The Bank of Canada held its key interest rate at 0.50% this week, after dropping it from 0.75% in July 2015. That July cut came as the Canadian economy slowed along with falling prices for oil and other commodities. Even so, the long-term outlook is for higher interest rates—especially after the U.S. Federal Reserve raised its benchmark rate by 0.25% in December 2015 and signaled further increases to come.
We continue to advise against investing in bonds right now. That’s because 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 Canadian bond ETFs 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 DEX Short-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 2.97 years. The bonds in the index are 62.3% government and 37.7% corporate. The fund’s MER is 0.28%.
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The iShares Canadian Short-Term Bond Index ETF 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 1.19%—less than the 2.4% yield but still higher than the 0.51% 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 ETF 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 the Canadian Universe Bond Index. The 944 bonds in the portfolio have an average term to maturity of 10.26 years. The fund’s MER is 0.33%.
The bonds in the index are 71.0% government and 29.0% corporate.
The fund yields 2.8%, compared to the Short-Term Bond Fund’s 2.4%. Its yield to maturity is 2.00%, 0.81% 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
For our overall view on the best way to profit in the expanding field of exchange-traded funds, read When you invest in ETFs, keep it simple
For our look at the features and practices of different types of investment funds and how they affect you as an investor, read What are the risks and rewards of securities lending?