Daniel Straus, managing director, National Bank of Canada Financial Markets

FOCUS: ETFs and financial products research 

MARKET OUTLOOK:

As ETF investors round the bend into year-end, they may be doing so with risk appetites a notch above the cautious and tentative attitude that has characterized the year so far. All through 2023, the demand for safety in the form of fixed income has dominated the inflow leaderboard. We observed a pronounced “barbell” type pattern in the bond flows, with twin streams of assets pouring into the extreme short-term (cash) and long-term portions of the maturity spectrum.

ETF inflows in November bucked this pattern. Of the nearly $5 billion in new assets that Canadian ETFs gathered last month, $2.7 billion went to equities. In the U.S., where ETFs pulled in over US$100 billion, $70 billion entered the equity asset class. Perhaps investors are finally starting to notice that despite sticky inflation, geopolitical conflict and other doomy headlines, the S&P 500 Index is up 20 per cent this year and the S&P/TSX Composite Index has returned almost 10 per cent.

National Bank’s economists and strategists are hopeful, but their base-case scenario still argues for defensive positioning. Their tactical weights favour the U.S. and EAFE over Canada and emerging markets, pulling some cash from under the mattress to allocate towards duration. With rates in the four to five per cent range, aggregate and long bonds have reclaimed their ability to be the apocalypse-insurance ballast that should “zig” if the market “zags” to the downside.

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TOP PICKS:

BMO Long Federal Bond Index ETF (ZFL TSX)

Since the global bottom in rates in late 2020, long-term bond ETFs like TLT in the U.S. fell by almost 50 per cent in the subsequent two years. It’s the kind of painful drawdown that equity investors might be accustomed to, but bonds? We’re highlighting this ETF to illustrate the importance of understanding the mathematical concept of duration: ZFL has an overall portfolio duration of 18 years. This means that despite its fortress-like appearance of safety, it’s actually quite risky with enormous gearing to small changes in interest rates. Investors who are over-allocated to cash can include a small position in a long-bond ETF like ZFL to inject some diversification benefit to their portfolio.

IIMF – Invesco International Developed Dynamic Multifactor ETF (IIMF TSX)

This ETF is very new, but it lets us highlight National Bank’s strategic positioning for international equities over emerging markets. Unlike other multifactor ETFs that have been around for a while, this ETF (which wraps an older, slightly more established U.S.-listed ETF IMFL) rotates between size, value, momentum, volatility, and quality factor tilts based on the macro regime. When the economy is trending towards slowdown and contraction, quality factor leaning is what you want, and this ETF delivers it automatically.

HCLN – Harvest Clean Energy ETF (HCLN TSX)

This highlight comes from our recent research on tax loss harvesting, which we traditionally publish towards year-end. If you own a clean energy stock that is down materially year-to-date, you could sell it before the settlement deadline (Dec. 27) to realize a loss for the tax year. A 30-day switch to this ETF would let you recognize the loss for tax purposes (consult your tax advisor). Similar tax-loss trades can be done in other materially underperforming sectors this year, like utilities, materials, or some energy and financials. 

PAST PICKS: May 19, 2023

BMO Money Market Fund ETF (ZMMK TSX)

• Then: $50.07
• Now: $49.95
• Return: 0%
• Total Return: 3%

iShares Core TSX Capped ETF (XIC TSX)

• Then: $32.46
• Now: $32.67
• Return: 1%
• Total Return: 2%

Vanguard Conservative ETF Portfolio (VCNS TSX)

• Then: $26.25
• Now: $26.85
• Return: 2%
• Total Return: 3%

Total Return Average: 3%