First Asset announces contest winner, launches ETF

To come up with its next ETF, First Asset asked advisors what’s missing from the Canadian ETF community.

Advisors answered. As a result, the firm is launching First Asset DEX 1-5 Year Laddered Government Strip Bond on June 11, 2013. The ETF invests primarily in strip bonds derived from Canadian federal and provincial government bonds issued in Canada and denominated in Canadian dollars.

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Justin Bender, portfolio manager at Toronto’s PWL Capital Inc. made the winning submission and chose the Centre for Addiction and Mental Health (CAMH) as the recipient of the $10,000 first prize donation.

“We are excited to launch an ETF based on Mr. Bender’s winning submission, which solves a significant problem for taxable investors in bonds,” says Barry Gordon, president and CEO of First Asset.

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In the spirit of the contest, First Asset will not charge a management fee to the ETF until July 2014.

In discussing his submission, Bender says strip bond ETFs are suitable for clients who hold fixed income in non-registered accounts. That’s because nominal bonds that trade at premiums (i.e. have higher coupon interest payments than their yields to maturity) are tax-inefficient when held in open accounts.

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“At times they can even result in a negative after-tax return for the client because the investor is fully taxed on the high coupon interest, while at the same time receiving a capital loss at maturity of the bond,” he explains. “Even if they’re able to offset the capital loss with a capital gain, the benefit is only half the cost of the taxes paid on the high coupon interest.”

Bender adds the problem with using GICs in taxable accounts is they’re relatively illiquid. There are also issues with CDIC limits for larger accounts.

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“[This is why] a strip bond ETF could be used to rebalance a portfolio in a down market, or gain access to cash when an unexpected expense arises,” he says. “You do not have the same tax issue that you do with nominal bonds trading at a premium — you buy strips at a discount, ensuring that you do not receive a capital loss at maturity (making the entire yield interest income).”