond portfolio. It helps reduce interest rate sensitivity and improves the overall stability of the fixed income component.”

Accumulating units ETFs differ from traditional bond ETFs in a fundamental way. Rather than paying monthly distributions in cash, the investors’ coupon income is automatically reinvested back into the fund. There is an annual consolidated distribution of the coupon income, which is added back to the net asset value.

“Accumulating units ETFs really simplify the reporting aspect of the client’s investment returns, it’s much more intuitive,” says Toth. “Investors are seeing the genuine total return on their account statements, which means there is no longer a need to calculate market value and coupon income, or look at a third party website to get the total return. These ETFs are an ideal solution for an investor who does not need to rely on his or her investments for cash flow.”

BMO GAM offers four accumulating units fixed income ETFs: ZST.L, the Ultra Short-Term Bond ETF; ZFS.L, the Short-Term Federal Bond ETF; ZPS.L, the Short Provincial Bond ETF; and ZCS.L, the Short-Term Corporate Bond ETF.

Toth describes ZST.L as the “most boring and stable bond ETF in Canada”. It provides investors with a basket of investment grade Canadian corporate bonds that are maturing in less than a year. As a result, the overall portfolio duration is around 0.7 years*. The strategy ensures that the future value of bonds in the basket can be predicted with a degree of certainty; their values remain relatively stable even if the Bank of Canada continues to hike rates.

“The ZST.L complements other fixed income holdings in a portfolio that carry a mid or even longer term duration,” Toth says. “This can help reduce the impact of rising rates on the overall portfolio and add a degree of stability. It doesn’t hurt that ZST.L is the lowest cost ultra-short-term bond ETF on the market here in Canada. It has a management fee of 15 basis points, and, once you add the tax, you have a MER of 17 basis points, so investors are getting some really good value.”

ZST.L follows some simple yet decisive portfolio construction rules. There are 49 holdings in the basket and portfolio managers are currently looking for yields to maturity of above 2%. Term to maturity has to be less than a year and the differential between the coupon and the yield to maturity must not be too high. Credit quality, explains Toth, has to be BBB or better. The basket has exposure across all the different sectors of the bond market in Canada and portfolio managers are also in constant discussion with dealers to ensure they are aware of any potential downgrades in advance.

With short term interest rates beginning to trend upwards, it’s realistic to expect price declines even if yields remain steady. So, even though investors are still positive from a total return perspective, the actual price of bonds in a basket could decline.

“This is why, particularly in this environment, it is a sensible option for Canadian investors to have accumulating units in their portfolios,” Toth says. “They deliver more consistency, stability and they really simplify fixed income returns for end clients.”


*Source: BMO Asset Management Inc. All data as of June 30th 2018

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