The Bank of Canada cut its benchmark interest rate in March to 0.25% from 1.75%. The move was meant to spur the economy after COVID-19 hit. Whether the bank holds that rate steady, or cuts it even further, depends on the country’s economic growth and unemployment levels.
Meanwhile, even for our conservative investors, we caution against investing in bonds. Today’s low interest rates make bonds unattractive. While another drop in rates would do little to enhance the return for bondholders, a rise would push down their returns. However, if you need stable income and want to hold bonds, these two funds offer lower fees and high-quality holdings. Each is a buy.
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ISHARES CORE CANADIAN SHORT-TERM BOND INDEX ETF $28.28 (Toronto symbol XSB; buy or sell through brokers) mirrors the FTSE TMX Canada Short-Term Bond Index. You pay a low MER of just 0.10%.
That FTSE index tracks investment-grade government and corporate bonds with one- to five-year terms. The ETF holds 487 bonds; the average term to maturity is 3.03 years.
The bonds are 68.5% government and 31.5% corporate. Issuers of the corporate bonds include TD Bank, Hydro One, Intact Financial, Hydro Quebec, Bank of Nova Scotia, Enbridge, CP Rail and other high-quality companies.
The fund offers investors a high 2.3% yield, which reflects the number of its bonds paying above-market interest rates. As a result, they trade above their face value, although when they mature, holders only get their face value. That means the ETF’s portfolio will incur predictable capital losses, which could partially offset your high yield.
When looking for the long-term return of this fund, you should study its yield to maturity. That ratio weighs the series of capital losses or gains the fund will experience as its bonds mature. Here the yield to maturity is 0.65%. So for this ETF, that’s effectively the yield you will get. Note, it’s less than the current 2.3% interest yield, but still higher than the 0.16% you’d earn by investing in, say, a one-year treasury bill.
If you want to invest in a bond fund, the iShares Core Canadian Short-Term Bond Index ETF is a buy.
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.
ETFs: Higher yield reflects greater risk of long-term bonds
ISHARES CORE CANADIAN UNIVERSE BOND INDEX ETF $33.75 (Toronto symbol XBB; buy or sell through brokers) mirrors the FTSE Canada Universe Bond Index. The portfolio’s 1,343 bonds have an average term to maturity of 11.07 years. You pay a low 0.10% MER. The bonds in the Canadian Universe Bond Index are 72.8% government and 27.2% corporate. Its bond issuers are similar to those of the Short-Term Bond Index Fund.
This ETF yields 2.6% versus the Short-Term Bond fund’s 2.3%. Its yield to maturity is 1.23%—58 basis points above the Short-Term Bond fund’s. That reflects the added volatility this ETF exposes you to (long-term bonds move up and down more on interest rate changes than do short-term bonds).
The iShares Core Canadian Universe Bond Index ETF is a buy for investors prepared to accept that risk.
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.
For our advice on how to make the right choices amid the growing number of ETFs, read Selecting the best Canadian funds for your portfolio.
For our recent report on one of the best ways to invest in global markets, read Two ETFs offer low-fee access to global markets.