The basic concept behind equity ETFs is diversification by security. But with the creation of ETFs that hold just a single stock, that’s no longer always true.
In the U.S., the first single-stock ETFs began trading in July 2022 after they received approval from the Securities and Exchange Commission. In Canada, the first such funds to obtain regulatory approval were from Purpose Investments Inc.
Purpose launched its five Yield Shares ETFs in December of last year. The management fee for each ETF is 0.40%. They currently hold a combined total of about $107 million in assets.
“The utility and the use case for them is in line with what we would have expected before we launched them,” said Vlad Tasevski, chief operating officer and head of product with Purpose. In structuring Yield Shares, Purpose consulted with clients to find out what was important to them. In response to the offering, “the clients’ feedback has been very positive.”
Single-stock exposure from an exchange-traded security was introduced in July 2021, when CIBC launched its first Canadian depositary receipt (CDR), providing fractional ownership of shares of Amazon.com Inc. Although CDRs are structured as segregated securities accounts, they are listed on Cboe Canada and trade like ETFs.
From five CDRs launched in the summer of 2021, the lineup has expanded to 47, with assets of $2.7 billion.
“Investor response has been very positive, with strong adoption for both the self-directed [DIY] and advice channels,” said Elliot Scherer, managing director and head of the wealth solutions group with CIBC Capital Markets. “The straightforward nature of CDRs makes them an easy-to-understand investment product for advisors to explain to clients, as well as for DIY investors.”
CIBC’s CDRs and Purpose’s Yield Shares both provide fully currency-hedged exposure to U.S. stocks and enable fractional stock exposure. Otherwise, even when the underlying interest is the same stock, the two products differ substantially.
The five Yield Shares — providing exposure to Alphabet Inc., Amazon.com Inc., Apple Inc., Berkshire Hathaway Inc. and Tesla Inc. — employ a combination of covered-call writing and relatively modest leverage.
Covered calls, written on 40%–50% of the underlying holding, generate monthly distributions to investors and thus reduce volatility. Conversely, leverage of up to 25% of the held shares boosts potential returns but also increases risk.
The income that Yield Shares generate from covered-call writing acts as a buffer against the increase in risk brought on by the leverage, Tasevski said: “Over a long period of time, the actual risk profile, when you measure the risk in the form of volatility, should be fairly similar to holding the stock.”
Tasevski said the monthly income, in the form of tax-efficient capital gains, is the key attribute that sets Yield Shares apart from a CDR or buying a U.S. stock directly.
Yield Shares also enable investors to express a less bullish view on the underlying stock, Tasevski said. Assuming a scenario in which the investor believes the stock is range-bound with a lower near-term prospect of capital gain and with high volatility, the Yield Share will be more attractive because of the covered-call writing.
However, if the stock goes up enough that it gets called away by the purchaser of the covered call, the Yield Share will miss out on some of the price appreciation. If the investor believes that there’s a sharp upside opportunity for the stock, Tasevski said, the corresponding CDR or a direct stock purchase will provide better exposure.
Scherer said simplicity has been a key aspect of the CDR product line’s success.
“CDRs provide a similar experience to investing directly in one of the underlying U.S. companies, and clients can expect similar performance, dividend yield and the look and feel of holding U.S. equities in their brokerage account while mitigating currency risk,” he said.
Currency hedging is a business necessity for CIBC, as the CDRs don’t incur management fees or custodial or other expenses. CIBC earns revenue by managing the currency risk, at an estimated embedded cost to investors of up to 0.6% a year.
Offsetting this cost, CDRs trade in Canadian dollars, so investors don’t need to bear the cost of converting Canadian currency to U.S. dollars, as they would when buying a U.S. stock directly. The same goes for investors in Yield Shares.