Split Shares: Why Not Buy Both?

This is the last article concerning split shares. Why did I write 3 articles? Well it started out as one but it was just too long. The other reason is because I found there wasn’t much information on the web. There were the few articles I found, but it took me a long time to find those, and some of them were not even available from the source, I had to use Google’s cache to view them.

This last article asks the question, “Why not buy both?” Well, the answer is simple. If you bought both that would be no different than buying the common stock in the trust’s underlying portfolio. But you would be paying annual fees for the management of the split shares/split trust (see Split Shares: the Downside for more information about fees).

Let’s see an example. Say a split share was set up and it owned common shares in ABC Corp. The split trust sold 50% of their assets as preferred shares and 50% of their assets as capital shares. If ABC Corp paid a dividend of 3% annually, the preferred split share will pay 6% (3%/0.5 = 6%). You get the dividend from the equivalent amount of common stock your preferred share is invested in, plus the forfeited dividend from the capital shares. If the common stock rises 3%, the capital share will go up 6% (3%/0.5 = 6%). So if I bought either the preferred share or the capital share I will get a 6% total return (capital gain + dividend). If I buy both the capital shares and the preferred shares I still get a 6% total return, the exact same return I would get if I had bought shares in ABC Corp. directly (see above, I mentioned that ABC Corp. paid a dividend of 3% and it’s stock went up by 3%); however, I will be paying about 1% in managment fees (as an example), so that will reduce my return to 5%.

Some articles online provide further proof that buying both the capital shares and the preferred shares makes no sense. From an article previously available here but now no longer availablel anywhere online:

Now, as to how you would use either of these in a portfolio, the answer may be obvious by now. First, you would buy either the preferred shares or the capital shares, but not both – if you wanted both you could just buy the XIUs. Second, you would hold either outside an RRSP to reap the tax benefits, unless you were using the capital shares to speculate within an RRSP.
But most of all, you’d buy the preferred shares if you needed to supplement your income, and your tax situation made dividend income attractive relative to interest income. Alternatively, you’d buy the capital shares if you didn’t need income and needed enhanced tax-deferred capital gains. So it really comes down to your investment objectives: do you need income, or gains, or both? [emphais mine]

More from Money Digest:

Stripped common investments take dividend-paying stocks and split them into two parts: capital and dividend. Those who buy the capital part benefit from capital gains, while those who buy the dividend part benefit from dividends and any increases in dividends over time. . . To reduce the risk, many split share corporations buy a basket of dividend-paying stocks. An example of a stripped common is Can-Banc, traded on the Toronto Stock Exchange. Can-Banc represents shares in the five largest Canadian banks. You can buy either the dividend part (check the dividend yields with your broker before investing) or the capital gains part (which entitles you to participate in capital gains should these bank stocks appreciate).

The reason I investigated this is because my parents are invested in both the capital and preferred shares of the Top 10 Split Trust, a split trust that invests in common shares of the 6 largest banks and 4 largest insurance companies in Canada. Buying both is equivalent to buying the common stocks themselves in the underlying portfolio. Except when you buy the common shares themselves instead, you don’t have to pay the extra fees imposed by the company managing the trust. If you really want income buy the preferred shares only, not the capital shares as well. Especially with a potential bear market looming, the capital part of the split shares could tumble a lot.

Or just buy the the S&P/TSX Capped Financials Index through the iUnits XFN index. The 6 big banks make up over 70% of that index (so you’ll get a similar return to banks stocks in the Top 10 Split Shares, but with less risk). You’ll also pay less in MER (0.55% for the ETF vs. at least 1% for the split shares). Or just get the iUnits S&P/TSX 60 index through the XIU ETF which has a large financial component.

Their financial advisor is seriously out to lunch. At first I could not believe that he had invested them in both the capital and preferred shares of the split trusts, but he has. He is either: a) afraid to buy banks’ common stock, b) has never heard of XFN, XIU, or has a fear of indexes, c) doesn’t understand how split shares work, d) doesn’t care about cost and MERs (like the 1% MER on the split shares). I really hope they get burned in the next bear market just like they did with Nortel so they can finally leave this guy and his crappy advice for good.

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