In a declining interest rate environment like the one we’ve observed over the last 12 months, it can be tempting to move investments into ultra-defensive income strategies—most notably, cash.

In Canada, we’ve seen approximately $2 billion go into High-Interest Savings Account ETFs this year, according to National Bank (as at December 1, 2019). These ETFs have certain liquidity and safety advantages compared to GICs, but when we factor in core inflation as measured by the Consumer Price Index-trim measure (CPI trim) — which filters out extreme price movements potentially caused by factors specific to certain components — most cash or cash-equivalent rates fall short of generating a positive real rate of return. After adjusting for inflation, these ETFs often generate a negative real return.

As you can see, most major developed markets have moved back towards ultra-low or even negative interest rates over the last year.

Federal Overnight Rates



Source Bloomberg from November 30, 2014 to November 30, 2019.

This means the only real reason to hold cash is for portfolio risk protection. An investor who opts to hold cash has either:

a) A short-term or immediate need for cash to purchase something
b) An assumption of a negative real-rate of return

A Cash Alternative to Consider

For investors looking to generate a real rate of return in the traditional cash-allocation or conservative portion of their portfolio, there is the Horizons Active Floating Rate Bond ETF (HFR) and the Horizons Active US Floating Rate Bond (USD) ETF (HUF.U) for U.S. dollar accounts.

Here’s how HFR and HUF.U work:

1) They are high investment-grade corporate bond strategies (average credit rating of A- for HFR and BBB+ for HUF.U).
2) These ETFs currently hedge the interest rate risk to maintain portfolio duration of less than two years through interest rate swaps on the underlying portfolio of bonds. This swap earns the Canadian Dealer Offer Rate (CDOR) for HFR and the London Interbank Offered Rate (LIBOR) for HUF.U.
3) As the CDOR or LIBOR rises, the value of the underlying bonds in each ETF portfolio is expected to decline in value. However, the value of the swap is expected to increase, meaning the market value of the ETF is expected to see minimal change. Nevertheless, the yield of the ETF should increase. Conversely, if the CDOR or LIBOR drops, the opposite is expected to happen, with the yield of these ETFs ultimately declining.
4) According to Bloomberg, as at November 30, 2019, HFR had a trailing 12-month yield of approximately 2.57%, and HUF.U had a trailing 12 month yield of 3.98%.

These yield metrics are important because they are slightly above the core inflation rate, which is currently around 2%. In the graph below, we’ve plotted HFR and the Purpose High Interest Saving ETFs (PSA) to demonstrate that HFR’s return has generally been above inflation, a benefit of its floating yield structure. Meanwhile, PSA holders have generally seen a negative real rate of return after core inflation is factored in.

Over the five-year period from November 30, 2014 to November 30, 2019, the trailing 12-month yield of PSA only exceeded core inflation in four months, averaging 1.31%, with an average trailing 12-month real yield of -50 bps. On the other hand, HFR’s trailing 12-month yield only dipped below core inflation three times, averaging 2.18% with an average trailing 12-month real yield of 37 bps over the same period.



Source: Bloomberg as at November 30, 2019

Taking Advantage of Corporate Credit

One of the advantages of owning corporate credit is that a declining interest rate environment is generally favourable for corporate credit. The cost of debt-funding for corporations decreases as interest rates do, so the spread on corporate bonds tends to be historically tighter during periods of interest rate contraction.

Right now, there is a potential upside in owning high-investment grade corporate debt compared to short-term government debt or basic cash, since there is not a lot of concern regarding corporate defaults. While spreads of high-investment grade corporate debt are low by historical standards, they can potentially remain in this range (or tighten even further) for quite a long time.

As a result, we believe that the risk of negative real rate of return probably supersedes corporate default risk at this point in the credit cycle. By using HFR or HUF.U, investors can potentially benefit from the higher yield from corporate credit. At the same time, they can reduce overall interest rate risk and generate a yield for their conservative fixed income allocation that can generates returns keeping pace with inflation.

More info on HFR, HUF.U and PSA:

HFR Product Sheet
HUF.U Product Sheet
PSA Fund Facts

Ticker 1-M 3-M 6-M YTD 1Y 3Y 5Y Since
HFR 0.37% 0.82% 1.49% 3.91% 3.89% 2.50% 2.04% 2.39% 2.57% 2010-12-10
HUF.U 0.39% 1.02% 2.45% 5.42% 5.11% 3.05% 2.27% 2.23% 3.98% 2012-02-14
PSA 0.17% 0.54% 1.09% 2.00% 2.19% 1.61% 1.39% 1.38% 2.16% 2013-10-10

Source: Bloomberg as at November 30, 2019

The indicated rates of return are the historical annual compounded total returns, including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The rates of return above are not indicative of future returns. The ETFs are not guaranteed, their values change frequently, and past performance may not be repeated.

The views/opinions expressed herein may not necessarily be the views of Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.

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The Horizons Exchange Traded Products include our BetaPro products (the “BetaPro Products”). The BetaPro Products are alternative mutual funds within the meaning of National Instrument 81-102 Investment Funds, and are permitted to use strategies generally prohibited by conventional mutual funds: the ability to invest more than 10% of their net asset value in securities of a single issuer, to employ leverage, and engage in short selling to a greater extent than is permitted in conventional mutual funds. While these strategies will only be used in accordance with the investment objectives and strategies of the BetaPro Products, during certain market conditions they may accelerate the risk that an investment in shares of a BetaPro Product decreases in value. The BetaPro Products consist of our Daily Bull and Daily Bear ETFs (“Leveraged and Inverse Leveraged ETFs”), Inverse ETFs (“Inverse ETFs”) and our BetaPro S&P 500 VIX Short-Term Futures™ ETF (the “VIX ETF”). Included in the Leveraged and Inverse Leveraged ETFs and the Inverse ETFs are the BetaPro Marijuana Companies 2x Daily Bull ETF (“HMJU”) and BetaPro Marijuana Companies Inverse ETF (“HMJI”), which track the North American MOC Marijuana Index (NTR) and North American MOC Marijuana Index (TR), respectively. The Leveraged and Inverse Leveraged ETFs and certain other BetaPro Products use leveraged investment techniques that can magnify gains and losses and may result in greater volatility of returns. These BetaPro Products are subject to leverage risk and may be subject to aggressive investment risk and price volatility risk, among other risks, which are described in their respective prospectuses. Each Leveraged and Inverse Leveraged ETF seeks a return, before fees and expenses, that is either up to, or equal to, either 200% or –200% of the performance of a specified underlying index, commodity futures index or benchmark (the “Target”) for a single day. Each Inverse ETF seeks a return that is –100% of the performance of its Target. Due to the compounding of daily returns a Leveraged and Inverse Leveraged ETF’s or Inverse ETF’s returns over periods other than one day will likely differ in amount and, particularly in the case of the Leveraged and Inverse Leveraged ETFs, possibly direction from the performance of their respective Target(s) for the same period. For certain Leveraged and Inverse Leveraged ETFs that seek up to 200% or up to or -200% leveraged exposure, the Manager anticipates, under normal market conditions, managing the leverage ratio as close to two times (200%) as practicable however, the Manager may, at its sole discretion, change the leverage ratio based on its assessment of the current market conditions and negotiations with the respective ETF’s counterparties at that time. Hedging costs charged to BetaPro Products reduce the value of the forward price payable to that ETF. Due to the high cost of borrowing the securities of marijuana companies in particular, the hedging costs charged to HMJI are expected to be material and are expected to materially reduce the returns of HMJI to unitholders and materially impair the ability of HMJI to meet its investment objectives. Currently, the manager expects the hedging costs to be charged to HMJI and borne by unitholders will be between 10.00% and 45.00% per annum of the aggregate notional exposure of HMJI’s forward documents. The hedging costs may increase above this range. The manager publishes on its website, the updated monthly fixed hedging cost for HMJI for the upcoming month as negotiated with the counterparty to the forward documents, based on the then current market conditions. The VIX ETF, which is a 1x ETF, as described in the prospectus, is a speculative investment tool that is not a conventional investment. The VIX ETF’s Target is highly volatile. As a result, the VIX ETF is not intended as a stand-alone long-term investment. Historically, the VIX ETF’s Target has tended to revert to a historical mean. As a result, the performance of the VIX ETF’s Target is expected to be negative over the longer term and neither the VIX ETF nor its target is expected to have positive long-term performance. Investors should monitor their holdings in BetaPro Products and their performance at least as frequently as daily to ensure such investment(s) remain consistent with their investment strategies.

Horizons Total Return Index ETFs (“Horizons TRI ETFs”) are generally index-tracking ETFs that use an innovative investment structure known as a Total Return Swap to deliver index returns in a low-cost and tax-efficient manner. Unlike a physical replication ETF that typically purchases the securities found in the relevant index in the same proportions as the index, most Horizons TRI ETFs use a synthetic structure that never buys the securities of an index directly. Instead, the ETF receives the total return of the index through entering into a Total Return Swap agreement with one or more counterparties, typically large financial institutions, which will provide the ETF with the total return of the index in exchange for the interest earned on the cash held by the ETF. Any distributions which are paid by the index constituents are reflected automatically in the net asset value (NAV) of the ETF. As a result, the Horizons TRI ETF receives the total return of the index (before fees), which is reflected in the ETF’s share price, and investors are not expected to receive any taxable distributions. Certain Horizons TRI ETFs use physical replication instead of a total return swap. The Horizons Cash Maximizer ETF and Horizons USD Cash Maximizer ETF do not track an index but rather a compounding rate of interest paid on a cash deposit that can change over time.

*The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the ETF or returns on investment in the ETF. Only the returns for periods of one year or greater are annualized returns.