BMO launches new income ETFs in Canada
BMO Global Asset Management has launched a new suite of income ETFs, including autocallable ETFs, which use structured notes to deliver income to investors. The value of linked securities must remain within a certain price band for investors to receive income. Autocallable ETFs have attracted around US$5 billion in investments since their launch on US markets last year.
Bipan Rai, Managing Director and Head of ETF and Alternatives Strategy at BMO GAM, explained that his firm launched these strategies due to the growing popularity of structured notes in the Canadian market. The structured notes market in Canada has doubled since March 2020, reaching over $34 billion.
How Autocallable ETFs Work
Autocallable ETFs work by holding a portfolio of structured notes tied to particular large-cap US names or single stocks. These structured notes involve multiple thresholds, triggering certain outcomes if the price of the underlying stock hits different levels. The coupon threshold is one of the most important thresholds, as it determines whether the ETF will earn coupon income.
If the stock price remains above the coupon threshold at the agreed-upon date each month, the ETF will earn coupon income. The structured note also sets an autocall threshold above the coupon threshold. If the stock price moves above that threshold, the note is sold for that threshold price, with the proceeds returned to the ETF.
Rai explains that the goal of these strategies is to offer investors a chance to earn income tied to a stock price while shielding them from downside risk up to a certain point. Even if the share price declines somewhat but remains above the coupon threshold, the income can offset any exposure to price decline.
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The risk for investors comes primarily when the share price falls below its two low-end thresholds. Falling below the coupon threshold means the ETF loses out on coupon income, while falling below the protection threshold means the ETF holder experiences the full loss of the underlying stock.
Autocallable ETFs can enhance the overall income yield of an investor’s portfolio while reducing overall volatility through limited price movements.
The BMO Strategic autocallable Income US Large Cap ETF (ZACU) paid its first distribution of $0.305 at the end of October, representing a roughly 12 per cent annualized yield on its then-price of $29.76. The single-stock ETFs have not yet paid a distribution but targeted conditional coupon rates of 13.25 per cent for the Nvidia ETF, 14.25 per cent for Tesla, and 17.5 per cent for Palantir.
Risks and Utility of Autocallable ETFs
ZACU comes with a management fee of 0.65 per cent, while the single-stock ETFs have a management fee of 0.40 per cent. ZACU and the three single-stock autocallable ETFs will pay distributions on a monthly basis.
Rai contrasts autocallable ETFs with covered call ETFs, which trade off potential upside in a security for income. Autocallable ETFs primarily derive returns from coupon income and any capital gains realized when contracts hit their autocall threshold.
