Today, we look at an ETF that holds preferred shares. Dividends on preferred shares must be paid out before dividends to common shareholders, but prefereds usually do not carry voting rights. BMO S&P/TSX Laddered Preferred Share Index ETF holds Canadian floating-rate preferred shares: this means the shares fluctuate with interest rates. They are “laddered” for rate-reset dates ranging from the current year to four years out. This is an advantage for investors if interest rates go up. However, the structure of this ETF also causes it to trade regularly, which drains its capital.

For our view on the most effective way to profit with ETFs, read: When you invest in ETFs, keep it simple.

BMO S&P/TSX Laddered Preferred Share Index ETF, (symbol ZPR on Toronto; www.etfs.bmo.com) holds Canadian floating-rate preferred shares. Issuers include Bank of Montreal, Enbridge, BCE, TransCanada and Canadian Utilities.

The fund’s MER is 0.45%, and it currently yields 4.9%. Note that the dividends you receive from this fund benefit from the Canadian dividend tax credit.

Floating-rate preferred shares pay dividends that fluctuate with changes in interest rates. The dividend rate may range from 50% to 100% of (usually) the prime bank rate. As interest rates rise, so do floating-preferred dividend yields.

Sometimes the floating-rate feature only kicks in several years after the issuer sells the preferred to investors. For example, the preferred may pay dividends at a fixed rate for five years, then the payout floats with interest rates.

ETFs: Higher interest rates would favour this ETF, but regular trading is a drain on its capital

This ETF’s 145 holdings are divided into five staggered, or “laddered,” rate-reset dates ranging from the current year to four years out. Each year is equally weighted. Every year, the one- to four-year preferreds will be a year closer to their rate-reset date, and current-year preferreds will reach their dates.

The ETF uses the proceeds from selling the current-year preferreds to buy new preferreds that restore the desired current- to four-year portfolio balance.

Floating-rate preferreds are an advantage to investors if interest rates go up but put you at a disadvantage if rates go down. Given that interest rates are likely to go sideways or trend upward over the next few years, floating-rate preferreds have some appeal. However, the regular trading this fund engages in is a steady drain on its capital.

The BMO S&P/TSX Laddered Preferred Share Index ETF is okay to hold if you want to own preferred shares.

Inner Circle recommendation: HOLD if you want preferred shares.