Today, we look at the prospects for investing in bonds at a time when interest rates remain low. The low rates that have persisted for some years make bonds unattractive. And when the likely increase in inflation arrives, it will undoubtedly trigger higher interest rates that will further depress the value of bonds. In our view, Canadian investors looking for bonds to provide stable income in 2017 and beyond have a reasonable alternative. It consists of two Canadian bond ETFs that have the appeal of quality holdings and low fees.
Here’s the secret to making the most of ETFs in your portfolio. Know the difference between the original, easy-to-understand ETFs and complex hybrids created for the greater profit of the investment industry. Pat McKeough explains it all in this new report and recommends 11 ETFs for a stronger portfolio.
The Bank of Canada cut its key interest rate to 0.50% from 0.75% in July 2015. The move came after the bank dropped its 2015 growth forecast for the Canadian economy to 1.1% from 2.0%. The cut partly reflects falling prices for oil and other commodities. Almost two years later, in April 2017, little has changed and the overnight rate remains at 0.50%.
Even so, the long-term outlook is for higher interest rates. That’s because heavy deficit spending and the expansion of the money supply in the past few years make higher inflation more likely.
We continue to advise against investing in bonds right now. Today’s low interest rates make bonds unattractive, and rising rates would push down their future value.
However, if you need stable income and want to hold bonds, these two bond funds offer low fees and high-quality holdings.
ISHARES CANADIAN SHORT-TERM BOND INDEX ETF (Toronto symbol XSB; buy or sell through brokers)mirrors the performance of the DEXShort-Term Bond Index.
This index consists of a range of investment-grade federal, provincial, municipal and corporate bonds with one- to five-year terms to maturity. The fund holds 430 bonds with an average term to maturity of 2.98 years. The bonds in the index are 64.8% government and 35.2% corporate. The fund’s MER is 0.28%.
The iShares Canadian Short-Term Bond Index Fund yields 2.4%, but this high yield is due to the fact that some of the fund’s bonds pay above-market interest rates. As a result, they trade above their face value. When these bonds mature, holders will only get the bonds’ face value, meaning the portfolio will incur predictable capital losses. These losses will offset some of the appeal of the above-market yields.
The key figure when looking at the long-term return of this fund is yield to maturity. This yield takes into account the series of capital losses the fund will experience as its above-market-rate bonds mature. The iShares Canadian Short-Term Bond Index ETF’s yield to maturity is around 1.08%—less than the 2.4% yield but still higher than the 0.42% you’d earn by investing in, say, a one-year T-bill.
If you want to invest in a bond fund, the iShares Canadian Short-Term Bond Index Fund is a buy.
Recommendation in Canadian Wealth Advisor: BUY
ISHARES CANADIAN UNIVERSE BOND INDEX ETF (Toronto symbol XBB; buy or sell through brokers)mirrors the performance of theCanadian Universe Bond Index. The 929 bonds in the portfolio have an average term to maturity of 10.34 years. The fund’s MER is 0.33%.
The bonds in the index are 71.3% government and 28.7% corporate.
The fund yields 2.8%, compared to the Short-Term Bond Fund’s 2.4%. Its yield to maturity is 1.93%, 0.85% above the Short-Term Fund. That reflects the added risk of holding long-term bonds. iShares Canadian Universe Bond ETF is a buy for safety-conscious investors who can accept that risk.
Recommendation in Canadian Wealth Advisor: BUY for those who can accept some risk.
This article was originally posted in June 2013 and is regularly updated.
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