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Investors who need or want to hold cash can use a few ETFs to earn yields beyond what banks offer.

Two ETFs designed for short-term savers pay higher yields than those generally available from deposit takers, and are doing so by holding savings accounts themselves. Both the nearly six-year-old Purpose High Interest Savings ETF, and the new CI First Asset High Interest Savings ETF launched on June 18, have interest yields exceeding 2%. A lower-yielding cash-equivalent rival is iShares Premium Money Market ETF, the only one of the three ETFs in the Canadian money market category that is legally permitted to call itself a money market fund.

Thanks largely to their low management expense ratios (MERs), all three ETFs outperform most mutual funds in the money market category, for which the asset-weighted average MER is 0.63%, as reported by Toronto-based Morningstar Canada. The iShares fund has a reported MER of 0.28%, while the MERs of the Purpose and CI First Asset ETFs are about 10 basis points lower.

The attractive yields of the deposit-holding ETFs, given their daily liquidity, are based on their ability to negotiate interest rates with deposit takers that are higher than those available to the average retail client. “We get a rate that’s in line with what many preferential institutional rates are. Often, those are negotiated based on the quality of the overall relationship [with Purpose],” says Rashay Jethalal, president of Toronto-based Purpose Investments Inc. “It’s not to say a retail investor couldn’t necessarily get that,” he adds. “But to get that on a sustained timeline at a bank is actually quite hard to do.”

In late July, the Purpose ETF was yielding 2.15%, while the CI ETF was quoting a gross yield of 2.25% — which, after fees, expenses and taxes, translates to a net current yield of 2.09%.

“We’ve been able to negotiate approximately bank prime rate minus 1.7 [percentage point], which is substantially higher than if you look at what [most] one-year GICs are offering, what T-bills are offering or what an individual investor can get if he were to enter a high interest savings account on his own,” says Peter Tomiuk, senior vice-president, ETF strategy, at Toronto-based First Asset Investment Management Inc., a subsidiary of CI Financial Corp.

The yields of the two high-interest ETFs won’t exceed all rates available to retail investors. According to Toronto-based Inc., high-interest savings accounts at banks, credit unions and other deposit-takers typically yield between 1.05% and 2.25%. Introductory rates, such as those designed to entice new customers, may be higher still at smaller deposit takers. Savers willing to commit to a specific holding period may also obtain higher yields. In addition, unlike ETFs, bank deposits are eligible for Canada Deposit Insurance Corp. coverage.

Transparency isn’t strong for the two high-interest ETFs: neither provides frequent disclosure of its portfolio holdings and weightings on its website, as most ETFs do.

Purpose confirmed that, as of the publication date, it holds more than 95% of its assets in three of the Big Six banks, namely Bank of Nova Scotia, National Bank of Canada and CIBC. Historically, it has also had substantial holdings in B.C. and Alberta-based credit unions, whose deposits are guaranteed by provincial governments. The risk of default is considered low, Purpose says in financial statements.

First Asset lists five of the Big Six banks on its website as its top five sources of deposits, without giving weightings. The ETF, which has far fewer assets to invest than the Purpose ETF, currently has no holdings with smaller institutions, a company executive confirmed.

Absent from the holdings of both ETFs are deposits with Toronto-Dominion Bank. The Toronto-based bank’s discount brokerage subsidiary, TD Direct Investing, is one dealer that refuses to allow its clients to place trades in either of the ETFs.

Though First Asset had no comment and Purpose declined to name names, Jethalal said “some banks” — either through their full-service or discount brokerages — have chosen to block trades in the Purpose ETF. Instead, these clients are steered toward lower-yielding products offered by their institutions. Jethalal says Purpose has been receiving about 12 to 15 calls a week directly from investors who want to buy its ETF but can’t obtain it from their investment dealers.

As for the iShares ETF, though its recent 1.83% yield is lower than that of the high-interest ETFs, the iShares product provides superior diversification and transparency. The complete list of its more than 50 holdings and their weightings is updated daily on the iShares website.

Unlike most iShares funds, the money market ETF is actively managed and not based on an index. “The nature of money market is that the securities are basically constantly being recycled, issued and then maturing, and then new securities [are] being issued,” says Steven Leong, head of ETF product with Toronto-based BlackRock Asset Management Canada Ltd. “That doesn’t especially lend itself to market representation indexes the way something like the S&P/TSX Composite would.”

Leong says the iShares portfolio meets the regulatory requirements for credit quality for money-market funds but is tilted toward commercial paper, certificates of deposit and other non-government securities that pay yield premiums over Government of Canada T-bills.

The iShares ETF, says Leong, would be suitable as an alternative to holding cash in a brokerage account that would otherwise be earning little or no interest. “It also makes sense for institutional investors who want the diversification that comes with a portfolio like this and who do not want large amounts of cash sitting on deposit at a bank.”

Unlike mutual funds, transactions in ETFs are subject to bid-offer spreads. However, these spreads are normally only a penny, which works out to two basis points per $50 share. That’s true not only for the $1.7-billion Purpose ETF and the $368-million iShares fund, but also for CI’s much smaller ETF, which had assets of $48 million in late July. Unless held in a fee-based account, brokerage commissions are also payable on ETF trades. These will cut into yields, though if the trades are large, the commission may be inconsequential.

Another noteworthy difference between the three ETFs and money market mutual funds is the pricing of net asset values. Mutual funds consistently trade at $10. By contrast, net asset values of the ETFs start at $50 at the beginning of the month and move higher as interest is accrued.

When interest is distributed to unitholders at the end of the month, the NAV reverts to $50. “Because of the way an ETF operates, it’s not especially practical to make distributions of income in units, because you can’t have fractional units,” Leong explains.