Rising Rates: The Best ETF Strategies for Canadian Investors

Here are two ways Canadian investors can play the current high interest rate environment.

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The Bank of Canada has held the policy interest rate at 5% as of December 6th, signaling a continued period of higher interest rates. This approach, often referred to as “higher for longer,” indicates that rates will remain elevated for the time being to manage inflation and economic stability.

Whether you’re a conservative, aggressive, or hands-off investor, the current rate environment could require a fresh look at your portfolio. Here’s a look at two ETF strategies to consider.

Keep calm and collect interest

For conservative investors, the current high-interest rate environment presents a rare opportunity to earn higher yields with very low risk. One way to capitalize is via BMO Money Market Fund (TSX:ZMMK).

ZMMK primarily invests in high-quality, short-maturity fixed-income securities. These include treasury bills (T-bills), bankers’ acceptances, and commercial paper. The focus on short-term maturities minimizes the interest rate risk typically associated with longer-dated bonds.

By investing in instruments like T-bills and commercial paper, ZMMK targets assets that are both highly liquid and backed by credible entities, thereby ensuring stability and reliability.

The appeal of ZMMK lies not just in its low-risk profile but also in its cost-effectiveness and yield. With an expense ratio of just 0.14%, it offers an efficient way to access the money market.

As of December 1st, 2023, ZMMK boasts an annual yield of 4.93%, providing a steady stream of passive income. This is distributed monthly, allowing investors to reap consistent benefits.

Speculate on a rate cut

Investors who are inclined towards speculation might consider the possibility of a rate cut, especially given the recent consecutive pauses in rate hikes by the Bank of Canada. For those looking to capitalize on such a scenario, BMO Long Federal Bond Index ETF (TSX:ZFL) presents a strategic option.

ZFL is designed to track the performance of federal government-issued bonds that have more than 10 years to maturity and boast the highest AAA credit rating. This focus on long-term, high-quality government bonds means that the ETF is particularly sensitive to interest rate changes.

One key metric to understand here is the average duration of the bonds in ZFL, which stands at around 16 years. Duration is a measure of the sensitivity of a bond’s price to changes in interest rates.

Essentially, for each 1% decrease in interest rates, the price of a bond with a duration of 16 years could be expected to increase by approximately 16%. Therefore, if there were a rate cut of 1%, ZFL could potentially see a significant rise in value due to its long duration bonds.

However, it’s crucial to note that this strategy comes with high risks. Just as a rate cut could lead to a sharp increase in ZFL’s value, another unexpected rate hike could have the opposite effect. ZFL experienced notable declines in 2022 due to rising rates, highlighting the volatility and inherent risk.

As such, investing in ZFL as a speculation on rate cuts is not suitable for everyone, particularly those with a low risk tolerance or a short investment horizon.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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