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How 2 bond funds measure up for income investors

bond funds

Canada’s inflation rate is just 1.1%, well below the Bank of Canada’s 2% target. That lets the bank keep interest rates low, which holds down our dollar, making our exports cheaper in world markets. That’s good for Canada’s economic growth, but bad for income investors.

We continue to advise against investing in bonds right now. Today’s low interest rates make them unattractive for income. Rising rates would push down their asset value.

However, if you need stable income you may consider holding certain bond funds. Here are two we cover in our advisory on safety-conscious investing, Canadian Wealth Advisor.

ISHARES DEX SHORT-TERM BOND INDEX FUND (Toronto symbol XSB; ca.ishares.com) mirrors the performance of the DEX Short-Term Bond Index.

This index consists of a wide range of investment-grade federal, provincial, municipal and corporate bonds with terms to maturity ranging from one to five years. The fund holds 384 bonds with an average term to maturity of 2.91 years. The bonds in the index are 60.2% government and 39.8% corporate. The fund’s MER is 0.28%.

iShares DEX Short-Term Bond Index Fund yields 2.6%. However, 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, which means 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. iShares DEX Short-Term Bond Index Fund’s yield-to-maturity is around 1.62%—less than the 2.6% yield but still higher than the 0.96% you’d earn by investing in, say, a one-year T-bill.

Longer-term bond fund has 3.2% yield and 2.9% yield-to-maturity

ISHARES DEX UNIVERSE BOND INDEX FUND (Toronto symbol XBB; ca.ishares.com) mirrors the performance of the DEX Universe Bond Index. The 784 bonds in the portfolio have an average term-to-maturity of 9.79 years. The fund’s MER is 0.33%.

The bonds in the index are 66.7% government and 33.3% corporate.

The fund yields 3.2%, compared to the Short-Term Bond Fund’s 2.6%. Its yield-to-maturity is 2.53%, 0.91% above the Short-Term Fund.

In the latest issue of Canadian Wealth Advisor, we examine the long-term outlook for interest rates and balance the relative risks of short-term and long-term bonds. We conclude with our clear buy-hold-sell advice on these two funds.

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COMMENTS PLEASE—Share your investment knowledge and opinions with fellow TSINetwork.ca members

Do you always keep a portion of your portfolio in bonds? Do you hold bonds or bond funds? Do you feel that the stable income you get with bonds makes up for today’s low interest rates?

Comments

  • pierre P.

    The only bonds and coupons that I own, only because I want to stay disciplined with my targeted asset mix,are held in my RRSP. in a taxable account, after taxes and inflation even a 3pct yield does’nt leave me any thing .Since I’m retired and I need a régular income every month I took the decision(and risk) ,for the fixed income part of my taxable account I décided three years ago to invest in a large number of high income tax advantaged préféréd shares (P1 or P2), income trusts in pipelines, public resources,infrastructure, and à diversity of the léast vulnérable Reits that invest in shopping centres, industrial and commercial buildings, retirement homes,rental properties, The income and yield on thèse is close to 6pct.and I was fortunate(and surprised) to benefit from fairly large (and tax advantaged) capital gains on some of them (pipelines and infrastructure) which I sold when their yield became too low.Thanks to this and the growth portion of my portfolio, I was happy to see a return of 10.5pct in 2012 and 14.3pct in 2013 équal or higher than my benchmarks which are the annual return of the Caisse de Dépôt, and the average of all balanced funds on the market. So far so good and I was able to say bye to bonds and bond funds (with their enormous mgt fées.)

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