The flattening of the US Treasury curve over the past 12 months has created both challenges and opportunities for investors.
Investors have not been compensated with additional yield for taking on duration risk. And, as the difference in the 10- and 2-year Treasury yield moved from 56.4 to 17.2 basis points*, many investors have been prompted to move to the short-end of the curve while also trying to maximize yield.
BMO GAM has identified the current conditions as an ideal time to launch a US version of its Ultra Short-Term Canadian Bond ETF, which is one of the firm’s fastest-growing products. BMO Ultra Short-Term US Bond ETF will trade under the ticker of ZUS.U, and is the latest edition to BMO GAM’s line up of ETFs.
“By holding bonds that mature in a year or less, investors are able to minimize interest rate risk,” Lee says. “Given the bonds in the portfolio are held until maturity, the bonds ultimately mature at par value. By doing so, the portfolio can better insulate interest rate risk. Additionally, by investing primarily in U.S. investment grade bonds, investors can obtain a more attractive yield without having to take on duration risk.”
ZUS.U invests in a diversified portfolio of US investment grade bonds with a maturity of one year or less. The ETF is diversified across industries and issuers. The low duration risk and investment grade characteristics of the portfolio allow investors to use the new ETF as a cash-plus instrument to earn a higher yield for idle US dollars.
“It is beneficial because it is similar, but not exact, to cash,” Lee explains. “Since it holds bonds until maturity, it has the ability to behave like cash … so as interest rates go up or down, they don’t have as much impact on the portfolio.”
Alternatively, Lee explains, ZUS.U can be used as a substitute for US bond exposures as a strategic position in a portfolio.
“For those investors who have exposure to US bonds, this ETF allows them to position themselves in the very short-end of the yield curve to remove almost all of the interest rate risk, without having to sacrifice yield, or take excessive credit risk,” Lee notes.
The Ultra Short-Term US Bond ETF can also be used as a tactical tool in a portfolio. With equity market volatility expected to remain a reality, investors who exit out of US dollar equity and/or equity ETF positions can use ZUS.U to collect a higher yield compared with cash as they wait out volatility.
“Based on conversations with our clients, we felt creating a US version would be of interest,” says Lee. “A lot of our Canadian clients have US cash in accounts and this ETF is a way to create a higher yield for them.”
Lee says he doesn’t believe there is any other ultra-short-term product quite like ZUS.U available to Canadian investors. In times of such market uncertainty, having access to such unique products gives advisors a new, much-needed option.
“It is a first of its kind for 0-1 year bonds and the first to be a cash-like or cash-plus product that gets a higher yield for little credit risk with all investment grade bonds,” Lee says. “Canadian investors can now replace U.S. bond exposure without sacrificing yield.”
*Source: BMO Asset Management Inc. As of January 31st, 2019. This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.
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