How to Find Canadian ETFs for Income

Consider a screen for consistent distributions from ETFs and DIY Mutual Funds.

Ian Tam, CFA 25 January, 2023 | 4:58AM
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Hunting for ETFs that produce consistent income can sometimes be a bit tricky as it involves a bit of detective work around what the fund has paid historically.

Behind the scenes of an ETF, income can be produced in a few ways, with the most common being (1) dividends from stock holdings, (2) coupon payments from bond holdings, and (3) return of capital payments (more on this later). As such, using measures like dividend yield does not necessarily capture the full amount that the investor receives.

Screen for the Best Canadian Income ETFs

To help with this task and to generate a few reasonable ideas for ETF investors who need income, I used Morningstar Direct to search for funds that:

-          Have received a 4 or 5-star rating overall, used to highlight funds that have outperformed their respective category peers on a risk-adjusted basis over time.

-          Have received a Morningstar Quantitative or Analyst rating of gold, silver, or bronze, isolating funds that Morningstar believes will produce after-fee alpha in the future.

I then ranked this universe on two metrics:

-          The total distributions received over the last five years

-          The consistency of distributions over the last five years (measured using annual standard deviation)

In the ranking process, I placed a greater emphasis (70% weight) on consistency of distributions, and a lower (30% weight) emphasis on the total amount of distributions. After all, a giant distribution isn’t particularly useful for income investors if it doesn’t happen consistently.

The above table showcases the top 19 funds on this basis. Also shown are the after-fee total returns for each fund. Investors are reminded that large distributions don’t necessarily mean better investment outcomes. However, if your financial circumstances require a steady income from the portfolio, these ETFs might be a reasonable place to begin further research.

A Note on Fixed Distribution Funds and Return of Capital:
There are several products available in Canada that outrightly state a fixed distribution. In other words, these funds will use return of capital payments to ensure that you receive a set amount every single month. Return of capital payments are a mechanism whereby the fund company returns a portion of your principal back to you in the form of a distribution. For example, let’s say you invested $1000 in one of these funds that advertises a 5% fixed distribution (or in other words they must pay you $50 a year). In a given year, if the portfolio generates say $38 in cashflow (from dividends and bonds), it might use this return of capital approach to fill in the remaining $12. However, your investment position is now reduced to $988, also known as the adjusted cost basis. This mechanism also offers a slight tax benefit, as these return of capital distributions are not taxed right away. Rather, you pay capital gains tax when you eventually sell the position, (hopefully in retirement when your marginal tax bracket is lower).  

This article does not constitute financial advice. It is always recommended to conduct one’s own independent research before buying or selling any of the investments listed here. 

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About Author

Ian Tam, CFA  is Investment Specialist at Morningstar Canada. 


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