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The ETF Lab
ETF Spotlight: Mackenzie’s new fixed income ETFs
To meet advisor needs in building efficient and effective fixed income portfolios, we’re excited to be adding three new ETFs to our fixed income ETF suite.
Source: Bloomberg; Mackenzie Investments; *based on underlying holdings from each index as of October 24, 2023
Opportunity in fixed income today
Given the backdrop of attractive yields, falling inflation and peaking rates, the current environment for fixed income appears quite favourable.
Attractive valuation: Yields today in core fixed income appear attractive relative to what is offered in more volatile asset classes.
Source: Bloomberg. As of September 30, 2023.
Equity: S&P 500 TR Index, REIT: Dow Jones Equity REIT TR Index, Corp Bond: Bloomberg US Corp Index, T-Bills: Bloomberg US Treasury Bills Index, US Treasury: Bloomberg US Treasury Index
Potential tailwind for fixed income: Rate cuts are being priced in for 2024 in both Canada and the US. See below the current implied Fed funds rate, in which the market is currently pricing in just under 3 and a half rate cuts by end of 2024.1
Source: Bloomberg. As of November 6, 2023
Whether or not rate cuts come to fruition, rates appear to have stabilized at their current levels. Following a pause after a series of rate increases, bonds have historically delivered positive returns.
Source: Bloomberg. As of September 30, 2023
What is the role of government bond ETFs in a portfolio?
- Portfolio diversification: Government bonds’ negative correlation with equity implies that, under normal circumstances, they move in opposite directions. Such a negative relationship is desired to build a portfolio with lower volatility and a higher risk-adjusted return.
- Equity risk diversification: Because government bonds and equity tend to move in opposite directions during market downturns, government bonds can act as an equalizer to equity risk in a portfolio.
- Tools to manage duration risk: These fixed income index building blocks can be critical tools to help advisors manage duration risk in client portfolios.
For illustrative purposes only.
Why consider ultra-short duration bond ETFs?
QASH – (Mackenzie Canadian Ultra Short Bond Index ETF) aims to provide exposure to both ultra-short Canadian corporate and government bonds for an optimal yield/risk combination.
Benefits:
- Attractive yield + low interest rate risk: As of October 31, 2023, the underlying index of QASH had a yield-to-maturity of ~5.48% and a duration of 0.48 years.2
- Liquidity: Unlike GICs, this ETF provides intraday liquidity, providing advisors flexibility to reallocate capital to higher risk assets as market dynamics change.
- Diversification: Ultra-short duration bonds typically exhibit low correlation to equities and corporate bonds, helping to lower portfolio volatility and downside risk.
Why consider long government bonds?
As rates moved precipitously higher over the last two years, long duration bonds sold off significantly, with ZFL – (BMO Long Federal Bond ETF), for instance, down -28.5% over the last two years (on a price basis).3
However, as we discussed in our last piece, 'The ETF Lab: Why now may be the wrong time to move to covered call bond ETFs', long dated bonds often help buffer portfolio returns in periods of higher equity volatility. For instance, during the 2007-2009 equity selloff, when the S&P 500 Index fell ~55%, long dated treasuries provided significant insurance for investors posting a +25% return during that same period.4
Benefits of QLB and QTLT:
- Potential offset to equity risk: Long duration bonds typically exhibited low correlation to equities.
- Carry value and high/stable coupons: Bond prices are currently heavily discounted and set to recover as the yield curve further normalizes.
- Better tax outcome on distributions versus investing in US-listed ETFs: As we discussed in 'Tax optimization using Canadian-listed ETFs', advisors should be aware of the potential impact from additional foreign withholding taxes on US-listed ETFs held by Canadian investors. QTLT will invest directly in the underlying holdings.
- Tax-loss harvesting opportunity: See more in the next section on this potential opportunity.
For more information on any of these ETFs, please reach out to your Mackenzie wholesaling team.
ETF News & Notes
Tax-loss selling opportunity – long duration bonds
Losses (on a price basis) range from -28.2% to -36.8% over the past two years for the two long duration government bond ETFs shown below.5
Source: Bloomberg; as of November 6, 2023
These losses could potentially provide a significant tax-loss selling opportunity. As one example, see below the potential tax savings from rotating out of ZFL into an ETF offering a similar exposure, such as QLB – (Mackenzie Canadian Government Long Bond Index ETF).
Source: Bloomberg; price return as of November 6, 2023. For illustrative purposes only. Hypothetical performance is theoretical, is subject to risk, and cannot guarantee or assure future results. Hypothetical performance does not reflect actual client trading or the impact of material economic and market factors on the teams decision-making process for an actual client account. Hypothetical performance is based on certain assumptions that are based on the current view of Mackenzie Investments and could change without notice or prove to be incorrect. Different assumptions would produce different results. Performance results were prepared with the benefit of hindsight. Backtest data are shown before fees and taxes. Additional advisory fees, transaction costs (not included within the assumptions described herein), and other potential expenses are not considered and would also reduce returns. Actual results experienced by clients may vary significantly from the hypothetical illustrations shown. Backtest data are not included to indicate the future results that might be generated by Mackenzie Canadian Government Long Bond Index ETF or any of its components and readers should: (i) recognize that any future performance will likely be inconsistent with, and distinct from, that shown; and (ii) not base any investment decision solely upon this information.
OSFI imposed changes coming to HISA ETFs
Earlier this month, OSFI announced that high interest savings account (HISA) ETF deposits would be considered wholesale deposits with a 100% liquidity coverage ratio (LCR) runoff factor and a 0% available stable funding (ASF) factor. This decision indicates that the OSFI views these deposits as unsecured wholesale funding, the least sticky type of deposits, which can be taken away at any time. Deposit taking institutions should apply this treatment by January 31, 2024.
As a result, HISA ETF yields are expected to fall in line with the BoC overnight rate – an expected ~50 bps drop from current levels. This likely makes alternatives, such as ultra-short duration bond ETFs relatively more attractive.
ETF Flows Update
- Fixed income ETFs continue to outpace equity ETF flows, as high yields attract investor interest. Long duration bond ETFs have gained significant momentum in recent weeks, attracting ~+$251M in net flows in the last two weeks.
- National Bank recently noted that the Asset Allocation ETF category has quietly added ~$2.4B YTD and has total asset of $19.7B.6
Mackenzie ETF Top Performers
Source:
1: Bloomberg; as of Nov. 6, 2023
2: Bloomberg
3: Bloomberg; as of November 6, 2023; cumulative return over this period
4: TLT (iShares 20+ Year Treasury Bond ETF) used as a proxy; period: 2007-10-09 to 2009-03-09
5: Bloomberg; as of November 6, 2023
6: Bloomberg, Mackenzie Investments, National Bank Canadian ETF Flows November 2023; as of November 3, 2023
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