BMO Canadian ETF Dashboard

— as of February 28, 2019 —

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Alfred Lee

ZUS.U: Generate a More Attractive Yield on U.S. Cash

Snapshot

Canadians are holding more foreign deposits than ever before, up 10% in the last year,1 which is driving demand for solutions to quickly invest their U.S. cash while still having access to it. Meanwhile, investors are also shortening the term of their fixed income to reduce volatility and more quickly participate in any rising rates. This combination has created a demand for solutions that focus on ultra-short-term U.S. bonds. 

Alfred Lee

ZUS.U: Generate a More Attractive Yield on U.S. Cash

Snapshot
Canadians are holding more foreign deposits than ever before, up 10% in the last year,1 which is driving demand for solutions to quickly invest their U.S. cash while still having access to it. Meanwhile, investors are also shortening the term of their fixed income to reduce volatility and more quickly participate in any rising rates. This combination has created a demand for solutions that focus on ultra-short-term U.S. bonds. Other uses include:

  • A stable investment that can offer investors a higher yield than cash. By investing in U.S. investment-grade corporate bonds with less than one year from maturity, ultra-short-term bonds can be used as a near-cash position.
  • Access to high-quality U.S. fixed income. With its focus on investment grade bonds, ZUS can avoid excessive credit risk by avoiding speculative corners of the fixed income universe.  
  • Insulate interest rate risk by investing in bonds that are near maturity. By holding bonds that mature in one year or less, investors can minimize duration risk, as bonds are held until maturity and ultimately mature at par value, regardless of interest rate fluctuations.  
  • Avoid equity market risk, while still collecting a yield. Given equity market volatility is expected to persist, investors may prefer to de-risk a portfolio, by moving out of equities and into a near-cash vehicle. 

Details
BMO Ultra Short-Term US Bond ETF – US Dollar Units (Ticker: ZUS.U)
BMO Ultra Short-Term US Bond ETF – US Dollar Accumulating Units (Ticker: ZUS.V)

A multi-purpose investment tool:

  • Cash Alternative Investment: Generate a more attractive yield for idle U.S. cash positions, by taking slightly more duration and credit risk.
  • Replacement for U.S. bond exposure: Eliminate almost all of duration risk, without sacrificing yield.
  • Strategic and tactical positioning tool for portfolio construction: Allows investors to tactically de-risk a portfolio or use as a long-term replacement for bond positions or alongside cash.  

Recent Developments
According to the national balance sheet accounts, Canadians held CA$76.9 billion in the form of foreign currency cash and deposits, up from $69.9 billion a year previous. This, combined with a move to the near-end of the yield curve, creates a growing need for solutions that help investors earn a higher yield on the idle U.S. dollars while still maintaining liquidity.

In the last year, the U.S. Treasury curve has continued to flatten with the difference in the 10- and 2-year Treasury yield moving from 56.4 to 17.16 basis points (bps). With a flatter yield curve, investors have not been compensated with additional yield by taking duration risk. 

As a result, many investors have been moving to the short-end of the curve, while also trying to maximize yield. As we near the later stages of a credit cycle; however, it will be important for investors to remain in investment-grade bonds, rather than those of more speculative issuers.

A growing number of investors have also moved or considered moving into cash, given equity market volatility and the possibility that the bull market is nearing an end.

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Trade Idea – Earn a Higher Yield for U.S. Cash
To help snowbirds put their U.S. cash to work while still having access to it, BMO Ultra Short-Term U.S. Bond ETF (ZUS.U) invests in a portfolio of U.S. investment-grade corporate bonds with a maturity of one year or less diversified across both industries and issuers. This exchange traded fund (ETF) will trade in US dollars and also be available in an accumulating units (ZUS.V).

By holding bonds that mature in one year or less, investors are able to minimize interest rate risk and benefit by allowing them to mature at par value. Not only does the lower term to maturity of the underlying bonds insulate interest rate risk more effectively, but the focus on investment-grade bonds helps investors obtain a more attractive yield without having to take on excessive credit risk.  

While not cash, the very low-duration risk and investment-grade characteristics of the portfolio allow investors to use the ETF as a “cash-plus” instrument to earn a higher yield for idle US dollars.

Alternatively, for those investors that have exposure to U.S. bonds, it allows investors to position themselves in the very short end of the yield curve to remove almost all of the interest rate risk, without having to sacrifice yield or take excessive credit risk. As such, investors can use ZUS.U as a strategic position in a portfolio, by using the ETF as a substitute for U.S. bond exposures. 

ZUS can also be used as a tactical tool in a portfolio. As equity market volatility is expected to reside, investors that exit out of equities and/or ETFs that trade in US dollars can utilize ZUS.U, and collect a higher yield, rather than remaining in cash as they wait out volatility, before re-equitizing their exposure.   

Outlook
Although equity market volatility has been rather complacent in recent years, investors were reminded about how quickly risk assets can fall in the fourth quarter of last year. As the market has become increasingly concerned about headline risk, it is expected that equity markets will experience frequent bouts of volatility going forward.

As we enter the later stages of an economic cycle, some investors are de-risking their portfolios by moving to cash. However, as interest rates remain relatively low, investors are seeking a higher yield for idle cash, without taking excessive risk. 

1 Statistics Canada/Haver Analytics.

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Emerging Markets Fixed Income: An EM-phatic Turnaround

Snapshot

A combination of a strong US dollar, a hawkish Federal Reserve and escalating trade tensions weighed heavily on hard-currency emerging market bonds in 2018. However, these headwinds have begun to dissipate, setting the stage for a period of strong returns.

Emerging Markets Fixed Income: An EM-phatic Turnaround

Snapshot
A combination of a strong US dollar, a hawkish Federal Reserve and escalating trade tensions weighed heavily on hard-currency emerging market bonds in 2018. However, these headwinds have begun to dissipate, setting the stage for a period of strong returns.

Details
BMO Emerging Markets Bond Hedged to CAD Index ETF (Ticker: ZEF)

Benefits
With macro conditions turning supportive for emerging markets, ZEF’s 5.92% yield-to-maturity, 60.4% investment-grade exposure and relatively short duration of 4.94 years are highly attractive.1

Trade Idea
From a longer-term perspective, emerging market (EM) assets maintain a compelling investment thesis. The proportion of global growth derived from countries outside of the developed world will only continue to increase over the coming decades. EM nations stand to benefit from further structural reform (e.g., strengthening property rights, liberalization of trade and financial market regulations, etc.), infrastructure development, economies of scale from technological adoption and favourable population dynamics. As incomes continue to rise, a burgeoning middle class will bolster domestic demand and reduce economic dependence on exports. These factors should help to structurally improve credit ratings, lower spreads and ultimately help a number EM sovereign issuers graduate to developed market classifications.

While these secular trends remain entrenched, in the shorter term, the path can be a bumpy one. Common sources of volatility include heightened political risk, deteriorating balance of payments and cyclicality stemming from an over-reliance on trade. Nations with less developed capital markets can get whipsawed as foreign “hot money” flows in and out of their borders. In 2018, EMs suffered from tightening global financial conditions and escalating protectionism. Some of the most externally vulnerable countries (namely Turkey and Argentina) were pushed into crisis.

The tide appears to be turning for EM. Although not a certainty, the U.S. and China appear to be working towards a trade deal. With lower oil prices and the U.S. Federal Reserve signaling a more patient, data-dependent approach to future interest rate hikes, EM central banks should enjoy much more policy flexibility. Additionally, the reflationary tailwinds from Chinese monetary and fiscal stimulus introduced in the latter stages of 2018 will begin to show up in the economic data. Based on the chart below, EM fixed income has quietly been outperforming global indices since September 2018. However, investment flows have only very recently turned positive, indicating that there is potential for a much broader rotation into EM assets ahead. 

ZEF is an attractively structured vehicle to capitalize on this positive momentum. The underlying index is GDP-weighted as opposed to issuance-weighted, which helps remove a bias towards more heavily indebted nations. Additionally, the Canadian-dollar hedge reduces exposure to the structurally overvalued US dollar. 

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Outlook

Allocating to EM debt can help bolster portfolio yield, without taking on excessive credit risk or duration. Although prone to bouts of acute volatility, EM assets play an important diversification role and help align portfolios with long-term structural growth trends. Investor sentiment has recovered measurably of late, as Chinese reflation efforts, more collegial trade negotiations and the prospect of less hawkish U.S. monetary policy have helped alleviate some of the largest concerns. Go long ZEF to position for an improving EM macro environment.       

 

1 BMO Global Asset Management, as of February 27, 2019.