Fundamental change to HISA ETFs can make other options more attractive

With interest rates around five percent of the overnight rate, cash has become an asset class for many investors, and that shift made high-interest savings account (HISA) ETFs a white-hot choice in 2022 and 2023. Providing a full picture of their investment profile by holding investments and cash all in one place and paying a premium yield relative to any alternative, the combination vehicle was a win-win. But there’s been a fundamental change in the market, warns BMO’s Matt Montemurro, that requires investors to reconsider their decision.

“The product was very successful for investors looking to maximize the yield in cash from their savings,” says Montemurro, head of fixed income and equity index ETFs, exchange traded funds at BMO Global Asset Management Inc. “Now there’s been a regulatory change that has structurally altered that benefit on a go-forward basis – but there are opportunities in other products for investors to make up what they’ve lost.”

OFSI steps in

Massive amounts of assets went into HISA ETFs in Canada as the vehicle’s popularity rose with the interest rates beginning in 2020, with the majority coming in over the last two years. By the end of 2023, HISA ETFs held around $30 billion in assets.1 Traditionally a vehicle to incentivize individuals to save and deposit cash, where it was used by the banks as capital, it was “no longer John and Jane and their savings,” Montemurro notes, but fund managers, investment advisors, and pension plans.

When the Office of the Superintendent of Financial Institutions (OSFI) stepped in to review the product, the regulator found that the ability to take that money out on demand posed a significant risk to the financial system. In response, OSFI ruled that banks can no longer use assets in HISAs and deem them deposits; they must be considered wholesale funding. The 100 percent liquidity requirement, which came into force on January 31, is intended to support all HISA ETF balances that can be withdrawn within 30 days, and in its wake, preferential institutional yields have fallen.2

“If the banks can no longer lend [the money] out, it becomes much less attractive capital,” Montemurro says, adding that yields have come down 40 basis points, they’re expected to continue to fall, and he predicts the long-term trend may see yields sit at around a 25-basis point discount of the overnight rate.3 Effectively, the underlying nature of the ETFs themselves have been changed and investors are looking for other options.

“Those who were doing it for the yield need to rethink the risk they’re taking and their overall exposure, because there may be better options out there. You can make the trade to another product in the market that allow you to bridge some of that gap.” 

What other options are there?

Montemurro sees two main solutions in which investors can earn more on their cash, with a few key differences. First is BMO’s ZMMK, a money market ETF that invests in ultra short-term fixed-income securities. Traditionally what institutional asset managers turned to for cash allocations, Canadian and provincial T-bills and short-term bonds make this option a safe investment route, Montemurro says. As it stands now, the money market funds offer a 25- to 30-basis point premium over the yield of a HISA.4

“Prior to OSFI’s decision, investors were getting less, so I can see why they chose one over the other – but now, for a similar risk profile, you have very little interest rate sensitivity,” Montemurro says. “If this is a yield trade, investors should consider all their options to make sure they are maximizing the opportunity.”

Second, for investors who want to take advantage of some of the opportunities in the fixed income market while also getting paid a greater yield, Montemurro recommends looking at BMO’s ZST. The product provides investors with exposure to ultra short-term fixed-income securities – mainly corporate bonds but potentially some Canadian T-bills as well – all under one year to maturity. The significant amount of exposure to Canadian banks provides a stable return stream, paying a premium between 30 to 40 basis points compared to the HISA products.4 It’s a high-quality portfolio, Montemurro says, and again, “for that yield-hungry investor, potentially taking a bit more risk can really make up what was lost following the OSFI decision.” Investors should seek professional advice with respect to any circumstance.

While nobody knows exactly when or by how much, the current consensus is that the hiking cycle is done, and rates look to be coming down in the near future. If rates do come down – say by 50 basis points, for example – a HISA’s yield would drop by that same amount. But in something like a ZST, buying bonds means that duration impact adds positive performance. A 50 percent drop in rates, with a duration of half a year in the portfolio, equals a 25-basis point pop in the price of the bonds and, subsequently, the price of the ETF. 

“When rates come down and prices go up, we’re able to take advantage of some of that, and the net asset value (NAV) of the ETF will increase,” Montemurro says. “Duration can be helpful, and something like ZST not only secures a yield premium, but also gets you some extra upside appreciation.”

Another added benefit of using something like ZST is that there’s a structural advantage in the bond market relative to the HISA products, providing greater tax efficiency in the current market environment. Because rates went up so quickly in 2022, bond prices went down, which means they’re trading at a discount to par: buying bonds with less than one year to maturity and holding them through to maturity means investors are getting a price appreciation. Taxable investors can take advantage of this because capital gains are taxed in a preferential way to income.  Please speak to a tax specialist with respect to any specific circumstance.

ZMMK and ZST are compelling solutions in the new landscape, Montemurro says. While HISA ETFs were a great trade historically – especially over the last 2.5 years – the market has shifted. Ultimately, if investors are looking to maximize yield, “there are more attractive options on the sidelines.”

Sources:

1. TD Securities as of October 31, 2023.

2. https://www.osfi-bsif.gc.ca/en/news/osfi-upholds-100-liquidity-requirement-hisa-etfs-promote-financial-resilience

3. TD Securities Report as of October 31, 2023, spoke of similar trends.

4. BMO Global Asset Management as of March 31, 2024.

BMO Global Asset Management. Since inception dates are 11/29/21 and 01/29/11, respectively for ZMMK and ZST.

Performance as of 03/29/24.

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