Are Cash-Alternative ETFs Right for You?

Are Cash-Alternative ETFs Right for You?

Hey Everyone,

Readers and passionate DIY investors who follow this site know I like owning dividend-paying stocks for income and growth, along with low-cost Exchange Traded Funds (ETFs) for extra diversification.

In fact, as an all-equities investor kinda-guy I haven’t owned any bonds in years.

Especially so with some great, new cash-alternative ETFs available on the market.

What are cash-alternative ETFs?

What should you consider before you own these ETFs in your portfolio?

What are the pros and cons of doing so when it comes to asset location?

With thanks to Horizons ETFs, team members there who are readers and supporters of this site tailored to DIY investors, we have these answers and more in today’s post.

Why bonds, why not bonds?

You’ll read from my link above that I’m hardly anti-bonds. I believe bonds can make great sense to many DIY investors – for certain reasons.

We could always discuss the merits of holding some bonds as a hedge for deflation (since inflation is a killer for bonds long-term), as just one example. When there’s inflation, as in now, your bond income is worth less over time but in a deflationary environment, if that were to occur, in the inverse is true. This means some investors might own bonds as a hedge for any recession – but who knows if and when that could happen.

Instead, I prefer to own various individual stocks, a few low-cost ETFs, and a modest cash wedge.

Your mileage may vary.

The Cash Wedge – Managing market volatility

If you do in fact decide to own some bonds, probably these three (3) key reasons come to mind:

1. Bonds can help your investing behaviour – helping you ride out stock market volatility– including being strategic to buy more stocks soon.
2. Bonds can be used to rebalance your portfolio – helping you keep your portfolio aligned to your investing risk tolerance and therefore asset allocation (mix of stocks and bonds).
3. Bonds can be used for spending purposes – where some fixed income is “king” for major, upcoming, near-term spending.

The main reason I would keep any bonds in our portfolio (and again, I still don’t have any in our portfolio right now) is if we were saving for a major purchase in a few years (e.g., like a secondary residence). Maybe then, only then, I would rely on bonds.

But that need for fixed-income is also fading for me thanks to new cash-alternative ETFs now available for any DIY investor.

Why cashflow is always king and why cash-alternative ETFs can deliver.

I’ve always liked holding some cash in an interest-oriented savings account (not via an ETF) for a few simple reasons:

1. I like the liquidity of cash if and when we need it, and
2. That cash is covered via CDIC insurance.

You might recall financial institutions that are members of the Canada Deposit Insurance Corporation (CDIC) insure savings of up to $100,000, while credit unions are insured provincially and usually cover the full deposit, with no limits. Money that is deposited in a savings account generates interest by allowing the bank to access those funds to loan to others. Unlike your cash savings, cash-alternative ETFs are not eligible for CDIC insurance.

Does this mean there are reasons to avoid these cash-alternative ETFs as part of your portfolio?

Hardly.

As many DIY investors, semi-retired folks, and retirees will attest, as some point cashflow becomes king to you and you need ample, sustained cashflow to fund any semi-retirement or retirement ambitions.

Cash-alternative ETFs offer that up.

As one of Canada’s leading (not to mention fastest-growing ETF providers) I had the privilege of chatting once again with Mark Noble, Executive Vice President, ETF Strategy at Horizons ETFs about their cash-alternative ETF line-up.

We touched on the benefits of owning these products in a well-diversified portfolio and why Mark Noble feels this new wave of ETF products is only going to see more ETF inflows over time.

I’ll link to a previous discussion that Mark Noble and I had about the tax-efficiency of some of their low-cost ETF funds, later on in this post, including some highlights of how Mark from Horizons ETFs invests his very own money.

Back to the subject of the day, Mark, welcome back to My Own Advisor. It’s always a pleasure to chat!

Mark to My Own Advisor, a pleasure and I appreciate the fine work you do here on your site educating DIY investors and sharing your experiences too.

Mark, let’s start with the basics. What should we call this new wave of financial products? High-Yield ETFs? Other? Why or why not?

Great question.

I prefer to call them “Cash-Alternative” or “Deposit-Alternative” ETFs. 

High-Yield denotes high-yield fixed income, which has a very different risk profile than these ETFs. These Cash-Alternative ETFs are very low-risk strategies, with amongst the lowest credit (i.e., default risk) of any ETFs, available to Canadian investors. Simply put, these type of ETF strategies are designed to be an alternative to traditional deposits, which may pay a lower yield. 

The appeal is that High Interest Savings ETFs, Money Market ETFs, and now Short-Term Treasury ETFs, are a similar risk profile but a higher yield than what would be earned in traditional deposit vehicles offered by banks and other financial institutions.

We will run with cash-alternative ETFs for sure. So, how do these ETFs work?

In terms of High Interest Savings ETFs, these ETFs invest in deposits offered by large Canadian banks. The banks offer a spread relative to the Canadian overnight rate – as the overnight rate goes up, so to does the yield offered by these ETFs (and vice-versa). That spread is set by the lender, typically for an agreed upon amount of deposit assets. The lenders can change the rate they offer, but historically, due to the benefits of tapping into a larger pool of retail investors through well-established ETF providers, it has been historically a preferential rate to what would otherwise be earned by an individual seeking to put money in a Cashable GIC or a High Interest Savings Account.  The ETFs allocate investor money to portfolios of deposits offered by Bank lenders.

I like it. What are the benefits of owning these ETFs?

The main appeal of the ETFs is that they are ETFs! This means (to one of your own desires above, Mark) is it can help keep things very liquid. Unlike GICs or traditional high interest savings accounts, there is no minimum investment threshold, beyond the price of one ETF and there is no minimum lock-up period.  You can literally buy and sell these ETFs anytime, while the Canadian market is open. Another key benefit is that investors participate in rising yields. Since the rate is determined as a spread over the overnight rate, investors are typically not missing out on potentially higher yields that they would with GICs, since the rate paid will increase whenever the Bank of Canada raises its overnight interest rate.  GICs are effectively risk-free investments, but because they have set interest rates, investors could be missing out on higher future rates. The High Interest Savings ETFs have been popular because they generally offer higher rates than other liquid savings vehicles with a rate that will go up if the overnight rate does as well.

Make sense. We need to discuss the downside. What are the risks of owning these ETFs? What about if/when Bank of Canada interest rates go down – how much will my yield suffer?

Happy to discuss, a few considerations:

1. The primary risk of these ETFs vis-à-vis traditional savings vehicles is that the High Interest Savings ETFs are not CDIC insured – you referenced CDIC above, Mark. This means that the ETF has 100% credit risk to the depositors in the ETF portfolio. This credit risk is extremely low, but not zero. With CDIC insurance, investors have 100% principal protection up to $100,000. 
2. There will come a day when the locked-in rate on a GIC might be higher than these ETFs if/when the Bank of Canada starts to reduce interest rates. Generally, I would anticipate the relative yield of these ETFs under the current regulatory regime would be attractive versus other savings vehicle rates at that time. Just like trying to time when to renew a mortgage, trying to know when a longer-term GIC is better requires a lot of conviction that interest rates will decrease to make locking in a higher rate more advantageous than buying one of these ETFs.
3. There are commissions and spreads related to these ETFs. This is a cost that should be factored into the purchase, particularly if this is a short-term cash hold. Paying $9.99 to buy $1,000 of one of these ETFs is the equivalent of 0.90%, it’s not something that’s assessed, but generally these ETFs probably make sense for higher-dollar values and longer holding periods to amortize the cost of purchase. At the same token, it’s very hard to find a rate as attractive as High Interest Savings ETFs on liquid solutions that wouldn’t have a locked-in time frame (i.e., GICs!).

Thanks, Mark.

Related Reading: What to consider from My Own Advisor when it comes to fixed- or variable-rate mortgages.

Weekend Reading – Mortgage renewals

Let’s talk tax-efficiency and asset location, since we both know not all forms of income are taxed the same… 

What are your thoughts about holding these ETFs in taxable/non-registered accounts vs. registered accounts? What are the tax implications in doing so, through an example?

I’m going to refer to the Trust-version of these ETFs only. Horizons does offer High Interest Savings ETFs that are within a tax-efficient corporate-class structure, but those ETFs are closed to new subscriptions. Generally, the returns of these ETFs then are going to be taxed as 100% investment income. Remember there is no capital appreciation on these ETFs, unless there is some sort of trading issue that allows investors to buy at a discount (we don’t really want that to happen!). The assumption should be made that all returns are investment income.

As a result, these ETFs are not overly tax-efficient for non-registered accounts, so having the ability to shelter them in a registered account (i.e., RRSP, TFSA, LIRA, etc.) would be advantageous, as they are eligible for registered accounts. That’s really a tax-planning decision for an investor.

Definitely noted on the tax-efficiency.

Mark, in our era of at least higher interest rates (than previous rates, pre-pandemic) can you speak to the merits of owning these ETFs amongst other diversified low-cost ETFs as an income-oriented approach to investing vs. idle cash?

Idle cash is earning you next-to-nothing. The current CPI rate according to Statistics Canada is 4.3% (current to the time of this post). I’m of the view that CPI is not even a great indicator of broader cost of living and inflation. Generally, you would be needing to generate a return in excess of 4.3% just to maintain the same purchasing power of your money. These ETFs are effectively offering a way for investors to generate a rate that’s likely just ahead of inflation while providing similar safety to traditional deposit accounts. That is an advantage for a broader portfolio allocation.

A more interesting development recently though has been the inversion of the yield curve, where short-term interest rates are higher than longer term interest rates. Purely from a risk and return profile, these ETFs are offering yields that are not much lower than what you would be getting in investment grade corporate bonds with longer duration, but the risk profile is dramatically different. This also applies to T-Bills, where the ultra-short T-Bills offer very attractive yields and virtually no credit risk. This was a key impetus for launching the Horizons 0-3 Month Treasury Bill ETF (CBIL).

I’ve put the links below for your readership to check out, including a quick summary table:

Cash-Alternative ETF Name	Description	Target Yield*
Horizons 0-3 Month T-Bill ETF (CBIL) MER = 0.10%	CBIL invests primarily in short-term Government of Canada T-Bills, which are backed by the credit of the Canadian Government.	4.23%
Horizons 0-3 Month U.S. T-Bill ETF (UBIL.U) MER = 0.12%	UBIL.U seeks to provide interest income through exposure to U.S. Treasury Bills with remaining maturities generally less than 3 months.	4.25%

Notes:

*Current to the time of this post.

1. CBIL and UBIL.U are the first ETFs in Canada to provide respective exclusive exposure to Canadian and U.S. short-term federal Treasury Bills (“T-Bills”): federal government securities with maturities of one year or less. Across the fixed-income spectrum, T-Bills are generally considered to be amongst the lowest-risk investments available to investors, given that they are short-term securities backed by the creditworthiness of large federal governments.
2. The ETFs will distribute the net income they generate from their T-Bill holdings to unitholders on a monthly basis. In doing so, the ETFs are anticipated to generate interest income that is in line with the yield on their respective short-dated T-Bills.

Here is a quick fact-sheet to help with your decision-making amongst other solutions too:

Reference/Source: Horizons ETFs (no affiliation)

Related to these cash-alternative ETFs vs. other products, are there any unique features that the Horizons ETFs offer vs. competitors?

On the High Interest Savings ETFs our key advantage is our fee, which is the lowest in Canada at 0.10%. Generally, this is a pretty commoditized category of products with similar lenders and yields, so having a lower fee generally results in a slightly higher yield. 

Again, the treasury component is interesting as that is a different credit risk component. There could be a situation where the yields offered by the lenders start to retract vs. the overnight rate, in which case the yields on T-Bills would be higher and with a better credit risk profile. This would be a the “sweet-spot” of an ETF like CBIL vs. the High Interest Savings ETFs.   

Where can prospective investors find out more information about these ETFs or any other Horizons ETFs?

Happy to share some links, Mark.

https://horizonsetfs.com/ETF/cbil/

https://horizonsetfs.com/ETF/ubil-u/

Those links should help your readers learn all they need to know and if they ever have any further questions, we are happy as a team to answer anything via our Contact page.

Mark Noble, thanks for time once again.

Readers, I don’t know about you, but I’ve already put a bit of cash to work by getting some CBIL. I am very likely to get more over time inside our registered accounts for all the reasons Mark and I discussed – building up my cash wedge for any semi-retirement. Getting an income boost beyond idle cash just makes sense to me while keeping my investment risks low.

While there is no affiliation associated with anything shared today, it is my hope such information can help you make an informed investment decision for your portfolio mix as well.

Interestingly enough, this space is growing – fast. Last I heard from Horizons ETFs, CBIL and UBIL.U T-Bill ETFs that were just launched now have a combined AUM over $300 million! They are only going to grow in popularity from here.

What’s your take on cash-alternative ETFs like these or others? Thinking of owning some?

Got questions for Horizons ETFs about these products or others? Leave me a comment and I will share them with Horizons ETFs so they can answer back here or personally. 

Thanks for reading.

Related Reading:

You can review other Horizons ETFs including learning how Mark Noble invests his own money here. 

How much cash should you really keep, anyhow?