The ETF Lab: Benefits and Limitations of GICs and Cash Alternatives vs. Bond ETFs (2024)

Making any investment decision requires considering many factors, such as a client's risk tolerance, time horizon, and investment objectives. Therefore, there is no “one-size-fits-all” solution. In this week's spotlight, we aim to illustrate that, while Guaranteed Investment Certificates (GICs) and other low risk alternatives have many benefits, they cannot fully substitute traditional fixed income solutions in a diversified portfolio.

First and foremost, for long term investors the return profile for cash is drastically different compared to bonds or stocks (see below).

Considering fixed income ETFs alongside GICs and cash alternative solutions

As rising rates led to broad based declines in bonds and equities in 2022, GICs and HISA ETFs provided steady returns and attracted significant flows from Canadian investors.

However, as we discussed in our last ETF Lab (“An insight into attractive yield opportunities in fixed income ETFs”), 2023 presents a very different macroeconomic backdrop, particularly in terms of the yields available in core fixed income.

In 2022, Canadians invested an estimated $121.7B in regular GICs¹. As we continue through volatile times, GICs continue to take in flows in response to investor fears.

Below are several differences between core fixed income ETFs and GICs for longer term investors to consider:

1. Liquidity: Non-redeemable GICs (which offer the higher rates) typically come with high penalties if investors try to redeem prior to maturity.
2. Tax implications: Interest income from a GIC (held outside registered accounts) is taxed at an investor’s marginal tax rate. Due to the significant repricing of bonds in 2022, much of the fixed income universe is trading at a discount. The total return from a discount bond will be a combination of capital gains and interest income received. In Canada, capital gains are taxed at half the rate of interest income.
3. Reinvestment risk: When GICs mature, investors face the risk that they will be unable to reinvest their principal and interest at a similar rate of return as their original investment. In contrast, a fixed income ETF will remain invested in a diversified portfolio of bonds, helping to mitigate reinvestment risk.
4. Return profile: When you account for tax and inflation factors, the real return of a GIC has often been negative throughout history. For more on this topic, see our piece – Account for the real return of a GIC.

HISA or cash alternative ETFs doubled in AUM in 2022 in Canada, attracting $8.83B in net flows². Cash alternative ETFs (like all ETFs) offers intra-day liquidity. These ETFs have seen their monthly distributions move higher in proportion to the Bank of Canada’s overnight rate.

However, if interest rates decline, the rate of return on these ETFs would also decline. In contrast, declining rates are likely a positive catalyst for the rate of return from bond ETFs.

Thus, HISA ETFs cannot entirely replace the critical function of bond investments that is equity risk diversification.

The value of active fixed income

For many investors, their bond portfolio’s primary objectives are capital preservation and risk mitigation.

Below are two core, actively managed fixed income ETFs that advisors can consider in the current uncertain macro environment.

MKB – Mackenzie Core Plus Canadian Fixed Income ETF

Tactical adjustments on duration, credit, and fixed income sectors have helped MKB deliver higher risk adjusted returns than index solutions in the Canadian fixed income category.

MUB – Mackenzie Unconstrained Bond ETF

MUB is benchmark agnostic, aiming to provide a positive total return over a market cycle, while mitigating volatility through various economic environments.

MUB has maximum flexibility in terms of duration and credit quality, which has helped the strategy navigate previously challenging fixed income environments.

MUB’s investable universe includes:

• High yield bonds
• Floating rate loans
• Investment grade corporates
• Government securities
• Global bonds

MUB additionally utilizes a derivatives strategy to help mitigate downside risk associated with significant credit spread widening in high yield markets.

MDVD and QINF were Mackenzie’s top performing ETFs in 2022 and remain well suited for the current macroeconomic environment.

MDVDemploys a multi-factor strategy to provide exposure to ~100 globally developed stocks which pay above average dividends. MDVD also incorporates volatility and quality screens.

QINF was up +7% in 2022and offers several advantages over other infrastructure equity ETFs in the marketplace:

• Cost effective with an annual management fee of just 40 bps.
• A 5% cap on individual stock exposure for improved diversification.
• A strong weighting to the defensive utilities sector (close to 80%),providing a useful hedge against continuing market uncertainty and recession fears.
• Global diversification to mitigate home country bias in Canadian portfolios.
• A broad exposure across sub-sectors such as electric utilities, multi-utilities and oil & gas storage & transportation. This allows investors to tap into the full range of opportunities within the publicly listed infrastructure equity space.

Phantom tax and ETFs – annual tax factors available

• A phantom distribution is a ‘non-cash’ distribution declared by a fund or trust where no cash is paid to unit holders.
• Non-cash distributions, phantom distributions, are taxable as capital gains in the year declared. Therefore, investors should increase the adjusted cost base (ACB) of the security by this distribution amount (as not to be taxed again on this portion at disposition).
• You can find the press release for Mackenzie ETFs’ phantom distributions in 2022 here.
• To learn more on the mechanism of phantom distributions see our paper – Phantom Tax Strategies.
• For a free resource to help calculate the ACB, see: www.adjustedcostbase.ca.
• Tax factors for Mackenzie ETFs can be found on our website under Distributions -> Annual Tax Factors.