BMO Canadian ETF Dashboard

— as of May 31, 2019 —

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Ultra-Short-Term Bonds: An All-Weather Solution

Alfred Lee

Ultra-Short-Term Bonds: An All-Weather Solution

Snapshot
Since early October, global markets have faced turmoil from increased headline risk and moderated global growth expectations. To combat this rise in uncertainty, investors should consider ZST for the following uses:

  1. Fixed income that works in today’s environment: The short-term nature of the ETF and high yield-to-maturity of 2.5% works well in today’s environment. (According to Morningstar data, ZST is in the 5th percentile on a 1-year return basis.)1
  2. Putting cash to work for the in short term: Money market exposure with 100% investment-grade Canadian corporate bonds that have a duration of 0.7 years and held to mature at par – all at the cost of a 17 bps management expense ratio.Investors looking to accrue monthly distributions can opt for ZST.L, which is available at the same management fee. 

Details
BMO Ultra Short-Term Bond ETF (Ticker: ZST)
BMO Ultra Short-Term Bond ETF (Accumulating Units) (Ticker: ZST.L)

Benefits
With the return of equity market volatility and a flatter yield curve, ZST insulates portfolios from a “yield curve inversion” and widening credit spreads, without relinquishing the possibility of additional returns.

Trade Idea – An All-Weather Solution
Last year, in what has historically been a rare occurrence, cash outperformed both bonds and equities. With continue concerns of “Brexit” and U.S.-China trade-related concerns, headline risk is expected to result in continued uncertainty. Should equity market volatility remain and the yield curve remain relatively flat, cash and short-term instruments may be an important tool for investors in 2019. While, not quite cash, ZST can be used as a “cash-like” vehicle that provides additional yield above treasury bills (T-Bills). 

Corporate bonds one year or less from maturity, which are held within ZST, tend to be less sensitive to interest rate movements, and given they are held to expiration, the underlying bonds ultimately end up at par value.

Alfred-Lee-Jan-2019-Graph.gif#asset:2004

Source: Bloomberg, as of December 18, 2018.

From a credit perspective, ZST contains high-quality bonds that are selected based on an investment-grade rating and a more attractive yield. As an ETF, it also provides constant liquidity, unlike Guaranteed Investment Certificates (GICs) that have a lock-up period and floating-rate vehicles that tend to be thinly traded.

Outlook
After hitting a post-recession high of 2.6%, the 10-year Government of Canada bond yield retraced all the way to 2.0%.3 At the same time, Canadian corporate bond spreads expanded 29 bps from early October, reflecting a higher degree of uncertainty in the market.4 While this downward pressure on long-term rates is matched by a rise in near-term borrowing costs, positioning on the short end of the curve is a way to manage interest rate risk, while obtaining a more attractive yield.

 

1 Morningstar, as of December 17, 2018.
2 Ibid.
3 Bloomberg, as of December 18, 2018.
4 Ibid.

Alfred Lee

Ultra-Short-Term Bonds: An All-Weather Solution

Snapshot
Since early October, global markets have faced turmoil from increased headline risk and moderated global growth expectations. To combat this rise in uncertainty, investors should consider ZST for the following uses:

  1. Fixed income that works in today’s environment: The short-term nature of the ETF and high yield-to-maturity of 2.5% works well in today’s environment. (According to Morningstar data, ZST is in the 5th percentile on a 1-year return basis.)1
  2. Putting cash to work for the in short term: Money market exposure with 100% investment-grade Canadian corporate bonds that have a duration of 0.7 years and held to mature at par – all at the cost of a 17 bps management expense ratio.Investors looking to accrue monthly distributions can opt for ZST.L, which is available at the same management fee. 

Details
BMO Ultra Short-Term Bond ETF (Ticker: ZST)
BMO Ultra Short-Term Bond ETF (Accumulating Units) (Ticker: ZST.L)

Benefits
With the return of equity market volatility and a flatter yield curve, ZST insulates portfolios from a “yield curve inversion” and widening credit spreads, without relinquishing the possibility of additional returns.

Trade Idea – An All-Weather Solution
Last year, in what has historically been a rare occurrence, cash outperformed both bonds and equities. With continue concerns of “Brexit” and U.S.-China trade-related concerns, headline risk is expected to result in continued uncertainty. Should equity market volatility remain and the yield curve remain relatively flat, cash and short-term instruments may be an important tool for investors in 2019. While, not quite cash, ZST can be used as a “cash-like” vehicle that provides additional yield above treasury bills (T-Bills). 

Corporate bonds one year or less from maturity, which are held within ZST, tend to be less sensitive to interest rate movements, and given they are held to expiration, the underlying bonds ultimately end up at par value.

Alfred-Lee-Jan-2019-Graph.gif#asset:2004

Source: Bloomberg, as of December 18, 2018.

From a credit perspective, ZST contains high-quality bonds that are selected based on an investment-grade rating and a more attractive yield. As an ETF, it also provides constant liquidity, unlike Guaranteed Investment Certificates (GICs) that have a lock-up period and floating-rate vehicles that tend to be thinly traded.

Outlook
After hitting a post-recession high of 2.6%, the 10-year Government of Canada bond yield retraced all the way to 2.0%.3 At the same time, Canadian corporate bond spreads expanded 29 bps from early October, reflecting a higher degree of uncertainty in the market.4 While this downward pressure on long-term rates is matched by a rise in near-term borrowing costs, positioning on the short end of the curve is a way to manage interest rate risk, while obtaining a more attractive yield.

 

1 Morningstar, as of December 17, 2018.
2 Ibid.
3 Bloomberg, as of December 18, 2018.
4 Ibid.