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One of the more popular options for investors looking to earn income from cash, while being shielded from volatility, has been high-interest savings account (HISA) ETFs. But the decline in yields on these exchange-traded funds, triggered by regulatory changes, has caused conservative do-it-yourself investors to seek alternative vehicles.
One option is money-market and short-term bond ETFs. “For a similar risk, they’re getting a higher yield, which makes them an ideal place to park cash,” says Matt Montemurro, Head of Fixed Income and Equity Index ETFs with BMO Global Asset Management in Toronto.
HISA ETFs became increasingly appealing in the rising-interest-rate environment between March, 2020 and July, 2023, when rates rose by 475 basis points. At the end of last year, HISA ETFs held almost $30-billion in assets, the bulk of which were invested over the past two years.
“In the last couple of years, there was an uptick in the use of HISA ETFs because they paid a significant premium over overnight and money-market rates,” says Mr. Montemurro. “Investors who wanted to sit on the sidelines in cash found HISA ETFs very attractive. They were able to use these ETFs to maximize their yields and maximize their safety in what was really a win-win situation.”
HISA ETFs invest money into high-interest savings accounts at various banks to get the best possible wholesale rates. Investors are able to access these higher yields through a single trade in the ETF.
However, in October, 2023, the Office of the Superintendent of Financial Institutions (OSFI) raised alarms about the potential impact on the liquidity of banks. If interest rates were to fall unexpectedly, the concern was that investors could rapidly pull their money out of HISA ETFs on demand, as the very structure of the ETFs facilitated such withdrawals.
To prevent such an outcome, OSFI ruled that as of January 31, 2024, all deposit-taking institutions offering HISAs within an ETF structure must cover 100 per cent of their liabilities with sufficient high-quality liquid assets, such as government bonds. The requirement is to support all HISA ETF balances that can be withdrawn within 30 days.
The ruling means that banks will likely be unable to offer preferential institutional yields to HISA ETFs. As a result, their yields have fallen.
Mr. Montemurro says that HISA yields have come down by 40 basis points already, and they are expected to continue to fall when anticipated interest cuts take effect. “As interest rate cuts come to fruition, the yield on these ETFs will follow suit. Many investors will be forced to reconsider these allocations as the lower yields may not meet their investment need.”
Among the products that can suit the need in the current interest rate environment is the BMO Money Market Fund ETF Series (ZMMK). It provides exposure to high-quality money-market instruments issued by governments and corporations in Canada. That includes treasury bills, bankers’ acceptances, and commercial paper, with an average term-to-maturity of less than 90 days.
The key benefits of ZMMK include preservation of capital, highly rated securities, high liquidity and no locked-up period (unlike GICs, they can be sold any time without penalty). Mr. Montemurro notes that with the overnight rate currently at 5 per cent, money-market ETFs are currently offering a 5.25-per-cent yield to maturity².
BMO is the largest fixed-income ETF provider in Canada by assets¹. Another of their options to reallocate cash is the BMO Ultra Short-Term Bond ETF (ZST), which holds a basket of investment grade corporate bonds with under one year to maturity. Its objective is to hold these bonds to maturity, offering defensive income, intraday liquidity and a diversified portfolio of high-quality corporate bonds. ZST currently offer a yield to maturity of 5.3 per cent².
“Most of the bonds ZST holds were issued when interest rates were lower than today, which means these bonds are trading at a discount to par value. In this strategy, we aim to hold bonds until they mature, meaning that the bond’s price will move upwards, toward par, as we move closer to maturity. Their return is made up of a mix of interest and capital gains, which are taxed at a lower rate, so they also provide greater tax efficiency for the end investor,” says Mr. Montemurro.
¹Source: Bloomberg, as of Dec 31, 2023
² As of April 2, 2024 Yield to maturity (YTM): The total expected return from a bond when it is held until maturity – including all interest, coupon payments, and premium or discount adjustments
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