In this One Chart, we compare the volatility profile of 1.25x the Solactive Canadian Bank Mean Reversion index (SOLCBMRT) – which the Hamilton Enhanced Canadian Bank ETF (ticker, HCAL) seeks to replicate before fees – to that of the Big-6 Canadian banks. We believe HCAL is a good choice for long-term investors, as its modest leverage offers the potential for higher returns in a steadily growing sector (like Canadian banking), while at the same time, offering a higher yield (currently 5.11%, paid monthly).
As the chart below highlights, the annualized standard deviation of returns of 1.25x SOLCBMRT is 21.7%. However, this volatility is only modestly higher than the average of the individual banks (19.1%). In effect, the reduced volatility that SOLCBMRT derives from diversification and mean reversion dampens the added volatility from adding 25% leverage. Interestingly, the chart below also highlights that a modestly levered Canadian bank portfolio has significantly lower volatility than the un-levered large-cap, KBW U.S. Bank Index (BKX).
In our view, the Canadian banks are firmly in the recovery stage of the credit cycle and, as we explained in our “Canadian Banks Q1-21 Takeaways – One Catalyst Down, Two to Go” (March 2, 2021), we believe future share price performance will be supported by reserve releases, capital return/deployment, higher GDP growth and margin expansion. It is also possible – if not likely – that analysts are underestimating the magnitude and velocity of the recovery and “real” price-to-earnings estimates are lower than they appear (see Canadian Banks: Are Analysts Underestimating the Recovery (Again)?).
To capitalize on the ongoing recovery, investors can consider the Hamilton Enhanced Canadian Bank ETF (HCAL), which uses modest cash leverage (25%). Over the long-term, we believe HCAL offers potential for higher long-term returns and a higher dividend yield (currently 5.11%, paid monthly). Alternatively, investors could consider the Hamilton Canadian Bank Mean Reversion Index ETF (HCA), which seeks to replicate the returns (net of expenses) of the Solactive Canadian Bank Mean Reversion Index and has a yield of 4.11% (paid monthly).
Canadian Banks: Are Analysts Underestimating the Recovery (Again)? (April 16, 2021).
Press Release: Hamilton ETFs Announces Name Change for HCAL (April 1, 2021)
Video: “Canadian Banks – Three Catalysts for 2021” (February 17, 2021)
Four Themes Driving Financial Innovation (January 25, 2021)
Canadian Banks: Q4 Takeaways – Recovery Has Started; What’s Next? (December 8, 2021)
Canadian Banks: Will Q4 be a ‘Clean-up’ Quarter? (October 26, 2020)
Canadian Banks: Outperformance from Mean Reversion (in 7 Charts) (June 11, 2020)
A word on trading liquidity for ETFs …
Hamilton ETFs are highly liquid ETFs that can be purchased and sold easily. ETFs are as liquid as their underlying holdings and the underlying holdings trade millions of shares each day.
How does that work? When ETF investors are buying (or selling) in the market, they may transact with another ETF investor or a market maker for the ETF. At all times, even if daily volume appears low, there is a market maker – typically a large bank-owned investment dealer – willing to fill the other side of the ETF order (at net asset value plus a spread). The market maker then subscribes to create or redeem units in the ETF from the ETF manager (e.g., Hamilton ETFs), who purchases or sells the underlying holdings for the ETF.
 HCAL employs its investment strategy by investing in the Hamilton Canadian Bank Mean Reversion Index ETF (ticker: HCA), which seeks to replicate the returns of the Solactive Canadian Bank Mean Reversion Index before fees.
 Lower by 180 bps as SOLCBMRT volatility is 17.3% versus the average of the Big-6 banks (at 19.1%).
 Higher by 260 bps as 1.25x SOLCBMRT volatility = 21.7% versus average of the Big-6 banks (at 19.1%).
 As of April 23, 2021
 As of April 23, 2021