Split Share Corporations: You May Split More Than Your Return With the Firm Who Sold It

Would you like to invest in a product that pays a 10% dividend yield and is built on banks and other blue chips?

 

This is what Dividend 15 Split Corp (DFN.TO) offers: a group of 15 companies where you can hold Class A and preferred shares. When I looked at the list of the 15 companies, I understood it was a select group: Bank of Montreal (BMO.TO), National Bank of Canada (NA.TO), Sun Life Financial (SFL.TO), Bank of Nova Scotia (BNS.TO), CI Financial Corp. (CIX.TO), TELUS Corporation (T.TO), CIBC (CM.TO), BCE Inc. (BCE.TO), Thomson Reuters Corporation (TRI.TO), Royal Bank (RY.TO), Manulife Financial (MFC.TO), TransAlta Corporation (TA.TO), Toronto-Dominion Bank (TD.TO), Enbridge Inc. (ENB.TO) and TransCanada Corp (TRP.TO). The list is pretty solid and the yield is even better, so… what could be wrong with split corps?

 

Never Trust a Broker

If a broker wants to sell you something, it’s probably because it’s really good… for his pocket! This is the case with most structured products. As you have probably figured out by now; an investor holding those 15 companies in his portfolio would not come to a 10% yield. The Dividend 15 Split Corp is able to generate such high yield because it is a structured product; a clever mix of shares and options that produce high returns… for the brokers. These products show lots of smoke to the investors but are built to generate generous commissions to any broker selling them. This is why these products make it on the market anyway.

As the company’s portfolio doesn’t generate enough to pay a 10% yield and cover the firm’s management fees, the remaining cash has to be found elsewhere. Since this portfolio would generate around 5% dividend yield, the mutual fund company (yes, DFN is in fact a mutual fund company) trades the underlying securities and writes call options on them too. These operations also trigger additional costs to the investors as even performance bonuses for traders are included in the “creation of wealth process”.

 

Okay, this doesn’t look that good… but what about the 10% yield???

When I hear about something that is too good to be true, I always check its return over the past 10 years. So here’s what the DFN.TO graph looks like:

DFN chart_logo

As you can see; lots of fluctuation and a loss of 8.50% in value over 10 years. I guess the good news is the 10% dividend yield remained during the whole period. Still, during the same period, the Canadian market grew by 60% excluding the dividend (if you held Canadian banks for the past 10 years, I don’t have to convince you made a lot more than the Split Corp).

So the structure is not the best thing for an investor and the return is not impressive… are you still going to argue with the 10% yield? All right, check out what happened when things turn sour. Here’s another split share corp that was very popular prior to 2008:

US financial

This is the chart of the US Financial 15 split corp (FTU.TO). The stock lost almost everything while US banks took a hit but bounced back. Why FTU wasn’t able to get back on track like the underlying stocks? Because the firm was too busy trading the stocks and writing options that they completely lost the investors capital.

 

So Are Split Corps a Good Investment?

For any type of investments (stocks, ETFs, structured products or funds), I always rely on my 7 investing principles I follow to succeed. The first one is “high yield doesnt equal high returns” and the third one is “A dividend payment today is good, a dividend guaranteed for the next ten years is better”. Using these two principles; I’d tell you that a split corps would never be part of my portfolio. But if you don’t like my investing principles, you can also argue with the most prolific investor of all time, Warren Buffett who once said:

Never invest in a company you dont understand.

If you think you understand how traders write their call options and trade those stocks to make money for you (and not for them), good… I don’t! What I understand is only how they make those trades to generate fees for the firm…