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In a confusing year for all of finance, the slaughter of the bond market might be the biggest surprise.

The FTSE Canada Long Term Bond Index was down about 11.5 per cent for the year through mid-September, a horrible result from an asset that investors hold to provide portfolio stability. Four thoughts for limiting this damage:

  • Move to a more aggressive portfolio mix of stocks and bonds – 70-30 instead of 60-40, for example.
  • Use short-term bond funds, particularly those that hold corporate bonds as opposed to government debt.
  • Mix guaranteed investment certificates into the fixed-income side of your portfolio.
  • Add cash alternative exchange-traded funds to your portfolio.

The latest stats on money flows into ETFs suggest cash alternative funds are gaining popularity as a fixed-income holding. According to National Bank Financial, four of the Top 10 funds as ranked by inflows in August were in this category. Total inflows to the category totalled $589-million, the highest of any subcategory within the fixed income ETF universe.

Cash alternative ETFs, also known as high interest savings funds, do not hold bonds. Rather, the assets in these ETFs are placed in bank savings accounts that pay higher rates of return than banks offer their retail customers. In mid-September, the net yield after fees was typically around 3.6 per cent. Expect this yield to rise and fall in sync with the Bank of Canada’s overnight rate.

The overnight rate is expected to remain at elevated levels through the remainder of 2022 and well into 2023. Only when inflation fades will it fall back to more normal levels.

In the meantime, cash alternative ETFs offer a conservative way to offset the risk of a stock market crash. In contrast to bond funds, these ETFs don’t change much in price. They’re primarily a vehicle for generating a modest yield tied to prevailing interest rates.

When rates do fall at some point, bond funds will be in demand again. Remember, bond prices move in the opposite direction as interest rates. Cash-alternative ETFs will lose their appeal in a falling rate world, but for now they get the stabilizing effect of bonds, without the downside.

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