The Attractiveness of Monthly Dividend ETFs in a Rising Rate Environment: A Deep Dive into BMO Aggregate Bond Index ETF (ZAG)

In an era where central banks are tightening monetary policy to combat inflation, investors are increasingly seeking income-generating assets that can withstand shifting market conditions. Among these, monthly dividend ETFs like the BMO Aggregate Bond Index ETF (ZAG) have emerged as compelling options for those prioritizing consistent cash flow. This article examines ZAG's role in a rising rate environment, its historical resilience, and its strategic value for income-focused portfolios.

ZAG: A Pillar of Predictability in a Volatile Market

The BMO Aggregate Bond Index ETF (ZAG) offers a 3.50% dividend yield as of August 2025, with monthly payouts of $0.04 per share. While its dividend growth rate has stagnated over the past five years, its consistency is a hallmark. ZAG's structure—replicating the FTSE Canada Universe Bond Index—ensures broad exposure to Canadian investment-grade bonds, including federal, provincial, and corporate debt. This diversification mitigates idiosyncratic risks, making it a low-volatility option for conservative investors.

However, ZAG's performance is not immune to macroeconomic forces. During the 2020–2025 interest rate hiking cycle, the ETF experienced a -16.11% drawdown, reflecting the inverse relationship between bond prices and rising rates. Yet, its long-term compound annual return of 4.39% over 30 years (as of July 2025) underscores its resilience. Even after adjusting for inflation, ZAG delivered a 2.22% real return, outperforming many equity counterparts during periods of economic uncertainty.

Navigating Rising Rates: ZAG's Strategic Positioning

ZAG's heavy allocation to government and government-related bonds (typically over 70%) makes it sensitive to rate hikes. When interest rates rise, newly issued bonds offer higher yields, causing existing bonds in the ETF's portfolio to depreciate in value. This dynamic was evident during the 2020–2025 cycle, where ZAG's 60-month recovery period highlighted the drag of prolonged rate increases.

Despite this vulnerability, ZAG's low 0.09% expense ratio and broad diversification provide a buffer. Its focus on long-term bonds, while increasing volatility, also positions it to benefit from rate cuts or economic downturns. For instance, during the 2023–2024 period, ZAG posted a 4.48% return, demonstrating its ability to rebound when market conditions stabilize.

The Role of ZAG in a Diversified Portfolio

Monthly dividend ETFs like ZAG serve as a stabilizing force in portfolios, particularly for investors seeking predictable income. ZAG's negative correlation with equities and commodities (correlation of 0.96–0.97 with long-term bonds like ZFL.TO) enhances diversification. This is critical in a rising rate environment, where equity markets often face headwinds.

Moreover, ZAG's dividend reinvestment options and split-adjusted historical data make it accessible for both passive and active income strategies. While its yield of 3.50% is below the top 25% of financial services sector dividend payers (9.19%), it remains above the bottom 25% (1.15%), striking a balance between safety and income.

Investment Considerations and Strategic Advice

For investors navigating a rising rate environment, ZAG offers a dual benefit: capital preservation and steady income. However, its sensitivity to rate hikes necessitates a strategic approach:
1. Pair with Short-Duration ETFs: Combining ZAG with short-term bond ETFs like BMO Ultra Short-Term Bond ETF (ZST) can mitigate volatility while maintaining yield.
2. Leverage Diversification: ZAG's broad exposure to Canadian bonds reduces sector-specific risks, making it a core holding in fixed-income portfolios.
3. Monitor Rate Cycles: While ZAG thrives in long-term horizons, investors should remain cognizant of near-term rate expectations. A tactical shift to cash-like allocations (e.g., BMO USD Cash Management ETF, ZUCM) during aggressive rate hikes can preserve capital.

Conclusion: A Steady Anchor in Turbulent Waters

The BMO Aggregate Bond Index ETF (ZAG) exemplifies the appeal of monthly dividend ETFs in a rising rate environment. Its consistent payouts, low fees, and diversified portfolio make it a reliable source of income, even as it navigates the challenges of rate hikes. While its performance during the 2020–2025 cycle underscores the risks of prolonged tightening, its long-term resilience and strategic positioning affirm its value for income-focused investors.

For those prioritizing stability and regular cash flow, ZAG remains a compelling choice—particularly when integrated into a broader, diversified strategy that accounts for macroeconomic shifts. As central banks continue to navigate inflationary pressures, the role of fixed-income ETFs like ZAG in balancing portfolios will only grow in importance.