Topic: ETFs

Two low-fee Canadian bond ETFs a good way to hold bonds today

Canadian bond ETFs

Two Canadian Bond ETFs offering low fees and high-quality holdings

Today, we look at the prospects for investing in bonds at a time when interest rates still remain low.The Bank of Canada increased its benchmark interest rate in October 2018 from 1.50% to 1.75%. That rate has remained steady since then, but it could fall or rise further early next year depending on economic growth and the level of unemployment.

We continue to caution against investing in bonds. Today’s still-low interest rates make them unattractive, and rising interest rates will push down their future value. However, if you need stable income and want to hold bonds, these two funds offer lower fees and high-quality holdings.

For a recent article on other Canadian ETFs we recommend, read Most of Canada’s best stocks are in these two ETFs. And 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.


Less likely to harbour hidden risks

“Here’s a good general rule to follow when choosing investments: Simple is better. The easier an investment is to explain and understand, the less likely it is to harbour hidden risks and costs that can only work against you. As the old investor saying goes, “Stick with plain vanilla.”
Pat McKeough explains why in this special report and recommends 11 ETFs for a stronger portfolio.

 

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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 reflected falling prices for oil and other commodities. Almost two years later, in April 2017, little has changed and the overnight rate remained at 0.50%, although it ended the year at 1.00%.

Since then the Bank of Canada has now increased its benchmark interest rate  three times in 2018, from 1.00% to 1.75%. That rate could rise further in 2019 depending on economic growth and the level of unemployment. 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, including Canadian bond ETFs. Today’s low interest rates make bonds unattractive, and rising rates would push down the future value of Canadian bond ETFs.

However, if you need stable income and want to hold bonds, these two Canadian bond ETFs offer low fees and high-quality holdings.

ISHARES CORE CANADIAN SHORT-TERM BOND INDEX ETF $27.64 (Toronto symbol XSB; buy or sell through brokers) mirrors the FTSE TMX Canada Short-Term Bond Index. The funds MER is a low 0.10%.

That index tracks investment-grade government and corporate bonds with one- to five-year terms. The ETF holds 488 bonds with an average term to maturity of 2.91 years.

The bonds are 67.7% government and 32.3% corporate. Most of the corporate bonds are from high-quality issuers such as TD Bank, Hydro One, Intact Financial, Hydro Quebec, Bank of Nova Scotia, Enbridge and CP Rail.

The fund yields 2.4%; the high yield reflects the fact that some of the bonds it holds pay above-market interest rates. As a result, they trade higher than their face value. However, when these bonds mature, holders will only get the face value, meaning the portfolio will incur predictable capital losses. These losses could partially offset the above-market yields.

The key figure when looking at the long-term return of this fund is its yield to maturity. That ratio takes into account the series of capital losses the fund will experience as its above-market-rate bonds mature.

The yield to maturity for the iShares Canadian Short-Term Bond Index ETF is 1.83%. That’s less than the 2.4% yield, but still higher than the 1.7% you’d earn by investing in, say, a one-year T-bill.

Recommendation in Canadian Wealth Advisor: If you want to invest in a bond fund, the iShares Core Canadian Short-Term Bond Index ETF is a buy.

ISHARES CORE CANADIAN UNIVERSE BOND INDEX ETF $32.07 (Toronto symbol XBB; buy or sell through brokers) mirrors the FTSE TMX Canada Universe Bond Index. The portfolio’s 1,280 bonds have an average term to maturity of 10.78 years. The fund’s MER is 0.10%

The bonds in the Canadian Universe Bond Index are 72.3% government (federal, provincial and municipal) and 27.7% corporate. Its bond issuers are similar to those of the iShares Canadian Short-Term Bond Index Fund.

This fund yields 2.8%, compared to the Short-Term Bond Fund’s 2.4%. Its yield to maturity is 2.10%27 basis points above the Short-Term Fund’s. That reflects the added risk of long-term bonds.

Recommendation in Canadian Wealth Advisor: The iShares Core Canadian Universe Bond Index ETF is a buy for safety-conscious investors who can accept that risk.

How interested are you in Canadian bond ETFs given current interest rates and the outlook?

This article was originally published in 2013 and is regularly updated.

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