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Suffice to say, this year has presented a complex investment conundrum for many Canadians. While it appears the volatility that we saw in March 2020 is in the rear view mirror, the rally in equity and credit markets has likely exceeded the expectation of all but the most bullish market commentators. The S&P 500 is up more than 51% from its March lows as at September 30, 2020, while the S&P/TSX Composite Index is up more than 46% and the NASDAQ-100 is up an astounding 63% over the same period.

The magnitude of this rally likely has some investors understandably concerned about another correction occurring somewhere in the future – whether just around the corner or lurking in 2021. Some sentiment surveys are showing this – for example, a recent Bank of America Survey of 199 fund managers, who cumulatively manage more than US$601 billion, found that 80% of fund managers believe the U.S. technology stock trade is “the most crowded trade” in the market, as it has been for three months in a row.

The tech sector has been, by far, the most important driver of returns for major U.S. equity indices to date, as of September 30, 2020. If this trend were to reverse, it could result in a broader market sell-off. Concerns about a potential sell-off might make some investors wary of increasing their portfolio’s equity market exposure, and instead, they might be accumulating greater cash reserves while navigating their uncertainty.

This all raises the question of what to do with that cash if an investor wishes to remain in cash or take a defensive position in their portfolio. We’ve highlighted two potential strategies below that investors could take a look at as a way to employ their idle cash.

Strategy 1: High Interest Savings ETFs

Horizons Cash Maximizer ETF (HSAV)
Horizons US Cash Maximizer ETF (HSUV.U)

High Interest Savings ETFs are fairly straightforward investment mandates, which invest in high interest deposit accounts with major Canadian financial institutions. The biggest challenge when holding cash is that interest rates offered by traditional liquid savings vehicles can be quite low. While yields on savings vehicles like GICs or high interest savings accounts (HISAs) can potentially be higher, they typically have investment minimums or lock-up periods.

High Interest Savings ETFs offer the best of both worlds, providing daily liquidity for cash holdings while offering interest rates that are expected to be competitive with other high interest savings vehicles.

On average, the yield generated by the high interest savings ETFs are expected to be higher than the equivalent yield generated by the banks’ savings products available to retail investors. In general, the yield offered by High Interest Savings ETFs is approximately the Bank of Canada overnight rate, which is currently 0.25%, plus an additional 50 basis points (bps). So, the gross yield (before fees) on these ETFs is about 0.75% verage as at the time of writing.

One of the main reasons behind the recent popularity of high interest savings ETFs among Canadians is their very competitive interest rate relative to other short-term, or in some cases long-term, savings rates, with the added benefit of daily liquidity. This allows investors to effectively hold cash in their portfolio, which is the ultimate ‘risk-off’ asset but with a higher interest rate than most short-term GICs or high interest savings accounts and, just as important, no high threshold of investment and intra-day liquidity.

The interest rate decline we’ve seen globally in 2020 really puts the fees on these ETFs into perspective. A high-interest savings ETF with management fee of 14 bps, yielding 0.75%, would see the equivalent of nearly 20% of the net return go to fees. . For this reason, we made an important decision to rebate the management fee on HSAV by 10 bps (reduced to 0.08% from 0.18%) while the interest rates remain this low. We would examine eliminating the rebate if/when yields start to increase again.

This makes HSAV the lowest-cost offering currently within Canada’s high interest savings ETF space while including the rebate. HSAV is also a bit more of an outlier in that the ETF is part of a corporate class structure, so we have the ability to offset the income generated by the deposit accounts with losses within the corporation. This means that the interest accrues directly to the ETF’s net asset value (NAV), and investors are not expected to receive taxable distributions from the ETF. This allows the tax liability to be deferred until such time as the investor sells the shares at which point they may realize a capital gain.

Horizons ETFs also offers a similar high interest savings ETF for U.S. dollar holdings, the Horizons US Cash Maximizer ETF, although this ETF offers a lower interest rate, reflecting the lower borrowing rates on U.S. cash for Canadian investors. Similar to HSAV, it is still an attractive option relative to other U.S. high interest savings solutions, given its interest rate and daily liquidity.

Strategy 2: Ultra-Short Term Investment Grade Bond ETFs

The Horizons Active Ultra-Short Term Investment Grade Bond ETF (HFR) provides a way to potentially increase the income generated for a portfolio relative to holding cash.

The ETF portfolio yield on HFR, after the most recent sell-off, is now above 2.5% as at September 30, 2020. This may not seem high compared to other income strategies at this point in time, but consider that HFR only invests in high investment-grade bonds with an A- average credit quality, and has virtually no duration risk since it is mandated to maintain a duration of less than one year.

High interest savings rates are currently around 0.75%, as previously highlighted, so HFR is generating a yield spread of roughly 175 bps to own high quality, Canadian corporate bonds. Unlike other investmentgrade strategies that yield in this range, HFR has very limited duration risk due to the innovative structure it uses.

How HFR Works:

1) HFR only invests in high investment-grade corporate bonds (average credit rating of A-)

2) HFR has the ability to hedge the interest rate risk of its portfolio to maintain a portfolio duration of less than one year through interest rate swaps on the underlying portfolio of bonds. These swaps earn the Canadian Dealer Offer Rate (CDOR) for HFR, which is currently about 0.50% as at September 20, 2020.

3) As the CDOR 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 drops, the opposite is expected to happen with the yield of HFR — which would ultimately decline — but the value of the bond it holds would increase.

Is HFR Positioned for Outperformance?

The primary risk of owning HFR is corporate spreads widening. During the worst of the COVID-19 sell off in March 2020, HFR saw significant drawdowns in its NAV as investors became concerned about the viability of corporate bonds.

Generally, the holding period of the ETF should at least be longer than six months if it is used as a cash alternative to compensate for the underlying volatility of the corporate bond its holds.

Purchases of corporate bonds by central banks in both Canada (buying Canadian bonds) and the U.S. (buying U.S. corporate bonds) have largely backstopped the corporate bond market; in fact, the spread on corporate bonds have largely return to historical levels of around 1.25%. As spreads have normalized, HFR has seen its NAV come back strongly. The ETF is now up 7.18% on a total return basis from its March 25, 2020 low as at September 30, 2020, and more importantly, now has an average annualized return of nearly 2.5% over the last five years. Again, almost all of this return is largely comprised of income, since HFR has typically stayed close to its initial offering NAV of $10.00.

As a long-term cash alternative, HFR has generated a yield spread significantly higher than other cash alternatives, making it a potentially powerful way to boost income over other cash alternatives.

In the chart below, we plot the NAV of HFR versus the Bloomberg Barclay’s Canadian Aggregate Corporate Average OAS, a measure of Corporate Bond spreads in Canada, and the short-term rates as represented by the Canadian Bankers Acceptances – 3 month.

1. You can see that corporate bond spreads and HFR’s NAV tend to be inversely correlated. When spreads spike, HFR’s NAV tends to decline, but historically, these periods have actually been ideal entry points to purchase the ETFs because invariably, as corporate spreads have declined back into the 1.00% to 2.00% range, HFR’s NAV has tended to be higher.

2. You can also see that the NAV on HFR is largely unaffected by moves in the shorter-term interest rates. This is by construction and largely owing to HFR’s ultra-short duration. This is crucial because spreads impact pricing. All else being equal, as interest rates move up and down, HFR’s performance should be largely unaffected.

3. Finally, you can see that HFR’s NAV spends very little time below $9.90, and there’s no period of greater than one-year where HFR’s NAV has remained below this threshold historically. This supports the idea that, for a cash-holding period for more than six months, the yield spread and total return make it a compelling alternative to cash for investors comfortable with the corporate spread risk.

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FOR ILLUSTRATIVE PURPOSES ONLY.
Source: Bloomberg as at September 30, 2020

Conclusion

For investors concerned about future volatility in the markets and the potential of a draw-down, they may elect to retain a cash position instead of maintaining a fully vested exposure to the equity markets. However, there are alternatives to potentially put idle cash to work. High interest savings ETFs like HSAV and HSUV.U offer competitive interest rates with daily liquidity and no investment minimums or lock-ups, and for investors with slightly longer holding periods who are comfortable with additional credit exposure, HFR potentially offers higher yields than traditional cash-alternatives, such as government bonds or money market funds, with very little sensitivity to changes in prevailing interest rates.

ANNUALIZED PERFORMANCE

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Source: Bloomberg as at September 30, 2020. **HFR Inception Date: December 10, 2010.
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 ETF is not guaranteed, its value changes frequently, and past performance may not be repeated.

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Commissions, management fees and expenses all may be associated with an investment in exchange traded products managed by Horizons ETFs Management (Canada) Inc. (the "Horizons Exchange Traded Products"). The Horizons Exchange Traded Products are not guaranteed, their values change frequently and past performance may not be repeated. The prospectus contains important detailed information about the Horizons Exchange Traded Products. Please read the relevant prospectus before investing.

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 (Horizons Nasdaq-100 ® Index ETF and Horizons US Large Cap Index ETF) use physical replication instead of a total return swap. The Horizons Cash Maximizer ETF and Horizons USD Cash Maximizer ETF use cash accounts and do not track an index but rather a compounding rate of interest paid on the cash deposits 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.