The Income Illusion, Part II

ZWUBMO’s Covered Call Utilities ETF: the 7% yield, and what it quietly costs

An honestly framed version of the BMO Covered Call Utilities ETF (ZWU) would read: you will likely earn a lower total return over time, and pay a higher fee, in exchange for a bigger monthly cheque, part of which is simply your own capital handed back to you. That is not a great marketing slogan, which is exactly why you never see it on the front of a brochure.

This is Part II of our Buyer Beware series on BMO’s covered-call ETFs. In Part I we set the covered-call bank fund, ZWB, against its plain-index twin, ZEB, and ZWB earned a failing grade from us: a full decade of lower total return for a higher fee. ZWU runs the same covered-call playbook on utilities, pipelines, and telecom, so it is the natural next fund to hold up to the same light.

The verdict, up front: ZWU is not as severe a failure as the bank fund. It is more diversified, and its overlay genuinely does smooth the ride. But it still comes up short for a buy-and-hold investor. Over a full decade, ZWU has handed investors a materially lower total return than the plain utilities benchmark, ZUT, while charging a higher all-in fee. What clients most need to see is that they are giving up significant long-term growth in exchange for a bigger monthly cheque, and a large slice of that cheque is return of capital: simply their own money being handed back to them. Frontwater uses disciplined option overlays in our own portfolios, which is exactly why we do not endorse a ready-made version like ZWU.

We want to be fair, because this is a more nuanced case than the bank fund. That smoother ride is real, and for some investors it has value. But the comfort is bundled with a permanent drag on long-term growth, a higher fee, and a distribution padded with your own capital. The headline number is magnetic; the trade-off underneath it is the part worth reading.

The magnetic headline

ZWU advertises a distribution yield around 7%, more than double the roughly 2.8% you would earn holding plain utilities through ZUT. For an investor who wants cash flow, that number does a lot of quiet work. The catch is that a large slice of it is not investment income at all; it is your own money being returned to you, lowering the fund’s value as it goes.

Understanding why requires looking under the hood. On the next page, the scorecard: two BMO utilities funds, close cousins, differing mainly in the option overlay layered on top.

The scorecard: ZWU versus ZUT

Unlike the bank funds in Part I, these two are close cousins rather than identical twins. ZWU casts a wider net. But the practical choice an income investor faces is the same: the plain index, or the covered-call version layered on top.

Metric	ZUT (plain index)	ZWU (covered call)
What it holds	Canadian utilities, equal-weighted	Utilities, pipelines & telecom (incl. U.S. names), with calls written on top
Headline yield^†	~2.8%	~7%
All-in cost (MER, approx.)	~0.61%	~0.71% (~0.94% with trading costs)
10-year annualized total return	~8.0%/yr	~6.4%/yr
The gap that matters	~1.5% to 2% per year of total return, given up every year

† Distribution yields as of June 30, 2026. Returns are BMO-reported ~10-year annualized figures (ZUT to Dec 31, 2024; ZWU to Dec 31, 2025).

A point and a half, compounded

On a $100,000 investment held for 10 years, compounding at 8.0% rather than 6.4% is the difference between roughly $216,000 and about $186,000, a shortfall near $30,000. The gap is narrower than the bank funds’ in Part I, but it runs in the same direction, and it compounds the longer you hold.

Three forces working against the strategy

1

Capped upside in a sector that just ran

A covered-call fund sells away its best up-days. BMO’s own reporting is candid that the strategy tends to underperform in sharp market advances. That matters right now: utilities have rallied hard (ZUT returned roughly 29% over the past year), and ZWU, by design, could not keep pace. The cost of a cap is invisible until the very moment the sector takes off.

2

A higher, layered fee

Running an active options overlay costs more. ZWU’s MER sits near 0.71%, and once the trading costs of constantly rolling options are included, all-in expenses run closer to 0.94%, against roughly 0.61% for plain ZUT. You pay the most for the product that delivers the least growth.

3

A yield built partly from your own capital

ZWU’s monthly distribution regularly includes return of capital: the fund paying you back with your own money rather than with earnings. That is not free income; it lowers the fund’s net asset value, which is a key reason ZWU’s unit price has drifted lower over the years even as it pays a high “yield.”

Two funds, diverging paths

The chart tells the honest, two-sided story. ZWU’s line is smoother, and its dips in 2020 and 2022 are shallower, which is the downside cushion the marketing promises, and it is real. But watch the rallies: as utilities surged into 2024 and 2025, the cap held ZWU back, and the plain index pulled steadily ahead. A calmer ride, for a lower finish.

Growth of $10,000 over 10 years

Smoother ride, lower destination: ZUT compounds ahead

ZUT (plain index) ZWU (covered call)

Illustrative. Growth paths scaled to BMO-reported ~8.0% (ZUT) and ~6.4% (ZWU) 10-year annualized returns; year-to-year volatility shown schematically to convey ZWU’s smoother profile. Confirm against current fund data before relying on specific values.

The yield illusion

The most important mental shift is to stop treating a distribution as a return. A 7% distribution feels like a 7% gain, but when a meaningful share of it is return of capital, the fund is simply handing back money you already owned, and lowering its net asset value to do so. You have effectively sold a sliver of your holding to pay yourself. A high headline yield paired with an eroding unit price can leave you worse off than a lower-yielding fund that quietly compounds.

“Total return is the only number that measures whether your wealth is actually growing, not the size of the monthly cheque.”

Is the risk reduction real? Partly.

Here is where we will be fairer to ZWU than to the bank funds in Part I. ZWU genuinely is more diversified and lower-volatility than ZUT, and the overlay does soften down-markets, and that benefit is real, not imagined. The honest objection is not that the cushion is fake; it is that you pay for it permanently, through a lower long-term return and a higher fee, while a chunk of the “income” that makes it feel worthwhile is just your own capital coming back.

~7%

Headline yield
(partly return of capital)

~1.5% to 2%

Total-return drag
per year vs ZUT

~0.94%

All-in cost
vs ~0.61% for ZUT

Are banks being forthright about ZWU?

As in Part I, it is worth being precise: this is not fraud. ZWU is a legitimate, fully disclosed product. The covered-call strategy does exactly what the prospectus says, the distributions are paid as promised, and the use of return of capital is spelled out for any reader willing to dig through the fund facts. The issue is not honesty in the legal sense; it is honesty in the emphasis.

The product is marketed on the part that feels good (a 7% cheque, every month, with a smoother ride) and very quietly on the parts that cost you: a lower long-term total return, a higher fee, and a yield padded with your own capital. All of those things are true at the same time. The marketing simply turns the volume up on one and down on the others.

The bottom line

What to take away

ZWU is not a bad fund; it is a misunderstood one. For an investor who deeply values a steady monthly cheque and a calmer ride, and who knowingly accepts lower growth to get them, it can have a place. The problem is that most buyers are drawn in by the 7% headline without registering the roughly 1.5% to 2% per year of total return they give up, the higher fee they pay, and the fact that part of their “income” is just their own capital handed back. Know the trade you are making. That is the whole of buyer beware.

For most long-term investors seeking both income and growth, owning the plain index and simply selling a few units when cash is needed delivers the same cash flow with less drag and more control. The covered-call wrapper feels easier; over a decade, it has been the more expensive convenience.

Frontwater Capital Inc. is an independent, fee-only registered Portfolio Manager based in Toronto. This newsletter is provided for general educational purposes only and does not constitute investment, legal, or tax advice, nor a recommendation to buy or sell any security or ETF. Yields, fees, and performance figures are approximate, drawn from publicly available fund data as of June 2026, and are subject to change; 10-year return figures are BMO-reported and measured to slightly different dates for each fund. Illustrations are not a guarantee of future results, and past performance does not predict future returns. ZUT and ZWU are products of BMO Asset Management; Frontwater is not affiliated with BMO. For advice specific to your circumstances, please speak with a registered professional.