This post is part of a series called Under the Hood, where l take a detailed look at specific Canadian ETFs or index funds.
The index: Zacks Global Multi-Asset Income Index, which was created specifically for Claymore. It combines the Zacks Multi-Asset Income Index (made up of U.S. securities) and the Zacks International Multi-Asset Income Index, which includes developed and emerging countries outside the U.S.
This is a “strategy index,” which means it is not designed to passively track the whole universe of dividend-paying stocks. Rather, the securities are hand-picked “using a proprietary model based on dividend growth, the capacity to increase the current dividend, liquidity, and dividend yield.” The methodology is not made public.
The most important thing to understand about the Zacks index is that it is not limited to common shares of dividend-paying companies. Almost half the index is made up of preferred stocks, American depositary receipts (ADRs), real estate investment trusts (REITs), master limited partnerships, and closed-end funds.
The cost: The fund’s MER is 0.67%, but the prospectus says that the forward agreement (explained below) will add up to 0.50% more. The Globe and Mail recently reported that the full cost of the fund is 0.81%.
The details: This is no plain-vanilla dividend ETF. It’s a complicated product, and if you’re considering investing in it, take the time to understand how it works.
CYH is based on two US-listed ETFs from Guggenheim, Claymore’s parent company: 40% is allocated to the Guggenheim Multi-Asset Income ETF (CVY), which covers the US, and 60% to the Guggenheim International Multi-Asset Income ETF (HGI), whose largest allocations are to the UK, Canada and France. In all, CYH holds a widely diversified portfolio of 283 companies with no stock comprising more than 2% of the fund.
The holdings include blue-chip names in many sectors — Nokia, Allianz, Novartis — but the fund is highly skewed to the energy sector. This isn’t obvious if you look at the fund’s fact card, which shows a 20% weighting to financials. In fact, most of the companies classified as financials are income trusts in the oil and gas sectors, not banks or insurance companies.
Now for the complicated part. CYH doesn’t actually hold the two US-listed ETFs upon which it’s based. Instead, it has teamed up with National Bank of Canada to create a type of derivative called a forward agreement. It works like this: Claymore invests CYH’s assets in a portfolio of Canadian non-dividend-paying stocks. Then they periodically swap the returns from these Canadian stocks with National Bank at prices determined by the performance of the Zacks index.
Why such a convoluted structure? Because foreign dividends would be subject to a 15% withholding tax and are fully taxed as income. Thanks to the forward agreement, CYH’s distributions can be characterized as return of capital, which is non-taxable, or as capital gains, which are taxed at half the rate of regular income. (While this sounds like financial sleight of hand, forward agreements are common in the industry and not a cause for concern.)
When CYH was launched in January 2008 it had a yield of almost 9%, but that year it lost about 41% — of course, so did a lot of other equity funds. In 2009 the fund returned 47.5%, considerably more than the overall equity markets. The ETF’s tracking error was high in both years: –3.2% in 2008, and –1.5% in 2009. So far in 2010 it has returned just over 6%, most of which has come from its monthly distributions (the fund currently yields 4% annually). The ETF hedges foreign currency exposure, so the index returns are measured in Canadian dollars.
In the liquidity department, this ETF has some concerns. Given the wild popularity of dividends these days, I’m surprised the daily trading volume averages only about 13,000, compared with more than 100,000 for Claymore’s S&P/TSX Canadian Dividend ETF. It’s also common to see a large gap between the fund’s net asset value (NAV) and its market price. If you’re considering investing in CYH, you’d be wise to place a limit order.
The alternatives: No other Canadian ETF provider offers an international dividend-focused index fund. However, Horizons AlphaPro recently launched the actively managed Global Dividend ETF (HAZ), which is approximately 50% in US stocks, 11% Canadian and 39% international.
Bottom line: CYH has a lot to offer investors who are looking to earn current income in a non-registered account, such as retirees who are living off their portfolio. The fund allows these investors to diversify outside Canada and get extremely favourable tax treatment on a healthy 4% yield.
However, it is far less attractive for investors who do not need current income or the tax-advantaged structure — which includes anyone investing an RRSP. The actively managed Zacks index is completely opaque, and the forward structure adds an extra layer of complexity and cost that is unnecessary in a tax-sheltered account.
There’s also no reason to focus on dividends in an RRSP, where total return is all that matters. With that in mind, you can get much more complete exposure to US and international equities at a fraction of the cost with truly passive broad-market ETFs.
Disclosure: I do not own CYH in my own portfolio. The US and international equity holdings in my RRSP are Vanguard ETFs.