With bond yields tumbling below zero worldwide, investors hungry for returns are piling into Canadian exchange-traded funds focused on the country's long-term debt at a record pace.
Flows into ETFs focused on long-term Canadian bonds have increased almost 25 per cent to $450-million (U.S.) this year, according to data compiled by Bloomberg. Growth in those funds is leading a $3.3-billion march into Canada's fixed-income ETFs, putting the flows on track to hit an all-time high, the data show.
"Investors are looking for yield any which way they can get it," Aubrey Basdeo, head of Canadian fixed income at BlackRock Inc., said by phone from Toronto. "Every single basis point counts."
In particular, money is pouring into funds that hold fixed-income securities with maturities longer than 10 years. Retail investors are copying pension funds and insurance companies that are snapping up individual bonds to match their liabilities and driving values higher, said Mark Chandler, head of fixed-income research at RBC Dominion Securities.
"When they rallied a lot, it leads to good performance, good performance leads to interest in the retail sector, and the retail sector looks for the easiest way to invest in those, and that happens to be ETFs," he said. "It's from the same ultimate source."
Flows to medium-term Canadian bond ETFs have risen by 11 per cent to $681.5-million and short-term funds have picked up almost 11 per cent to $995.1-million, according to the data. But ultrashort-term ETFs have seen a pullback of 16 per cent to $40-million.
Bank of Montreal's Long Provincial Bond Index ETF has the highest flows among long-dated bond ETFs this year at $292.4-million. That's followed by BMO's Long Federal Bond Index ETF with $127-million in flows, and BlackRock Inc.'s iShares Core Canadian Long Term Bond Index ETF with $78.7-million in flows, according to data compiled by Bloomberg.
"For the same maturity, provincial bonds are going to have a higher yield than Government of Canada bonds," BlackRock's Mr. Basdeo said.
Ontario and Quebec, whose debt is widely traded in the provincial bond market, both have 10-year yields around 1.9 per cent. Canada's 10-year benchmark government bond yields around 1.1 per cent, but it fell to as low as 96.1 basis points amid market turmoil after Britain voted to leave the European Union. The 30-year government bond yields 1.7 per cent.
Provincial bonds are also typically longer dated than federal bonds, which also makes them attractive to institutional investors, Mr. Chandler said.
BMO's provincial index has returned more than 8 per cent this year compared with the federal index return of roughly 6.8 per cent. BlackRock's iShares long Canadian index, which includes both provincial and federal government debt, also has returned more than 8 per cent.
More institutional investors are also starting to use fixed-income ETFs because of the diversification of the bonds in the fund and the enhanced liquidity of an ETF, which trades like a stock, compared with an individual bond, Alfred Lee, an ETF portfolio manager at BMO Asset Management, said by phone from Toronto. Tactical portfolio managers move in and out of positions quickly and the ETF allows investors to do that more easily, he said.
"Because longer-dated fixed-income has done well, a lot of these tactical guys chase momentum so they have made more an allocation to the long end of the curve," he said.
ETFs also allow institutional investors to express a view on the market without going all-in, BlackRock's Mr. Basdeo said.
Almost two-thirds of Canadian institutional ETF assets are categorized as strategic, used for objectives such as portfolio diversification or core investment exposure, according to a survey released in January by Greenwich Associates and sponsored by BlackRock Asset Management Canada. Nearly 70 per cent of Canadian institutions use fixed-income ETFs, up from slightly more than half last year, according to the survey.
The strategy comes with its own risks. Fixed-income ETFs are highly interest rate-sensitive, and if rates were to rise or sentiment were to turn against the debt, holders could see their value quickly erode. That said, National Bank of Canada forecasts that the Bank of Canada won't begin hiking interest rates until 2018.
With global growth stagnant and interest rates near or below zero, Mr. Basdeo doesn't see demand for long-dated debt or ETFs abating any time soon.
"We still believe in the low-growth environment," he said. "We have been advocating a long-duration exposure."