With talk of recession risks on the rise, investors are getting nervous about bank stocks.
You can see this in the fate of the $1.1-billion BMO Equal Weight Banks Index ETF (ZEB). In August, it led all mainstream ETFs in outflows with a decline in of $212-million.
The ZEB sell-off makes sense to some extent – loan losses would rise in an economic downturn and increasing revenues to fund future dividend increases would be tougher than ever. But if you’re a yield-focused investor, ZEB and its underlying banks have some appeal.
ZEB’s yield as of the second week of September was just a tick below 4 per cent, which compared with 1.5 per cent for a five-year Government of Canada bond and the high 2 per cent range at best for guaranteed investment certificates (though Oaken Financial was at 3 per cent as of Sept. 10). In non-registered accounts, ZEB’s yield looks all the more impressive because of the dividend tax credit. Bond and GIC income is treated less advantageously when held in taxable accounts.
Bank stocks might get thrashed at some point, so the risk level in holding ZEB is considerable. But lots of income-seeking investors have veered out of bonds/GICs and into stocks in search of income in recent years. In some cases, they have bought preferred shares; in others, shares of blue chip companies like banks, electrical utilities and pipelines.
You’d think preferred shares would have been the more conservative play for these yield-seekers, but that’s not how things have played out. For reasons I outlined in a recent column you can read here, pref shares have been nasty. While ZEB had a pretty bad time of it in the past 12 months, losing 5.5 per cent on a total return basis, the BMO Laddered Preferred Share Index ETF (ZPR) lost 16.8 per cent over that same period.
If interest rates fall further because of concern about the economy, expect both banks and preferred shares to suffer. Likewise, both have rebound potential when the economy and rates stabilize. But ZEB is the more appealing choice if your goal is not just dividend income, but also dividend growth. As its bank holdings have increased their dividends, so has ZEB hiked its monthly payouts over the years. You won’t get that kind of steady dividend growth from preferred shares.
ZEB’s biggest drawback might be its pricey management expense ratio of 0.62 per cent. That’s the price you pay for the convenience of tapping into the dividend production of the Big Six banks in one purchase.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.