Second Quarter 2022

BMO ETF Portfolio Strategy Report

All prices, returns and portfolio weights are as of market close on March 31, 2022, unless otherwise indicated.

Alfred Lee, CFA, CMT, DMS Director, BMO ETFs Portfolio Manager & Investment Strategist BMO Asset Managment Inc. [email protected]
Russian Roulette

In what was already a complex macroeconomic backdrop, Russia’s invasion of Ukraine has now added an additional wrinkle for investors. While the North Atlantic Treaty Organization (NATO) has so far focused exclusively on economic sanctions rather that providing military support, there is concern that the ongoing conflict has the potential to escalate. While the main concerns regarding Russia’s act of aggression have been mainly geopolitical, it has also had global economic ramifications as investors have pared back risk and flattened the yield curve through the buying of bonds in a flight to safety move. Though market concerns have somewhat alleviated, it his has seemingly added another ball in the air for central banks and policy makers to juggle.

With Russia being one of the world’s largest exporters of oil and natural gas, sanctions both self-imposed and by NATO have taken further supply off the grid, which has further exacerbated commodity prices. Though peace talks have continued, a ceasefire agreement has yet to be reached, which has been detrimental to the NATO nations themselves. Ongoing conflict would further fan the inflationary fires, thus potentially forcing the hand of central banks in North America and Europe to become even more hawkish.

Source: Bloomberg; commodity prices as of April 4, 2022, while CPI and PPI readings are for February 2022.

Both the Bank of Canada (BoC) and the U.S. Federal Reserve (Fed) have initiated their move towards higher overnight rates by making their first-rate hikes at their March meetings since the start of the pandemic. The BoC recently made a further 50bp rate hike at their April meeting, showing to the market it can be hawkish if needed. The Overnight Interest Rate Swap (OIS) market is currently pricing in very aggressive moves by both central banks for the remainder of the calendar year. Low unemployment rates and improving gross domestic product (GDP) north and south of the border suggest that much of the economic slack has been absorbed, which warrants tighter monetary policy. However, it should be noted that with a good part of inflation caused by supply chain disruptions, an overshoot by the central banks can send us into stagflation without solving for higher prices.

The recent temporary inversion of the yield curve (the difference between the 10- and 2-year U.S. treasury yields) signals the potential for an economic recession and thus an equity market turnover on the horizon.
While the Canadian yield curve has yet to become inverted, it came to being just a mere 10bps away from doing so (Chart B). This may limit how aggressive central banks can act in taming inflation, unless they adopt a Volkeresque” type mandate by putting economic growth on the backburner. As noted, with supply chain disruptions likely to continue in spite of Just-In-Time” inventory management systems, its likely tighter monetary policy will have a more limited impact on inflation after a certain point.

Since Pfizer and BioNTech announced the success of their vaccine in early November, cyclical stocks have outperformed defensive-oriented stocks.
Cyclical stocks, which tend to be more sensitive to economic growth, experienced a more significant repricing, as investors became more optimistic for an eventual economic reopening. In the second quarter, however, that outperformance became less evident, as the appetite for risk has waned and investors have become less willing to overpay (Chart B). We anticipate equities will continue to outperform fixed income for the remainder of the year, but investors should keep risk in check and have the core of their equity exposures in factors such as quality and low volatility. More cyclical-oriented exposures can be used around the peripheral.

Given that any change in monetary policy takes months before its impact is felt throughout the economy, we expect both the BoC and Fed to pause with its rate hikes in late summer or early fall.
At that point, both central banks will have a number of successive rate moves under their collective belts, which should restore credibility and thus allow them to utilize forward guidance. We believe this would be a more impactful tool as it would not only provide time for the economy to digest the changes related to the key overnight rate, but it would also allow the central banks to tame inflation without further inverting the yield curve or slowing economic growth.

Canada and U.S. 10-2 Year Yield Spread
Source: Bloomberg, BMO Global Asset Management.

Things to Keep an Eye on

Two indicators investors often use to highlight market risk are U.S. High Yield Bond credit spreads and the CBOE Volatility Index (“VIX”). Typically, the two are highly correlated given they indicate levels of risk aversion in the market. Due to the Russian invasion of Ukraine, both indicators notably increased to illustrate concerns related to the escalating conflict and the potential for other NATO members to become involved. More recently however, the VIX has returned to more normal levels while high yield credit spreads remain wide. At first glance, this appears to suggest that bond and equity investors are perceiving risk very differently.

Recommendation: Part of this divergence is due to yield chasers de-risking their portfolios as sub-investment grade bonds have been one of the main benefactors of lower interest rates, as bond investors had to search for yield. With treasury yields on the rise, some have moved back into investment grade assets, which are now offering yields to maturity not seen in years. For those bond investors that have a longer time horizon and can stomach some volatility, you should consider the BMO High Yield US Corporate Bond Index ETF (ZJK) or the BMO High Yield US Corporate Bond Hedged to CAD Index ETF (ZHY). With current credit spreads in the high yield market well above historical rates, most issuers in the space are well insulated from the geopolitics outside of North America.

CDX US High Yield Bond Spread and CBOE Volatility Index (VIX)
Source: Bloomberg, BMO Global Asset Management, as of April 12022.

Of the S&P 500 Composite sectors, information technology has been one of the main laggards year-to-date. Rising rates have been a headwind for the sector since some of the less mature companies tend to rely on debt, with higher interest rates potentially meaning higher costs for debt servicing. While this may be true for the smaller cap companies in the space, the larger more mature technology stocks tend to be cash rich, but unfortunately have been indiscriminately sold-off within the sector. With interest rates expected to rise further, the sector could be faced with continued volatility.

Investors looking for technology exposure may want to consider the BMO Covered Call Technology ETF (ZWT). This fund invests in only the larger cap, more mature companies in the sector. In addition, the covered call overlay of the portfolio allows investors to harvest the uncertainty and earn higher option premiums as volatility remains elevated in the sector. When looking at the companies in the portfolio, they carry a lower debt-to-total assets ratio than both the S&P 500 Composite and the S&P 500 Information Technology sector. Furthermore, when considering net debt, which factors in cash and liquid assets, many of these companies in the sector exhibit lower debt burdens than the broader sector and market.

Long-Term Debt to Total Assets and Net Debt Per Share
Source: Bloomberg, BMO Global Asset Management, as of April 12022.

The Japanese economy has long been shunned by equity investors given its aging demographics, low economic growth and deflationary environment. As the global economy currently struggles with high inflation, Japan is now being explored by some as a potential safe haven. With many central banks in other economies becoming more hawkish, and thus raising rates and tightening quantitative measures, Japan’s year-over-year CPI remains at 0.9%, suggesting its equity market won’t be met with the same headwinds as its peers in other developed markets.

Recommendation: The low valuations of Japan’s equity market make it attractive now as its price-to-earnings (P/E) ratio is below other developed markets. Some investors have been looking to move away from Europe given its exposure to the war between Russia and the Ukraine. As a result, weightings in Japan have increased with some institutional investors. Many of Japan’s companies also have globally derived revenues while its local labour market has not experienced wage inflation, suggesting the potential for higher profit margins. The BMO Japan Index ETF (ZJPN) and BMO Japan Index ETF (Hedged Units) (ZJPN.F) provide investors with efficient access to the Japanese equity market. 

P/E Ratio
Source: Bloomberg, BMO Global Asset Management, as of April 12022.

Changes to Portfolio Strategy
Asset Allocation:
  • Currently, all the various asset classes have their respective concerns. Higher inflation and rising rates will weigh on fixed income, while rising prices will erode the real value of cash. Equities may face additional challenges given the recent inversion of the yield curve. Despite the many challenges that asset markets currently face, as they often say There Is No Alternative (TINA)” to stocks right now, particularly given equities have historically outperformed even commodities in times of inflation. Despite our preference for equities, it should be noted that diversification is still important. The rally in bonds on the days following the Russian invasion is a good example of how fixed income can help mitigate equity market volatility.
  • Our portfolio strategy is already well overweight equities with its current allocation at 66.0%. As such, we believe we are well positioned from an asset allocation perspective for an inflationary environment. Our core equity exposures remain more defensively positioned in low volatility and high-quality factors. We are not making any adjustments to our asset allocation strategy this quarter, nor to our positioning within the various assets.
Fixed Income:
  • While there’s been some short-term pain for fixed income investors particularly in the last year, we believe over the long-term the rise in yields is a much-needed calibration for the bond market. With bonds trading at a premium in recent years, yield to maturity on bonds has fallen short of coupon rates, making them tax inefficient. However, the recent increase in bond yields has allowed plain vanilla fixed income ETFs to be as tax efficient as their discount bond counterparts. Nevertheless, as a general rule of thumb, investors should always default to products like the BMO Discount Bond Index ETF (ZDB) for fixed income exposure in non-registered accounts as tax implications are one less issue that investors need to worry about in this case, particularly if rates reverse course and bonds go back being at a premium.
  • Outside of default, the main risks that fixed income investors face are inflation and rising rates. Currently, both of these concerns are front and centre in the bond market. Though we prefer equities in the current environment, we would strongly dissuade investors from abandoning fixed income. Despite inflationary pressures, catalysts such as the Russia-Ukraine war could lead the equity market to potentially turnover, depending on how events unfold. As a result, duration exposure in a portfolio still helps mitigate potential equity market volatility. Positions such as the BMO Short-Term US TIPS Index ETF (Hedged Units) (ZTIP.F) can help offset some of the negative impacts of inflation on duration risk.
  • The quality factor has underperformed year-to-date, particularly in the U.S. equity market. One of the reasons has been due the exposure to the technology sector. Many of the stocks in the technology sector tend to be interest rate sensitive, as some are early-stage companies that rely on debt financing. Earlier this year, investors appeared to be indiscriminately selling technology stocks, including the mature, cash-rich companies that make up the BMO MSCI USA High Quality Index ETF (ZUQ). In recent weeks, these established tech companies like Microsoft Inc. and Apple Inc. have started to rally back, thus providing a lift for the quality factor. The quality factor remains a core position in our portfolio strategy for U.S. equities; we view it as an efficient way to get exposure to large-cap, blue chip companies with competitive advantages in their respective fields. We view their underperformance relative to other factors year-to-date as an accumulation opportunity for investors looking to build a long-term core position in their portfolios.
  • Energy stocks have had a significant run over the last two years. While recent gains in the West Texas Intermediate (WTI) benchmark have been largely driven by concerns over Russia, longer term capacity issues remain, which means supply and demand imbalances will persist even if a ceasefire is reached. With the aggressive government push towards renewable energy, capital expenditure on fossil fuels has been low, thus likely keeping crude supplies low. The strategy we’ve been recommending for our BMO Equal Weight Oil & Gas Index ETF (ZEO) has been called taking the house’s money,” where profits on ZEO are periodically rebalanced to core positions of a strategy such as ZUQ.
  • Both the BMO Laddered Preferred Share Index ETF (ZPR) and the BMO US Preferred Share Index ETF (Hedged Units) (ZHP) were trading at premiums to start the year. However, the recent credit spread widening in corporates provide an opportunity for both Canadian and U.S preferred shares. Issuers in both markets tend to be pretty well insulated by the geopolitics outside of North America, which may indicate credit spreads have overreacted. Should risk normalize, the opportunity particularly with ZPR may be attractive given the recent rise in the five-year Government of Canada yield.

Stats and Portfolio Holdings

Investment Objective and Strategy:

The strategy involves tactically allocating to multiple asset-classes and geographies to achieve long-term capital appreciation and total return by investing primarily in ETFs.

Ticker ETF Name Sector Position Price Management Fee* Weight (%) 90-Day Vol Volatility Contribution Yield(%)** Yield/Vol
ZDB BMO Discount Bond Index ETF Fixed Income Core $15.34 0.09% 9.0% 7.2 4.7% 2.4% 0.33
ZIC BMO Mid-Term U.S. IG Corporate Bond Index ETF Fixed Income Tactical $17.19 0.25% 6.0% 9.6 4.2% 3.9% 0.40
ZTIP.F BMO Short-Term US TIPS Hedged to CAD Index ETF Fixed Income Tactical $31.06 0.15% 5.0% 3.8 1.4% 0.4% 0.10
ZTL BMO Long-Term US Treasury Index ETF Fixed Income Tactical $49.90 0.20% 3.0% 7.1 1.6% 2.9% 0.40
Total Fixed Income 23.0% 11.8%
ZLB BMO Low Volatility Canadian Equity ETF Equity Core $41.80 0.35% 17.0% 9.6 11.8% 2.5% 0.26
ZRE BMO Equal Weight REITs Index ETF Equity Tactical $27.62 0.05% 4.0% 15.1 4.4% 3.8% 0.25
ZLU BMO Low Volatility US Equity ETF Equity Core $46.31 0.30% 8.0% 12.5 7.3% 1.9% 0.15
ZLD BMO Low Volatility International Equity Hedged to CAD ETF Equity Core $25.29 0.40% 7.0% 14.4 7.3% 2.4% 0.17
ZEO BMO S&P/TSX Equal Weight Oil & Gas Index ETF Equity Tactical $61.11 0.55% 4.0% 23.6 6.8% 3.0% 0.13
ZUH BMO Equal Weight US Health Care Hedged to CAD Index ETF Equity Tactical $76.95 0.35% 4.0% 22.0 6.4% 0.1% 0.01
ZEB BMO S&P/TSX Equal Weight Banks Index ETF Equity Tactical $39.94 0.55% 6.0% 16.4 7.1% 3.5% 0.21
ZUQ BMO MSCI USA High Quality Index ETF Equity Core $56.50 0.30% 10.0% 23.1 16.7% 0.9% 0.04
ZBK BMO Equal Weight US Banks Index ETF Equity Tactical $32.07 0.35% 6.0% 32.5 14.1% 2.0% 0.06
Total Equity 66.0% 82.0%
ZPR BMO S&P/TSX Laddered Preferred Index ETF Hybrid Tactical $11.09 0.45% 5.0% 8.3 3.0% 4.8% 0.58
ZHP BMO US Preferred Share Hedged to CAD Index ETF Hybrid Tactical $22.78 0.45% 6.0% 7.3 3.2% 5.4% 0.73
Total Alternatives 11.0% 6.2%
Total Cash 0.0% 0.0 0.0% 0.0%
Portfolio 0.32% 100.0% 13.8 100.0% 2.6% 0.19
Source: Bloomberg, BMO Asset Management Inc., as of March 31, 2022. * Management Fee as of March 31, 2022. ** Yield calculations for bonds is based on yield to maturity, which includes coupon payments and any capital gain or loss that the investor will realize by holding the bonds to maturity and for equities it is based on the most recent annualized income received divided by the market value of the investments. Please note yields of equities will change from month to month based on market conditions. The portfolio holdings are subject to change without notice and only represent a small percentage of portfolio holdings. They are not recommendations to buy or sell any particular security.
Stats Portfolio Holdings
Source: Bloomberg, BMO Asset Management Inc. (As of June 302021).

Portfolio Characteristics
Regional Breakdown (Overall Portfolio)
Regional Breakdown (Overall Portfolio)
Equity Sector Breakdown
Equity Sector Breakdown
Fixed Income Breakdown

Weighted Average Current Yield: The market value weighted average coupon divided by the weighted average market price of bonds. Weighted Average Yield to Maturity: The market value weighted average yield to maturity includes the coupon payments and any capital gain or loss that the investor will realize by holding the bonds to maturity. Weighted Average Duration: The market value weighted average duration of underlying bonds divided by the weighted average market price of the underlying bonds. Duration is a measure of the sensitivity of the price of a fixed income investment to a change in interest rates. The portfolio holdings are subject to change without notice and only represent a small percentage of portfolio holdings. They are not recommendations to buy or sell any particular security.

Source: Bloomberg, BMO Global Asset Management, as of March 312022.

The Good, the Bad and the Ugly

Conclusion: For the first time in years, COVID-related headlines have taken a backseat to geopolitical risk coming out of Russia and Ukraine. Countries learning to live with the virus marks a shift in policy that should re-open much of the global economy and allow supply chains to eventually normalize. First and foremost, our thoughts go out to the people of Ukraine for a quick path towards peace. The unfortunate crisis has also made it even more difficult for policy-makers to navigate, given rising inflation, growing political division and signs of a potential recession. Any mishaps in policy can lead to an undesirable outcome, making it a game of economic Russian roulette. In terms of portfolio construction, diversification must resolve positioning for various outcomes including inflation, stagflation, recession and a tail-risk event.

Global-Macro/Geo-Political Fundamental Technical
  • A growing number of countries adopting the “live with COVID” model and opening up their economies will also help normalize the situation.
  • Recent earnings growth in North America has allowed market valuations to normalize. This provides further room for multiple expansion, particularly as investors continue to rotate into equities.
  • After experiencing a notable increase, the VIX Index has drifted back towards a normal level of 20 or lower.
  • Good
  • Unemployment continues to trickle down in the U.S., and Canada has claimed that it has restored all its jobs lost to COVID. This suggests economic slack has been removed, paving the way for the central banks to be more aggressive in raising rates.
  • While higher interest rates have been painful for bond investors, it has been a healthy recalibration to the fixed income market. Lower prices have meant that coupon rates and yields-to-maturity are now better aligned, making the asset class more tax-efficient.
  • Despite short-term momentum waning in equities, commodity strength remains high, with the 50-day moving average on the CRB-All Commodity Index, gaining on its 200-day moving average.
  • If central banks overshoot monetary tightening without calming inflation, stagflation may be an outcome.
  • Higher commodity prices and rising wages have made it more difficult for companies that cannot pass higher input costs to the end consumer. This has made it difficult for certain companies to protect profit margins.
  • The S&P 500 Composite recently experienced a “Death-Cross,” suggesting that the equity rally is losing steam, at least over the short term.
  • Bad
  • Inflation continues to tick up with no signs of slowing. Its likely that inflation will get worse before it gets better, given that the economic reopening will lead demand to normalize quicker than supply.
  • Valuations of higher growth stocks, particularly in the technology sector, remain rich. Earnings need to catch up, which may be difficult with higher rates ahead.
  • The US dollar continues to exhibit strength, which will be a headwind for goldbugs. It does look as if inflation is becoming more of a focus for gold investors now.
  • The yield curve, as indicated by the differential between 10- and 2-year yields, has inverted in the U.S. and is on the verge of doing so in Canada.
  • Ugly
  • Household debt in Canada is still one of the main concerns, which can be a problem with higher rates to come. This may further separate the wealthy and the working class when interest rates start to rise significantly.
  • Margin debt is still one of the key contributors to how quickly risk assets can rise and fall. The Archegos fiasco is an example of misuse of leverage.
  • Visit or contact Client Services at 18003611392.
    To listen to our Views From the Desk BMO ETF Podcasts, please visit

    BMO ETF Podcasts are also available on

    Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

    The viewpoints expressed represents herein is our assessment of the markets at the time of publication. Those views are subject to change without notice as markets change over time.

    Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the ETF Facts or prospectus of the BMO ETFs before investing. The indicated rates of return are the historical annual compound total returns including changes in prices and reinvestment of all distributions and do not take into account commission charges or income taxes payable by any unitholder that would have reduced returns. Exchange traded funds are not guaranteed, their value change frequently and past performance may not be repeated.

    For a summary of the risks of an investment in the BMO ETFs, please see the specific risks set out in the BMO ETFs prospectus. BMO ETFs trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/​or elimination.

    The payment of distributions is not guaranteed and may fluctuate. The payment of distributions should not be confused with a fund’s performance, rate of return, or yield. If distributions paid by the fund are greater than the performance of the fund, your original investment will shrink. Distributions paid as a result of capital gains realized by a fund, and income and dividends earned by a fund are taxable in your hands in the year they are paid. Your adjusted cost base will be reduced by the amount of any returns of capital. If your adjusted cost base goes below zero, you will have to pay capital gains tax on the amount below zero. Please refer to the fund’s distribution policy in the prospectus.

    S&P®, S&P/TSX Capped Composite®, S&P 500® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and TSX” is a trademark of TSX Inc. These trademarks have been licensed for use by S&P Dow Jones Indices LLC and sublicensed to BMO Asset Management Inc. in connection with the above mentioned BMO ETFs. These BMO ETFs are not sponsored, endorsed, sold or promoted by S&P Dow Jones LLC, S&P, TSX, or their respective affiliates and S&P Dow Jones Indices LLC, S&P, TSX and their affiliates make no representation regarding the advisability of trading or investing in such BMO ETF(s).

    The BMO ETFs or securities referred to herein are not sponsored, endorsed or promoted by MSCI Inc. (“MSCI”), and MSCI bears no liability with respect to any such BMO ETFs or securities or any index on which such BMO ETFs or securities are based. The prospectus of the BMO ETFs contains a more detailed description of the limited relationship MSCI has with BMO Asset Management Inc. and any related BMO ETFs.

    This communication is intended for informational purposes only and is not, and should not be construed as, investment and/​or tax advice to any individual. Particular investments and/​or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment. Investors cannot invest directly in an index.

    BMO ETFs are managed and administered by BMO Asset Management Inc., an investment fund manager and portfolio manager, and separate legal entity from Bank of Montreal.

    BMO Global Asset Management is a brand name that comprises BMO Asset Management Inc. and BMO Investments Inc.

    Registered trade-marks/trade-mark of Bank of Montreal, used under licence.