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Understanding Cash ETFs – Benefits and Risks
Looking for a place to park your cash for an upcoming vacation? Or have you run into some money you want to keep safe until you figure out what to do with it? You may have more options than you think. While the traditional savings account is often the first go-to for stashing cash, these accounts generally offer little or no interest on your savings. Guaranteed Income Certificates (GICs) may be another option, but they usually come with limitations around how to access the money and how the interest gets paid out. Then comes various forms of cash exchange-traded funds (“ETFs”). These ETFs are designed to provide an alternative to GICs and Savings Accounts by offering a modest yield with a limited amount of risk, without locking away your money for an extended period.
Here’s a look at the ins and outs of Cash ETFs:
What are Cash ETFs?
Cash ETFs are investment vehicles that pools investors assets like a mutual fund but trade on a stock exchange. The objective of most Cash ETFs is to earn the best rate of interest they can while preserving their assets (so very low risk investments). Investors use these instead of a bank account because at times they pay more than a bank account (higher interest earned) or because they can be sold anytime the stock market is open (so easy access to your money compared to a GIC where you are typically locked in until maturity).
There are three main types of Cash ETFs: 1) High-interest savings account ETFs, or for short called HISA ETFs. Instead of purchasing stocks or bonds like many ETFs on the market, HISA ETFs invest primarily in cash deposits held at major financial institutions. They are putting their money in high interest savings accounts at banks but often can get a better rate than an individual might on their own.
When the Bank of Canada raises or lowers interest rate, banks usually follow suite and the interest rates earned by HISA ETFs will go up or down fairly quickly as well
2) Money market ETFs. These ETFs invest in the “money market” where very short-term loans are made by governments and corporations (issued in the form of T-bills and commercial paper). To call themselves a money market ETF they need to follow certain rules which include that they can only invest in loans that have a maximum of 365 days until maturity and that on average the loans held in the ETF need to mature in 90 days or less. They also need to ensure that they have money always available so that some of the investments mature every day and others every week.
Money Market ETFs will at times earn higher interest than HISA ETFs and at other times they might earn less. Usually, you will see them earning higher interest when in general interest rates are going down. HISA ETFs tend to adjust quicker to lower rates where money market ETFs earn less interest overtime as some of their investments mature and they reinvest in lower paying investments. The opposite is often the case when interest rates are going up.
3) Ultra-short bond ETFs. They may have “Ultra-Short” in their name, or they might have “Cash” or “Cash Management” in their name.
Ultra-Short-Term Bond ETFs also invest in money market securities, but they can invest in bonds, which can have longer times before they mature. Depending on the particular ETF this can be up to two years. These ETFs also tend to have longer overall average portfolio terms. The average portfolio term can vary quite a bit from around 90 days up to almost 2 years so you need to do your research (the issuers website is often a good source) to find out the specifics for ETF you might be considering
The benefit of Ultra-Short Bond ETFs is that because longer term to maturity tends to have higher interest rates associated with them these ETF tend to earn higher interest than HISA or Money Market ETFs. The longer terms also mean there could be more volatility in the price relative to HISA or Money Market ETFs There tend to be some common char characteristics in any Cash ETF:
1. Monthly interest payments: Most Cash ETFs pay interest every month, which may appeal to investors seeking regular income.
2. Net asset value (NAV): Cash ETFs usually (but not always) have a NAV of around $50 per share that steadily goes up as interest is earned on the cash holdings. When interest is paid, the NAV drops back to around $50, and the cycle starts again.
3. Low risk: Because the investments are in actual bank accounts or are very short term, these ETFs are considered a low-risk investment.
4. Interest-rate sensitivity: The yields on these ETFs are closely tied to interest rates, meaning they rise when interest rates go up and drop when they fall.
5. Liquidity: Unlike GICs, which typically have a fixed term and may penalize early withdrawals, Cash ETFs can be bought and sold like stocks and other ETFs.
Structure and functionality of Cash ETFs
Most Cash ETFs in Canada are set up as trusts which pool unit holder's cash to invest. Each will have an objective for how to invest and an investment strategy for how to achieve its goal. You can read about a fund's objective and strategies in its prospectus usually found on the ETF issuers website.
Cash ETFs can be bought and sold through a broker or in a brokerage account, similar to other ETFs or shares of a publicly traded company.
Benefits of investing in Cash ETFs
Cash ETFs share many of the same benefits as traditional High Interest Savings Accounts and GICs, but there are a few notable differences when it comes to accessibility, risk management and fees.
Liquidity and accessibility
Cash ETFs are attractive because they can be bought or sold any time while markets are open. The liquidity of these ETFs could be an advantage over locked-in GICs, which may restrict your access to the funds. Cash ETFs also don’t have minimum investment amounts, making them accessible to a wide range of investors.
Safety and risk management
While no investment is risk-free, Cash ETFs are considered a lower-risk investment because their holdings are either in the case of HISA ETFs primarily in cash deposits at major financial institutions, typically large Canadian banks or in the case of money market and ultra short-term bond ETFs they are invested in a diversified portfolio of short-term investment grade fixed income.
For HISA ETFs The risk is that a bank could fail to fulfill its obligations to investors; however, the regulations Canadian banks are required to adhere to, as well as their risk management practices, have greatly lowered that risk.
For Money Market or Ultra-short-term bond ETFs the risk is one of the investments made (loans to governments and companies) could default on their payments. Defaults on investment grade fixed income (loans) are very rare and the shorter the terms the less time there is for any one single issuer to default making money market and ultra-short bond ETFs safer than longer term bond investments
ETFs are not covered by the Canadian Deposit Insurance Corporation, which guarantees up to $100,000 of eligible bank deposits and GICs. The account you hold your Cash ETFs in are protected by the Canadian Investor Protection Fund (CIPF). CIPF will ensure that the ETF units or shares held are returned to you, within certain limits. However, CIPF does not guarantee the value of your ETF investment.
Additionally, you have to be mindful of the interest rates you’re earning in the fund compared to inflation. If the inflation rate is higher than the interest generated by the fund, then you run the risk of eroding your purchasing power.
Cost efficiency and low fees
As with any investment, it’s important to consider fees. Even though you’re keeping your money in cash, there are often modest fees on Cash ETFs, often between 0.10% and 0.20% of assets. Other cash-like investments can have fees, too – a savings account may charge for withdrawals, for instance – so even though these costs are small, you should still do your homework.
Comparing Cash ETFs to other investment options
Here’s a look at how Cash ETFs stack up against other investments, savings accounts, fixed-income securities and GICs:
Cash ETFs vs. savings accounts
Cash ETFs often have higher interest rates than traditional savings accounts, although that doesn’t factor in any potential fees and other costs that may be associated with those funds or accounts. Savings accounts can come with withdrawal costs, an expense for writing cheques from the account and more, while Cash ETFs will have management fees and come with potential transaction costs when bought and sold.
Cash ETFs vs. GICs
Cash ETFs are flexible investments that can be bought and sold without penalty (although there may be trading costs) whenever the market is open. On the other hand, GICs come with fixed terms, meaning you could be penalized for making early withdrawals or not able to access your money until maturity. Cashable types of GICs may allow you to get money out of these products in exchange for a lower rate than traditional GICs.
Cash ETFs Vs. Bonds
Bonds or other individual short-term fixed income securities can be purchased and held to maturity but often have purchase minimums well above the typical $50 of cash ETF. Depending on the term left to maturity and the issuer Bonds increase or decrease in price more than a cash ETF when market interest rates go up or down. If you only buy one bond you are exposed to the risk that this one issuer of the bond may default on its payments. While for investment grade bonds this is considered minimal risk, it is more than a cash fund which usually has more than one investment which reduces individual credit risks.
Key considerations when choosing Cash ETFs
Cash ETFs are relatively straightforward, but investors should understand a few characteristics, such as Management Expense Ratio, yield and performance. Here are some key considerations:
Understanding the Management Expense Ratio
A Management Expense Ratio (“MER”) is the total percentage of fund assets used for administrative, management and other expenses. They’re an important consideration for investors because they can affect returns. ETFs tend to have lower expense ratios than mutual funds.
Evaluating the yield and performance
There are many calculations of “yield”, and it can be confusing when comparing cash products. The calculation that allows the best apples to apples comparison it to look at the actual amount of cash flow paid out by the fund (often called the distribution yield. It’s calculated by dividing the most recent distribution by the most recent traded price or NAV (net asset value). Many cash ETFs have a NAV of around $50 per share which goes up throughout the month as the cash ETF earns interest. One monthly distribution (cash) is paid out, the NAV drops down by the amount of the distribution usually back to around $50 again.
Assessing the liquidity and tradability
A key attribute of Cash ETFs is that they can be bought and sold during market trading hours like any other stock or ETF. This makes them more liquid than some GICs. While there are cashable GICs, most are locked in for the period you purchased them for, usually one to five years.
Market volatility impact
Cash ETFs are considered relatively safe, but their returns can fluctuate with changes in interest rates. For example, when the Bank of Canada started raising interest rates in 2022 and 2023, the yields on Cash ETFs increased. Those yields have since pulled back as the central bank has started cutting interest rates.
Regulatory and economic changes
As of Jan. 31, 2024, the Office of the Superintendent of Financial Institutions now requires banks to treat funds invested in Cash ETFs as wholesale deposits rather than retail ones. This means that banks must hold enough high-quality liquid assets to support all cash ETF balances that can be withdrawn within 30 days. The stricter classification has resulted in slightly lower interest rates on these funds.
How to invest in Cash ETFs?
How to Invest in Cash ETFs
Cash ETFs and HISA ETFs can be purchased through a broker or directly through a discount brokerage account the same way you might buy another publicly traded security, such as stocks. For do-it-yourself investors using a brokerage account, simply decide how much money you want to invest and divide that amount by what the ETF costs per unit, usually about $50, to determine the number of units you want to buy. Also keep in mind that standard commission rates may apply.
Conclusion
Cash ETFs can be a good addition to an investment portfolio. They offer yields that may be similar or higher to what you might find with a high interest savings account or GIC and with liquidity that allows you to sell anytime the stock market it open. While the income generated by these funds may continue to decline as rates drop, they can be a useful tool in a diversified portfolio.
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