Bank of Canada Resumes Interest Rate Hikes: ETFs to Watch
Interest rates are marching upward again in Canada. Here are some ETFs that may prove more resilient.
On June 7th, 2023, the Bank of Canada (BoC) reversed course on its earlier "conditional" decision to pause interest rate hikes in January.
In doing so, the BoC raised its target for the overnight rate to 4.75%, with the Bank Rate now standing at 5% and the deposit rate at 4.75%. Additionally, the bank is persisting with its policy of quantitative tightening, reflecting the persistent excess demand in the economy.
The reason? Continued economic growth, with the first quarter of 2023 registering a GDP growth rate of 3.1%. New workers are still being rapidly employed, pointing to continued excess demand for labour. Even housing market activity continues to pick up.
In terms of inflation figures, the Consumer Price Index, or CPI rose slightly in April to 4.4%, marking the first increase in 10 months. Despite lower energy costs, goods price inflation increased, and services price inflation stayed high, demonstrating strong demand and a tight labour market.
The BoC is projecting CPI inflation to settle at around 3% during the summer as lower energy prices have their impact, and as the effects of last year's large price gains diminish. Nonetheless, inflation still remains well above their 2% long-term target, necessitating further rate hikes.
Here's a look at two types of Canadian-listed ETFs that stand to benefit from recent rate hikes and futures ones if the BoC continues with its current stance.
High interest savings account (HISA) ETFs
HISA ETFs are a unique product that have become highly popular with Canadian investors since its launch. These ETFs provide investors with cash management needs, a source of great liquidity in most brokerage account types, offering both safety of principal and steady income.
The underlying asset for these ETFs is interest-bearing deposit accounts with large Canadian banks. When an investor buys a share of these ETFs, they earn that interest, which is usually paid out on a monthly basis. In exchange, they pay a small expense ratio.
A unique feature of these ETFs is a very stable share price. Typically, it sits around $50. As interest accrues over the month, the share price will steadily increase until the monthly interest is paid out, upon which the ETF's share price drops. Then, the process repeats itself.
The yield on these ETFs moves in lockstep with interest rate hikes. In a rising rate environment, this is a positive. Compared to GICs, these ETFs can be bought and sold throughout the day with no lock-up period, making them a highly flexible way to invest spare cash.
The following HISA ETFs are available to Canadian investors. Clicking on each link will take you to a page where you can see a detailed breakdown and access their ETF facts document.
- Purpose High Interest Savings ETF (PSA): 5.23% gross yield, 0.17% expense ratio.
- High Interest Savings Account Fund (HISA): 5.23% gross yield, 0.15% expense ratio.
- CI First Asset High Interest Savings ETF (CSAV): 5.11% gross yield, 0.16% expense ratio.
- Horizons High Interest Savings ETF (CASH): 5.18% gross yield, 0.11% expense ratio.
Canadian Treasury bill (T-bill) ETFs
A recently launched alternative to HISA ETFs is the Horizons 0-3 Month T-Bill ETF (CBIL). Since its launch on April 12th, 2023, CBIL has grown rapidly, swelling to around $296 million in AUM as of June 13th, 2023.
Unlike the previous ETFs, CBIL does not invest in deposits with bank high interest savings accounts. Rather, the ETF holds a portfolio of Government of Canada Treasury bills, or T-bills with remaining maturities of generally under three months that payout monthly interest.
By doing so, EBIL effectively immunizes itself from interest rate risk due to the ultra-short average duration of 0.14 years possessed by its underlying portfolio of T-bills. There's also virtually no credit risk given the very unlikely scenario of the Canadian federal government defaulting on its debt.
The other benefit is very high liquidity, given that T-bills are one of the most traded types of bonds on the market. This translates into a very tight bid-ask spread and reduces the possibility of the ETF's market price trading at a large premium or discount to its net asset value, or NAV.
Currently, CBIL is charging a 0.10% management fee (expense ratio to be determined later) and is targeting an annual yield of 4.23%. Keep in mind that this can change based on prevailing interest rates. Its portfolio currently sports a weighted average yield-to-maturity of 4.78%
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
