Top 5 Canadian Fixed Income ETFs to Consider in a Rising Rate Environment

Top 5 Canadian Fixed Income ETFs to Consider in a Rising Rate Environment

The divergent interest rate path between Canada and the U.S. has accelerated when Donald Trump was elected President south of the border. The Federal Reserve and the market participants broadly agree that interest rates will continue to rise, with the former recently revising its forecast to three hikes this year from two previously. A rising interest rate environment has a negative influence on bond prices, which increases their risk. However, some types of bond ETFs are designed to protect investors from rising rates and achieve increased returns.

Here are five bond ETFs that are designed to shield investors from higher rates:

SymbolNameAUM ($MM CAD)12-Month YieldAvg. VolExpense Ratio
(CBO)iShares 1-5 Year Laddered Corporate Bond Index Common Class1,9003.00%67,7550.28%
(HYI)Horizons Active High Yield Bond Common88.745.68%12,5920.69%
(HFR)Horizons Active Floating Rate Bond Common372.151.99%22,0430.46%
(XHY)iShares US High Yield Bond CAD-Hedged582.675.60%32,2900.66%
(PSB)PowerShares 1-5 Year Laddered Investment Grade Corporate Bond Index807.373.99%28,1490.28%

Data from Morningstar as of February 7.

iShares 1-5 Year Laddered Corporate Bond Index Common Class (CBO)

The peculiarity of a laddered ETF is that it is a good choice, both when interest rates rise and when they fall. Mostly exposed to Canadian financial companies, iShares 1-5 Year Laddered Corporate is a risk averse alternative aiming to maximize returns in a high-interest rate environment, while minimizing risk, with almost half of the holdings having high investment ratings. Because it holds bonds with maturities of up to five years, duration risk is minimized and this ETF frees up cash at fairly short intervals of time to re-invest the proceeds in potentially higher yielding bonds.

Horizons Active High Yield Bond Common (HYI)

Perhaps another risk averse alternative, HYI offers exposure to corporate bonds of many strong U.S.-listed companies. Among HYI’s top holdings are healthcare firms HCA Holdings, telecommunications giant T-Mobile, and casino operator MGM Resorts International. The fund, which is fairly priced and has decent liquidity, is the middle way between secure government bonds and junk debt. Although it is clear that the U.S. economy is on strong footing, the pace of recovery is slow and the economy is still fragile. Correspondingly, investing in medium risk ETFs may provide better risk-adjusted returns than high or low-risk bond ETFs.

Horizons Active Floating Rate Bond Common (HFR)

This is a low-risk short-term bond ETF primarily exposed to Canadian and U.S. financial bond issuers. It attempts to maintain duration at no more than two years and is specifically tailored to mitigate the risks stemming from higher interest rates. Generally, the fund’s performance is tied to short-term interest rates and its yield is higher than money market funds.

iShares US High Yield Bond CAD-Hedged (XHY)

A non-investment grade bond ETF, XHY is a strict bet on a strong U.S. economy with high-interest rates. Rising interest rates may put pressure on companies issuing junk bonds because their financing costs rise. However, if the company operates in a sector that benefits from the strong economy, it should have no problems paying down the debt. Half of XHY’s exposure is to communications, consumer cyclical and energy firms, and the ETF is highly diversified, with the top ten holdings constituting no more than 5% of the total.

PowerShares 1-5 Year Laddered Investment Grade Corporate Bond Index (PSB)

The ETF invests primarily in well-established Canadian companies and generally provides a higher yield than government debt. It employs a concentrated strategy, with the top ten holdings making up 40% of the total. The ETF is particularly for risk-averse investors who want to shield themselves from rising interest rates and make a decent return on their investment while incurring a low costs.