Fixed-Income Yields in a Low-Interest-Rate World: Evaluating BMO Short Federal Bond Index ETF as a Defensive Strategy

In an era where central banks have kept interest rates near historic lows for years, investors seeking income face a paradox: yields are scarce, yet risk remains high in a world of unpredictable inflation and policy shifts. For those prioritizing capital preservation and steady cash flow, fixed-income strategies must balance safety with modest returns. The BMO Short Federal Bond Index ETF (ZFS) emerges as a compelling candidate in this landscape, offering exposure to Canada's most creditworthy debt while mitigating duration risk.

ZFS: A Closer Look at Structure and Performance

ZFS tracks the FTSE Canada Short Term Federal Bond Index, which aggregates Canadian government securities with maturities between one and five years, all rated AAA by S&PZFS - BMO Short Federal Bond Index ETF - CA-EN^[2]. As of July 30, 2025, the ETF delivered a 2.90% total return over the past year, including dividendsBMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3], outperforming its 1.65% average annual return since inception in 2009BMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3]. This performance underscores its role as a low-volatility option in a market where even short-term bonds struggle to generate meaningful yields.

The fund's dividend consistency further strengthens its appeal. ZFS has paid $0.0300 per share monthly since July 2025BMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3], translating to a 2.25% dividend yield—a rate that exceeds the bottom 25% of Canadian dividend payersBMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3]. While this yield pales in comparison to historical averages, it reflects the fund's focus on short-term, risk-free assets in a low-rate environment.

Defensive Characteristics in a Low-Yield World

ZFS's design inherently aligns with defensive investing principles. By concentrating on short-duration, government-backed bonds, it minimizes exposure to interest rate volatility. Unlike long-term bonds, which see sharp price declines when rates rise, short-term instruments mature quickly, reducing reinvestment riskBMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3]. This makes ZFS particularly well-suited for a low-rate environment, where rate hikes are either delayed or limited in magnitude.

Moreover, the fund's AAA-rated holdings eliminate credit risk—a critical consideration when corporate or municipal bonds might default in economic downturnsZFS - BMO Short Federal Bond Index ETF - CA-EN^[2]. While the sources do not explicitly state ZFS's duration or expense ratio for 2025BMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3], general principles suggest that short-term bond ETFs typically have durations under three years and expense ratios below 0.25%BMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3]. These characteristics would further enhance ZFS's appeal as a defensive vehicle.

Limitations and Considerations

No investment is without trade-offs. ZFS's focus on short-term bonds means it sacrifices yield for safety. In a low-rate environment, this is a necessary compromise, but investors must weigh the opportunity cost of forgoing higher-yielding assets like corporate bonds or equities. Additionally, while the fund's expense ratio is likely low (as is typical for index-tracking ETFs), even minor fees can erode returns when yields are already compressedBMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3].

Another caveat lies in interest rate sensitivity. Though short-term bonds are less volatile than their long-term counterparts, they are not immune to rate changes. If the Bank of Canada signals tightening, ZFS could see temporary price declines as bond prices fall. However, its short duration ensures these declines would be minimal compared to longer-dated alternativesBMO Short Federal Bond Index ETF (TSX:ZFS) Stock Price^[3].

Conclusion: A Prudent Choice for Conservative Portfolios

For investors prioritizing capital preservation and predictable income, ZFS represents a well-structured solution. Its combination of low risk, consistent dividends, and alignment with central bank policy makes it a cornerstone for defensive portfolios in a low-interest-rate world. While it may not deliver explosive returns, it offers a reliable floor in uncertain markets—a quality that becomes increasingly valuable as volatility persists.

As always, investors should complement ZFS with a diversified mix of assets to balance risk and return. But in a world where “safe” yields are elusive, ZFS stands out as a testament to the power of simplicity and discipline in fixed-income investing.