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High Interest Cash ETFs: All You Need to Know Heading Into 2024

ETF Market Canada - Mon Dec 11, 2023

Investor interest in various investment types often reflects prevailing macroeconomic conditions, a trend influenced by a herding mentality.

For instance, during the low-interest-rate environment of 2020, amid the COVID-19 pandemic, there was a noticeable rush towards growth stocks, technology equities, and cryptocurrencies, driven by the pursuit of higher returns in a landscape of diminished yields.

Conversely, the bear market of 2022 shifted investor focus to defensive investment options. This period saw an increased interest in covered call ETFs, dividend-paying ETFs, low volatility ETFs, and defensive sectors like consumer staples and utilities, as investors sought stability amidst market turbulence.

The year 2023 presented a more complex picture. While U.S. tech stocks rallied and attracted significant inflows, another category, seemingly less exciting yet equally important, captured the attention of Canadian investors: high interest cash ETFs.

These ETFs gained prominence due to the “higher for longer” interest rate environment, with the Bank of Canada’s policy interest rate standing at 5%. This led to these ETFs offering compelling yields, making them an attractive option for investors seeking a combination of safety and income.

If you’re considering investing in high interest cash ETFs, it’s crucial to understand what they are, the options available, and how they fit into your overall investment strategy. Additionally, it's wise to be aware of alternative investment choices that might also suit your financial goals.

What are High-Interest Cash ETFs?

High interest cash ETFs are a unique type of ETF that, instead of holding stocks or bonds, primarily park their assets in cash deposits at major financial institutions, typically large Canadian banks.

These ETFs have four distinct characteristics that set them apart from the more traditional ETFs:

  1. Net Asset Value (NAV): These ETFs usually have a NAV of around $50 per share. This NAV steadily accumulates as interest is earned on the cash holdings. However, unlike typical ETFs or stocks that might see continual NAV growth or decline, the NAV of these ETFs resets periodically, typically at the end of each month, corresponding to the distribution of the accumulated interest to investors.
  2. Monthly Interest Payments: High interest cash ETFs function similarly to a regular savings account in that they pay out interest on a monthly basis. This feature makes them an attractive option for investors seeking regular income, akin to receiving monthly interest from a savings account.
  3. Very Low Risk: These ETFs have virtually no market or credit risk because they do not invest in stocks or bonds, which are subject to market fluctuations and credit risk. Instead, the funds are held in cash, making them a much safer investment.
  4. Interest Rate Sensitivity: The yields on these ETFs are closely tied to prevailing interest rates. In a rising interest rate environment, or when rates are expected to remain high for an extended period, these ETFs become more lucrative as they earn higher interest on their cash holdings.

Beyond these specific features, a key advantage of high interest cash ETFs especially when compared to instruments like Guaranteed Investment Certificates (GICs), is their liquidity and flexibility.

Unlike GICs, which typically have a fixed term and may penalize early withdrawals, these ETFs can be bought and sold like any other ETF during market hours.

This means investors can access their funds without being subject to a lock-up period, providing a level of liquidity that is not usually available with traditional savings or fixed income products. Below is a list of high interest cash ETFs available in Canada.

What You Need to Watch Out for Before Investing

Recent regulatory changes by the Office of the Superintendent of Financial Institutions (OSFI) may affect the yields of high interest cash ETFs in the upcoming year.

In short, the OSFI has revised regulations that require banks to treat the funds invested in these ETFs as wholesale deposits rather than retail, leading to a requirement for more high-quality liquid assets to back these investments.

Consequently, various industry experts believe that this regulatory shift will cause HISA ETFs to offer lower yields starting January 31st, 2024. In light of these changes, it becomes even more crucial for investors to carefully shop around when considering cash management options.

Apart from HISA ETFs, there are other safe alternatives available for parking cash, such as Canadian Treasury bill (T-bill) ETFs and money market ETFs.

T-bill ETFs invest in short-term government securities with maturities typically less than a year. These are considered extremely safe due to their backing by the Canadian government, offering a low-risk option for capital preservation. The yields on T-bills are influenced by short-term interest rates set by the Bank of Canada, making them a relatively stable choice.

Money market ETFs, on the other hand, invest in a range of short-term, high-quality debt securities including government bonds, corporate papers, and other money market instruments. These ETFs aim to provide higher liquidity and stable returns, making them another suitable option for investors looking for safety and ease of access to their funds.

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.

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