Bank on Canadian Banks: Sustainable Yields and Upside Potential
With 2023 now in the rear view, Chris Heakes, Portfolio Manager, Exchange Traded Funds, BMO Global Asset Management, argues that it may be a tactical time to add bank exposure to your client portfolios via ETF-based mutual funds.
January 2024
Over the past several months, Canadian Banks have become increasingly attractive. Advisors may want to consider increasing their allocation to the sector not only for their sustainable yields, but for the upside potential as well.
Featured Funds:
- The recent quarterly earnings were constructive for Canadian banks, despite Scotia starting off reporting with a 23% earnings per share (EPS) miss. The rest of the banks in general picked up the slack, with most of them commenting on manageable credit exposures, particularly with the backdrop of increasing projections of a soft landing.2
- While the economic outlook still challenges the banks and growth more broadly, the resilience of the consumer, labour markets, and improving market sentiment bodes well. Canadian banks continue to trade at attractive valuations on a Dividend Yield, price-to-earnings (P/E) and price-to-book (P/B) level. Currently, the banks have an average P/E of 9.8 and an average P/B of 1.2 which is below its historical average P/E of 12.14 and P/B of 1.93 (since January of 2004).3
- Price action has been very constructive recently; performance of the funds was up for the month of December, as demonstrated in the table below.4
Annual Compound Returns:
| YTD | 1 Month | 3 Month | 6 Month | 1 Year | 3 Year | 5 Year | Since Inception | |
|---|---|---|---|---|---|---|---|---|
| BMO Canadian Banks ETF Fund (Series F) | 10.6% | 10.8% | 12.9% | 8.0% | - | - | - | -0.6% |
| BMO Covered Call Canadian Banks ETF Fund (Series F) | 6.7% | 7.5% | 9.3% | 4.6% | 6.7% | 7.4% | 7.5% | 7.6% |
As of December 31, 2023.
- BMO, Royal, TD, CIBC, and National Bank all raised Dividends for the next quarter. After the COVID moratorium on dividend hikes, bank dividend growth is firmly back on track with a 3yr dividend growth of 8% annualized.5 Overall, Canadian banks have a reliable dividend payment; the BMO Canadian Banks ETF Fund and BMO Covered Call Canadian Banks ETF Fund have an annualized distribution yield of 4.68% and 7.41%, respectively.6
- Both the BMO Canadian Banks ETF Fund and BMO Covered Call Canadian Banks ETF Fund are quite compelling, low-cost solutions to gain exposure to CAD banks. Despite challenging markets, their underlying ETFs gathered over $1.1 billion of AUM flows in 2023.7
- Central banks appear to have stopped raising rates for the time being and have signaled that high interest rates are working their way through the economy and pushing down inflation. The Bank of Canada (BoC) believes that existing rates may be restrictive enough to bring inflation down further, which may prove to be a tailwind for Canadian banks.
Benefits:
- Canadian banks are currently trading at a discount relative to the broad market.
- Previous market troughs in 2009 and 2020 proved to be opportune entry points into Canadian bank stocks.
- BMO Canadian Banks ETF Fund and BMO Covered Call Canadian Banks ETF Fund both offer single-ticket access to Canada’s Big Six banks.
Implementation:
Mutual Funds can provide an efficient way to gain exposure to Canadian banks.
The BMO Canadian Banks ETF Fund provides exposure to the Big Six Canadian banks on an equal weight basis. The Fund is rebalanced twice a year, allowing profits from winners to be redistributed in those banks that have underperformed—essentially a buy low, sell high strategy. The F series of the Fund currently has an annualized distribution yield of 4.68%.6
Investors that want to generate additional yield may consider BMO Covered Call Canadian Banks ETF Fund, which provides exposure to the same base portfolio as the BMO Canadian Banks ETF Fund with the addition of call options on the individual banks being sold in order to generate option premiums to enhance the yield of the portfolio. The F series of this Fund currently has an annualized distribution yield of 7.41%.6
Fund Codes:
BMO Canadian Banks ETF Fund
| FundSERV Codes | Front End8 | MER(%) |
|---|---|---|
| Advisor | BMO99262 | 1.41 |
| T6 | BMO34262 | 1.41 |
| F (Fee-Based) | BMO952628 | 0.28 |
| F6 | BMO36262 | 0.27 |
BMO Covered Call Canadian Banks ETF Fund
| FundSERV Codes | Front End8 | MER(%) |
|---|---|---|
| Advisor | BMO99765 | 1.64 |
| F (Fee-Based) | BMO957658 | 0.73 |
| F (Client Name) | BMO68765 | 0.73 |
Please contact your BMO Global Asset Management wholesaler for any support and guidance.
1 Management Expense Ratio, as of December 31, 2023.
2 Bank earnings source: Bloomberg, as of December 5, 2023.
3 Source for P/E ratios: Bloomberg, as of December 6, 2023.
4 BMO Global Asset Management, as of November 30, 2023.
5 Canadian banks 3-year dividend growth rate source: Bloomberg, as of December 5, 2023.
6 Annualized Distribution Yield as of December 31, 2023: The most recent regular distribution, or expected distribution (excluding additional year-end distributions), annualized for frequency, divided by current NAV. Source: BMO Global Asset Management.
7 AUM flows source: BMO Global Asset Management, as of November 30, 2023.
8 Front End = Sales Charge. MER as of December 31, 2023.
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