Can buyback-focused ETFs be profitable?

Can buyback-focused ETFs be profitable?

Can buyback-focused ETFs be profitable? Several ETFs have been launched to make investing in buyback-focused companies easier, according to a report from the Globe and Mail.

First Asset, a unit of CI Financial Corp., has launched these products for the first time in Canada. The First Asset Canadian Buyback Index ETF and First Asset US Buyback Index ETF began trading following strong results from backtests of their investment strategy. The ETFs outdid broad market indexes over 15 years ending on Sept. 30, with the Canadian ETF earning 11% annual returns compared to 8% for the S&P/TSX Composite Total Return.

The ETFs’ impressive performance comes from their concentration on companies that buy back their own stock from the open market. Typically done by companies flush with cash, this strategy effectively decreases the number of shares outstanding in the market, pushing the stock’s price up. Firms may also take advantage of prevailing low interest rates by borrowing cash to fund such buybacks.

Buyback ETFs have been available in the US for about a decade. “We think there is a lot of credence to a buyback strategy,” said National Bank Financial ETF analyst Daniel Straus, citing the strong historical performance demonstrated by some US buyback ETFs.

These specialized ETFs may also be attractive for tax reasons in non-registered accounts. “You have to pay taxes every single year on dividends, whereas buybacks are designed to increase the value of a company’s share price, and you don’t have to pay [capital gains] taxes until you sell the stock,” said Christopher Davis, director of research at Morningstar Canada.

However, he warned, buyback strategies can backfire when firms buy their shares as they trade above fair value. Another voice of caution, Straus noted that ETF buyback strategies can vary, which would result in variability of success. He also pointed out that debt-financed buybacks are expected to increase risks for companies, and rising interest rates could curtail the effectiveness of such a strategy – though he judged Canadian buyback ETFs to be less risky because he expects domestic interest rates to “remain stable for some time.”

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