3 Ways to Invest in Canadian Banks with ETFs
ETFs are a very capital-efficient way of gaining exposure to top Canadian bank stocks.
The Big Six Canadian banks, Royal Bank of Canada (RY), Toronto-Dominion Bank (TD), Canadian Imperial Bank of Commerce (CM), Bank of Nova Scotia (BNS), Bank of Montreal (BMO), and National Bank (NA) are widely considered to be a popular, safe, and reliable investment option for many domestic investors due to their oligopolistic nature.
These banks have a long history of stability, profitability, and steady growth. Their strong financial performance, low default rates and diverse sources of revenue make them less susceptible to market fluctuations and economic downturns. Additionally, the Canadian banking sector is highly regulated, which ensures that these banks maintain sound financial stability.
In addition to their stability, the Big Six Canadian banks also offer attractive returns to investors. They regularly pay above-average yields and have a track record of increasing their dividend payments over time. As a whole, Canadian banks have historically outperformed the domestic stock market and currently sit at the top of most Canadian indexes as a result.
ETF providers have taken note of these considerations when it comes to their product lineup. There exists a wide range of ETFs that provide exposure to Canadian banks, whether in terms of regular long exposure, income-oriented exposure, or enhanced exposure. Let's look at some notable ETF offerings.
Regular long exposure
The most basic Canadian bank ETF is one that holds the Big 6 bank stocks exclusively. While investors can go out and purchase shares of all six bank stocks on their own, this approach requires a large portfolio size given the high share prices of some banks.
Therefore, ETFs like the popular BMO Equal Weight Banks Index ETF (ZEB) and the Horizons Equal Weight Canada Banks Index ETF (HEWB) can provide capital efficiency. These ETFs hold an equally-weighted portfolio of bank stocks rebalanced periodically and charge a reasonable (0.28% & 0.27%) expense ratio.
HEWB is rather unique in that it does not pay out dividends. Its corporate class structure that uses swap contracts makes it a highly tax-efficient way of gaining Canadian bank exposure in a taxable account. For more information on these types of ETFs, give this article a read.
Income-oriented exposure
Investors who desire higher yields than the ~4% provided by ETFs like ZEB can opt for covered call ETFs that hold the Big Six Canadian bank stocks as their underlying assets. These ETFs sell call options, which essentially converts their upside potential into increased present income.
For a thorough exploration of the Canadian covered call ETF landscape, I suggest reading my two-part article hereand here. When it comes to covered call Canadian banks, investors have a variety of firms and ETFs to choose from. Reading the detail is critical here.
Some things to watch out for include the size of the options overlay (do they sell calls on 33%, 50%, or 100% of the portfolio?), the type of covered call strategy (systematic or actively managed), and the composition of distributions (beware of those with high return of capital).
- BMO Covered Call Canadian Banks ETF (ZWB)
- CI Canadian Banks Covered Call Income Class ETF (CIC)
- Horizons Equal Weight Canadian Bank Covered Call ETF (BKCC)
- Evolve Canadian Banks and Lifecos Enhanced Yield Index Fund (BANK) – Note that this ETF also includes exposure to Canadian insurance companies, so it isn’t a pure-play bank ETF.
Enhanced exposure
Investors with a higher risk tolerance can make use of ETFs that provide leveraged exposure to the Big Six Canadian banks. The benefit of this approach is the potential for higher returns. The risks include greater volatility and drawdowns and higher fees. Generally, these types of ETFs are better suited for advanced investors who have more complex objectives.
For short-term trading, investors can use the BetaPro Equal Weight Canadian Bank 2x Daily Bull ETF (HBKU) and the BetaPro Equal Weight Canadian Bank -2x Daily Bear ETF (HBKD). These ETFs provide 2x long and 2x inverse leverage respectively to the daily returns of Canadian banks. They are intended for short-term holding purposes.
For a long-term buy-and-hold that employs modest leverage, investors can use the Hamilton Enhanced Canadian Bank ETF (HCAL) which leverages up 25%, or 1.25x. This ETF does not employ derivatives, making it more akin to using margin on a portfolio of Big Six bank stocks. HCAL can be a hands-off alternative for investors concerned about managing a leveraged portfolio of bank stocks on their own.
Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.
