For close to two years now, the hottest exchange-traded funds (ETFs) in Canada have been high-interest savings account (HISA) ETFs. In the spring of 2022, these funds had minimal assets, but thanks to skyrocketing interest rates, they now hold about $30 billion, representing around 8% of the entire Canadian ETF universe (National Bank ETF Report, December 2023).

A regulatory change, however, threatens to reverse that flow, leaving investors in search of new cash alternatives that can provide decent yields with very little risk.

“This is a big, big story that’s hitting the ETF world right now and it’s affecting a lot of investors,” says Danielle Neziol, vice-president of ETF online distribution for BMO Global Asset Management.

HISA ETFs, instead of owning stocks or bonds, hold high-interest savings accounts. Rather than going through the work of signing up for an account, which is the traditional method for investors to access HISAs, HISA ETFs simplify the process by putting your money into several high-interest savings accounts with the efficiency of a single trade.

These funds allow investors to take advantage of rising yields with effectively zero volatility and high liquidity. You just place an order within your brokerage account and you’re done. “Canadians have figured this trade out,” Neziol says.

HISA ETF rules could lower yields

The phenomenon, however, also caught the eye of the Office of the Superintendent of Financial Institutions (OSFI), the federal agency that regulates banks. OSFI became concerned about the banks’ liquidity should investors rapidly pull their money out of HISA ETFs – say if rates fell unexpectedly – which the ETF structure enables them to do. “OSFI’s saying if interest rates drop and that cash trade goes away, you’re looking at close to $30 billion that could be cashed out of these accounts like that,” Neziol explains.

To forestall that outcome, the regulator ruled that come January 31, 2024, the banks offering HISAs within an ETF structure must cover 100% of their liabilities with collateral investments. That likely means the banks can no longer offer preferential institutional yields as they’ve been doing, and yields will come down slightly.

“The ETFs will remain, but the yield on them is going to drop by about 50 basis points (half a percentage point), which is significant enough to make them not the No. 1 yielding cash trade on the market now,” Neziol notes. “They’re not going to give as juicy a yield.”

If you hold a HISA ETF, “there’s no need to panic,” she adds. Being invested in cash, the fund will retain its net asset value. “But if you’re looking to maximize your yield you can start looking elsewhere.”

Other funds to consider

Two investments that fit the bill are money market and ultra-short-term bond ETFs. Money market funds are a traditional go-to instrument for investors to park their money, where they can obtain a modest yield with very little risk. These funds – and their ETF counterparts – invest in  money market securities, like Treasury bills, commercial paper, and certificates of deposits and are extremely liquid. The ETFs in this category, such as BMO’s Money Market Fund ETF Series (ZMMK),  carry an annualized distribution of around 5%* as of January 22, 2024, and should yield higher than HISA ETF yields in the near future, Neziol predicts.

Inching up the risk curve, you’ll find ultra-short-term bond ETFs, which hold bonds less than a year away from maturity. In addition to having an annualized distribution yield of around 5% as of January 31, 2024, funds like the BMO Ultra Short-Term Bond ETF (ZST) offer tax efficiency in taxable accounts. Most of the bonds they hold were issued when interest rates were lower than today, so they tend to be discount bonds with modest coupon rates. This means that their return is made up of a mix of interest and capital gains, which enjoy a lower taxable inclusion rate – a rate that helps to determine capital gains ­­– as they mature at full face value.

The huge flows into HISA ETFs showed “investors are not asleep at the wheel,” Neziol says. She expects Canadians to redeploy capital into other cash substitutes as soon as they begin offering 30, 40 or 50 basis points more yield than HISA ETFs.1

Since several ETF providers offer money market and ultra-short bond funds, mostly with similar yields and management expense ratios (MERs), investors’ decisions will boil down to the level of trust they place in the fund company’s brand. “We’re the largest fixed income ETF provider in Canada by assets,” she says of BMO ETFs.1 “This is our wheelhouse.”
 

Disclaimer:

1HISA ETF yields are anticipated to drop 0.5% as of January 31 2024. Source: TD Securities, October 31 2023.

*This yield is calculated by taking the most recent regular distribution, or expected distribution, (excluding additional year end distributions) annualized for frequency, divided by current NAV. The yield calculation does not include reinvested distributions.

ZMMK’s performance as of December 31 2023: 1 month 0.44%, 3 month 1.32%, 6 month 2.59%, 1 year 4.97%, since inception annualized 3.32%.

ZST’s performance as of December 31 2023: 1 month 0.46%, 3 month 1.54%, 6 month 2.84%, 1 year 5.32%, 3 year annualized 2.22%, 5 year annualized 2.17%, 10 year annualized, 1.80%, since inception annualized 1.91%.

1BMO ETF’s has $30.4 billion in assets in fixed income ETFs. Source: Morning Star Direct, January 2024.

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