If regulators had taken action against high interest savings account ETFs when they first appeared in the low-rate world of 10 years ago, hardly anyone would have noticed or cared.
But as interest rates surged in the past 18 or so months, investors seeking low-risk returns poured money into these exchange-traded funds. TD Securities Inc. says the total amount invested in HISA ETFs is $29-billion, which is massive.
The many investors using HISA ETFs have some thinking to do after a ruling this week by the Office of the Superintendent of Financial Institutions. TD says the federal banking regulator’s decision will have the effect of chopping roughly 0.5 of a percentage point off the returns of these funds, which isn’t by any means a deal-breaker. But there are competing products out there, and they’re worth a look if you have money to park safely in an investment account.
Money invested in HISA ETFs is held in big bank savings accounts offering jumbo-size interest rates unavailable to retail customers. There’s no deposit insurance, but the fact that you’re dealing with banks should offer a high level of comfort.
OSFI’s concern is that the investors who hold these ETFs might cash out in a big rush. The results of this happening would be a financial strain on banks holding HISA ETF deposits. To ensure banks are prepared for this outcome, OSFI wants HISA ETF deposits held at banks to be treated in a way that results in a lower interest rate.
HISA ETFs now offer a before-fee yield pegged to the Bank of Canada’s overnight rate, currently 5 per cent, plus markups around 0.5 of a percentage point. Expect that extra amount on top of the overnight rate to more or less disappear after the new OSFI regulation takes effect after Jan. 31, 2024.
Fees on HISA ETFs reduce today’s net yields to between 5.16 and 5.33 per cent, so expect something like 4.66 to 4.83 per cent once the change ordered by OSFI takes effect. This assumes the Bank of Canada’s overnight rate stays put, which seems likely in the near term.
OSFI’s ruling is aimed strictly at protecting banks and should have no effect on investors beyond the lowered return. “The decision is a bit of a non-event, apart from the rate,” said Andres Rincon, head of ETF sales and strategy at TD Securities.
Still, a lower rate for HISA ETFs will eliminate their yield advantage over competing products. For example, a report from CIBC Securities shows the net yield of Canadian-dollar money market and treasury bill ETFs ranges from 4.98 to 5.13 per cent currently.
Another competitor is the investment savings account, which is a deposit insurance-protected savings account that investors buy and sell like a mutual fund. Returns in this category range from 4.55 per cent to 4.75 per cent for widely available Series A versions.
One more competitor is the guaranteed investment certificate, which offers returns as high as 5 to 6 per cent for terms of one through five years. But these GICs are locked in and thus not suitable for investors who may spontaneously decide to dip into their cash to, say, jump on a stock market decline. Cashable GICs are available, but at the cost of lower rates.
GICs and investment savings accounts are at the low end of the risk scale for investment products aimed at investors looking to park cash, HISA ETFs are incrementally higher and T-bill and money market funds are slightly higher, still. T-bill funds hold short-term government debt maturing in a year or less, while money market funds hold T-bills plus short-term corporate debt
Risk wise, Mr. Rincon said the creditworthiness of the companies represented in the portfolio of a money-market fund is a consideration. He also pointed out that money market and T-bill ETFs may fluctuate in price according to interest rate trends, which is different from HISA ETFs.
There’s a floor price for most HISA ETFs, typically $50 per unit. Prices will rise slightly through the month and then return to $50 after the monthly interest payment is made.
Excitement about high yields for HISA ETFs has obscured the biggest drawback of these products, which is that you may have to pay brokerage commissions to buy and sell them. Various brokers have either done away with commissions altogether, or waive them for ETF purchases only. But some of the country’s biggest brokers still charge close to $10 per trade.
ETF companies that offer HISA funds said this week that these ETFs will continue to thrive, which seems right. The combination of liquidity, competitive returns and safety is still appealing.
The bigger reckoning for these funds lies ahead, when the Bank of Canada begins to lower its overnight rate. Each rate cut by the bank will reduce the return on HISA ETFs and make riskier assets like stocks look more attractive because of the potentially higher returns.
“If interest rates go down to 2 per cent or something like that, then obviously there are going to be better alternatives,” TD’s Mr. Rincon said. “But we’re still a ways from that.”
Are you a young Canadian with money on your mind? To set yourself up for success and steer clear of costly mistakes, listen to our award-winning Stress Test podcast.
Rob Carrick