Cash ETFs

I’m sitting on some relatively heavy losses (0.7%) in my investment in the Canadian Short Term Bond Index ETF (TSX: XSB). The loss was a result of speculating that an average 3-year yield would perform better than a short-term cash account. Needless to say, it is annoying that had I just kept the cash in the account (even earning zero-yield, as Questrade generously offers on cash) I would have done a lot better.

Now that the Bank of Canada has cranked up short-term interest rates even further, the yield curve is flatter and spot yields are about 70bps lower than 1-year yields. The compensation for duration is quite low.

So while I contemplate flip-flopping to even shorter maturities than 3.11 years in exchange for a boost-up of about 100bps on spot rates, we look at the cash ETF options (alphabetical order by ticker symbol):

(TSX: CASH) – info – gross yield 378bps – MER 13bps
(TSX: CSAV) – info – gross yield 296bps (pre-BoC 75bps increase on Sept 7) – MER 16bps
(TSX: HSAV) – info – gross yield 375bps – MER 12bps
(TSX: PSA) – info – net yield 359bps – MER 17bps

All four of the above trade with penny spreads on the TSX in sufficient liquidity volumes.

For comparison, Interactive Brokers offers 276bps on their CAD cash yields. The question is whether it makes sense to flip cash for near-cash, and for each $10,000 transaction, it would cost approximately $2 in commissions to make a trade for approximately 90bps of yield, good for a $90/year difference, or $7.50 monthly.

The question then becomes whether the structural risk of the cash ETF (What happens if the market makers decide to quit? What happens in a true market crisis where everything blows up? What happens if the “cash” investments the ETF invests in goes belly up? What happens if the custodial arrangements the ETF management has turns out to be fraudulent or defective, etc.?) becomes worth it for a $7.50/$10k monthly difference. Is it worth a 360bps difference? Likely. Is it worth a 90bps difference? Probably not.

Short term interest rates

Exciting times in Canadian government interest rates – finally seeing some yields again (2 year Canada government bond chart below):

Short-duration bonds are yielding higher than they were before the 2008-2009 economic crisis. The one-year bond is at 3.67% currently, and the two-year at 3.53%.

I’ve talked about this before, but one theory in finance is regarding the term structure of the yield curve in that the total returns is invariant to the term one invests in – e.g. if you invested in 1-year government bonds 10 times, the net result will be the same as if you invested in 1 10-year bond. Of course, practice is different than theory, but if one were to take this theory and apply it with the existing rate curve, it would suggest that the target rate is going to rise significantly higher than the so-called “neutral rate” which, according to the monetary policy report, is between 2-3% nominal. I’ll leave it up to the reader to decide on the validity of these financial theories.

In the monetary policy casinomarkets, the 3-month Bankers’ Acceptance Rate is currently at 3.46% and has crept up slowly in anticipation of September 7, 2022’s expected rate increase – the September futures indicate a 3.89% 3-month rate. I am not sure if this translates into an expectation of 50 or 75bps for the September 7 meeting, but either way short term interest rates are going up. The next meeting of the bank on October 26 is anticipated to have a 25 basis point increase as well.

All of this means that money is coming harder and harder to come by. Governments will find it much more expensive to borrow money, so I would look carefully at your portfolio for entities that are government-dependent.

The big risk continues to be that interest rates will rise further than the market anticipates – and it likely will if inflation does not reach the magical 2% target.

The chart that screams deflation

If we’re going through a period of mass inflation, then how come the 30-year treasury bond (at least the American one) is at 182 basis points yield?

The “long term” Canada government bond yield is sitting at around 198bps on November 8, 2021.

Even though short-term rates are projected to rise in 2022, you do not see this in the long-term bond yields.

A flattening yield curve does not bode well for the overall state of the economy.

There will be a day when simply holding cash will beat all the other asset classes. I don’t know exactly when that will be (indeed, anybody holding a good chunk of cash over the past 18 months, scared by Covid-19, will have made a catastrophically bad decision) but when it happens it will be swift and surprising to many.

In the meantime, the party continues.

Gran Colombia Gold Notes getting a slightly longer lease on life

Gran Colombia Gold announced some upcoming debt redemptions, including the following for (TSX: GCM.NT.U):

Currently, the aggregate principal amount of Gold Notes issued and outstanding is US$32,637,500. The next regularly scheduled Amortizing Payment of the Gold Notes, amounting to US$2,887,500, will take place on April 30, 2021, reducing the outstanding amount to US$29,750,000. The Amortizing Payment will include a Gold Premium, as applicable, based on the London P.M. Fix as of April 15, 2021.

Gran Colombia also announced today that pursuant to the Gold Notes Indenture, it will complete an early optional redemption on May 3, 2021 of an additional US$10,000,000, equivalent to approximately 33.6% of the aggregate principal amount of its Gold Notes outstanding, following the scheduled Amortizing Payment on April 30, 2021. In accordance with the Gold Notes Indenture, the early redemption price will be 104.13% of the aggregate principal amount of the Gold Notes being redeemed plus accrued interest.

Following the Amortizing Payment and the early optional redemption, there will be US$19,750,000 aggregate principal amount of Gold Notes issued and outstanding.

Full details of the cash amounts to be paid in connection with the Amortizing Payment and the early redemption will be announced on or about April 15, 2021.

I was expecting GCM to redeem the entire batch of notes in one shot. They have the cash to do it – about US$90 million at the end of 2020. These notes represent extremely expensive financing for the company – with an 8.25% coupon, coupled with a quarterly payment of 3-4% (this depends on the price of gold, but if it is around $1725 it will be in low double-digits annualized), the total cost of capital for the debt to the company is about 20%.

Surely they can obtain debt financing on better terms. Why aren’t they redeeming the entire slab of debt is beyond me.

Liquidity on the notes is also harder and harder to find – trading has been very light since February. After May 3rd, the notes will certainly trade closer to the call price due to the looming threat of being cheaply called out.

Unless the notes trade ridiculously high, I’m very happy to have them mature. It is nearly risk-free money at this point with only a question of whether the company will slowly redeem the residual value over the quarters.

How much to pay for yield?

Some near-guarantees of interest income, how much will people pay for it? This is typically represented in a “yield to maturity” calculation but here is another way of looking at things which may be a little more intuitive – it involves capitalizing the cash stream to be received to the present, with a zero discount rate. It is a fun exercise:

* Bombardier 8.75% December 1, 2021 unsecured debt, not callable: Trading at bid/ask 104.35 / 105.65. Bombardier has completed their disposition of their transportation division with Alstrom, and has indicated they are exploring how to manage their debt. This one is the nearest term maturity and is a lock to mature. As there is 10 months left to maturity, the remaining coupon is worth 7.3% of par, so at the midpoint, an investor would be paying 105% to receive 107.3% over 10 months.

* Yellow Pages (TSX: YPG.DB) 8%, stated maturity November 30, 2022 but callable at par, May 31, 2021. Trading at bid/ask 101.2 / 102.4. Management has stated for the past few quarters they will be redeeming this debt as soon as they can. With 4 months of interest remaining, that is 2.7%. There is a tiny, tiny amount of optionality in the potential conversion (they can be converted into stock at $19.04/share but that is 55% above the current trading price and not too probable, although one quarterly report showing revenue stabilization would alter that conclusion).

We also have some “zero-coupon” equivalents in the form of merger arbitrage.

* Atlantic Power (TSX: ATP) will be bought out for at least US$3.03 in the second quarter. Right now, trading at US$2.96, that is +2.4% over an estimated 3-5 months (more attractive than the bonds presented above, in addition to the gain being on capital and not income account!). The risk of merger arbitrage, of course, is that the deal will fall through.

The baseline for cash is the high interest savings ETF (TSX: PSA) which gives out a yield of about 50 basis points at present. There’s almost no point in investing in this ETF at present, but they have a whopping 2.4 billion in AUM, skimming off 15bps of MER, so good for them.

The above are examples that will yield superior returns than the risk-free option. Indeed, there are plenty of options to skim a few hundred basis points of yield for very little risk, but it involves work and paying attention. It does come at the cost, however, of liquidity.