income ETF with large % in Return of Capital

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kenwood
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income ETF with large % in Return of Capital

Post by kenwood »

While evaluating an income generating ETF that uses option strategies, I notice almost all of its monthly yield come from return of capitals (ROC). If I understand correctly, ROC comes from the investment principle. Is this a strong indication that the ETF manager is unable to generate the necessary income through options to pay off the promised monthly yield? Or could it be an intentional tax strategy, since ROC is tax exempted as long as the total returned does not exceed the investment principle?

p.s. the ETF I was looking at is the zpw.to and I was referring to 2015 tax year.
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ZPW.TO - income ETF with large % in return of captials

Post by Peculiar_Investor »

The best place to find that information would be the prospectus. I tried with Google and the closest I could come was BMO US Put Write ETF (ZPW/ZPW.U) - semi-annual management report of fund performance, but that doesn't speak at all to the distribution objectives.

According to ZPW: BMO US Put Write ETF ETF Price Quote | Morningstar in 2015 they distributed $0.48 and it was all Canadian dividends and no return of capital. 2016 was similar, distribution of $1.42, all indicated as dividends and no return of capital.
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Re: income ETF with large % in return of captials

Post by ig17 »

Google ZPW "return of capital"

https://www.google.ca/search?q=ZPW+%22r ... capital%22

Follow the first link

BMO ETF Taxation
Covered Call ETFs

For an equity ETF with written call options, the cash distributions will include dividend income, capital gains (from the premiums received) and ROC. From a tax perspective, the gains from writing options are combined with gains and losses from trading the underlying portfolio. If the underlying portfolio trades have generated losses, these losses reduce or negate the tax gain from the written options and create ROC. Note that in the money options do not decrease the value of the ETF, as the increase in the value of the written option, which negatively impacts the ETF, is offset by the increase in the value of the underlying portfolio holding. Overall, this is a tax advantage for the ETF as capital gains are taxed favourably to dividends and income, and ROC is not taxable.
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Re: income ETF with large % in return of captials

Post by Peculiar_Investor »

Good find. I was looking for the prospectus so used different search terms. Never thought to search for return of capital. :oops:
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Re: ZPW.TO - income ETF with large % in return of captials

Post by Spudd »

Peculiar_Investor wrote: According to ZPW: BMO US Put Write ETF ETF Price Quote | Morningstar in 2015 they distributed $0.48 and it was all Canadian dividends and no return of capital. 2016 was similar, distribution of $1.42, all indicated as dividends and no return of capital.
Morningstar must be wrong. According to BMO it was indeed mostly ROC with a touch of foreign income in 2015. They don't have data yet for 2016.
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Re: income ETF with large % in return of captials

Post by kenwood »

In general, is it bad for an income ETF to have ROC making up a large part of its yield?
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Re: income ETF with large % in return of captials

Post by AltaRed »

kenwood wrote:In general, is it bad for an income ETF to have ROC making up a large part of its yield?
It is going to happen especially in bond ETFs where the decline in bond yields over the past 30 years results in the ETF containing a lot of premium bonds (priced >$100). It will only turn around after yields start increasing for some period of time. But generally yes, it is not the best situation in a non-reg account because you are getting interest income taxed at the highest rates, while ROC simply results in deferred cap gains taxes down the road when the ETF is sold. In a registered account, I'd argue that it is not a big deal since there are no near term/immediate tax implications.

It would be a worse situation IF the payout is being 'managed' whereby the ETF is selling assets in order to maintain a certain yield. This happens a lot in the mutual fund business, particularly with "managed payout solutions". Investors get fooled in that thinking their return is better than it is, although if the NAV of the fund continues to increase, some of that concern is alleviated. I really don't know if this game is played in the ETF business.
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