Interest in money-market ETFs heats up as yields rise

With the increase in yields, cash has become an important asset class once again, said Greg Taylor, chief investment officer of Toronto-based Purpose Investments Inc. “And we want to make sure investors in Canada can have access to some of the more efficient vehicles to get hold of that yield in their portfolios.”

With the $4.9-billion Purpose High Interest Savings Fund (including mutual fund series), Purpose has been among the leaders in attracting assets to ETFs that invest in high-interest savings accounts (HISAs). These holdings are available for direct purchase only by big-ticket buyers like fund managers.

But three major banks — Bank of Montreal, Royal Bank of Canada and Toronto-Dominion Bank — refuse to allow HISA ETFs to be traded by their discount brokerage subsidiaries.

“What we were trying to solve for when we launched MNY, the money-market fund,” Taylor said, “is that we’re still running into some hurdles with some of the big banks that do not allow for ETFs that hold HISAs to be held by their clients.”

The launch of the Purpose Cash Management Fund last September followed the debut of the BMO Money Market Fund ETF Series in November 2021. These offerings joined the 15-year-old iShares Premium Money Market ETF, which for well over a decade was the only ETF of its kind.

The newest Canadian money-market entrant, launched in April, is the Horizons 0-3 Month T-Bill ETF. Mark Noble, executive vice-president, ETF strategy, with Toronto-based Horizons ETFs Management (Canada) Inc., said the ETF has been a “compelling cash alternative” for self-directed investors whose discount brokerages blocked them from buying HISA ETFs.

(The firm offers the $2.6-billion Horizons High Interest Savings ETF.)

The improvement in money-market yields compared with historical levels is dramatic. Over each of its 14 full calendar years, the iShares ETF returned less than 2%. And in all but three of those years, its return was below 1%.

But as of June 5, the iShares ETF’s distribution yield — based on annualizing its most recent monthly payout — has surged to 4.34%. That’s more than four times higher than its 0.97% average annual return from inception to May 31.

Yields vary among the ETFs depending on their holdings. The Horizons ETF invests exclusively in short-term Canadian treasury bills, so it isn’t the highest yielding but is “your ultimate risk-off investment,” Noble said.

He acknowledged that the broad cash-alternative category of ETFs, which includes HISA ETFs as well as money-market funds, is extraordinarily low risk. ”I personally have zero concern about money-market ETFs and corporate credit or corporate paper.”

But not all investors feel that way, Noble added. “There’s an emotional resonance that exists, particularly with retail investors where they do have ongoing concerns about the state of the world and where things are in the marketplace.”

Tapping into that risk-averse mindset, Horizons has been rewarded with more than $250 million in inflows to the Canadian T-bill ETF in less than two months.

Other managers of money-market ETFs take a more diversified approach, holding high-quality, short-term corporate credits such as commercial paper, banker’s acceptances and corporate bonds that are near their maturity dates.

“We’re always looking to balance stability with additional income,” Montemurro said. “We’ll look and evaluate the attractiveness of every investment, and they do tend to offer a yield pickup [over T-bills].”

Sometimes the yield advantage may be 10–15 basis points, Montemurro said, while in some instances it can be as much as 50–75 basis points over T-bills. These spreads apply to securities that meet the credit-quality and maturity constraints required under securities regulations for money-market funds.

Another potential source of yield enhancement is to vary the portfolio’s duration — a measure of sensitivity to changes in interest rates — though there are strict limits. Securities regulations limit the dollar-weighted average term to maturity of a money-market portfolio to no more than 180 days.

In practice, average maturities tend to be much lower than the allowable maximum. The Purpose ETF, for one, has recently kept its duration “somewhere in the 50s [days],” Taylor said, and emphasized highly liquid corporate securities and banker’s acceptances that can be traded at tighter spreads than T-bills. In the event of increases in the trend-setting Bank of Canada overnight rate, he added, “we want to be able to adjust our yield as quickly as possible.”

A favourable attribute for investors in money-market ETFs is low management fees. The $528-million iShares ETF, which enjoys the greatest economies of scale, lowered its management fee to 0.12% on Jan. 12 of this year, down from 0.25%.

The iShares reduction undercuts the Purpose ETF’s 0.20% management fee, and essentially matches key competitor BMO, whose latest reported management expense ratio, including operating costs, is 0.14%.

By a slight margin, the lowest-cost provider is Horizons, which set its management fee at 0.10%. “We just think that’s fair value for this asset class,” Noble said, given the ETF’s simple, T-bill-only strategy.