Topic: ETFs

Two ETFs may be the better way to buy bonds

The Bank of Canada increased interest rates in July 2017 for the first time since 2010. It then raised its key interest rate again in September 2017, from 0.75% to 1.00%. However, it decided to hold off on further increases in December.

We continue to caution against investing in bonds. Still-low interest rates make them unattractive, and rising rates will push down their future value. However, for investors who need income and want to hold bonds, these two funds offer lower fees and high-quality holdings.

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ISHARES CORE CANADIAN SHORT-TERM BOND INDEX ETF (Toronto symbol XSB; buy or sell through brokers) mirrors the FTSE TMX Canada Short-Term Bond Index.

That index consists of investment-grade government and corporate bonds with one- to five-year terms. It holds 477 bonds with an average term to maturity of 2.84 years. The bonds are 68.8% government and 31.2% corporate. In May 2017, the fund dropped its MER to 0.09% from 0.28%.

The iShares Canadian Short-Term Bond Index Fund yields 2.4%, but the 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. But when these bonds mature, holders will only get the bonds’ face value, meaning the portfolio will incur predictable capital losses. These losses will 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 1.85%. That’s less than the 2.4% yield but still higher than the 1.40% 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 Canadian Short-Term Bond Index Fund is a buy.

ETFs: Government bonds account for 72% of this ETF’s portfolio

ISHARES CORE CANADIAN UNIVERSE BOND INDEX ETF (Toronto symbol XBB; buy or sell through brokers) mirrors the performance of the FTSE TMX Canada Universe Bond Index. The 1,198 bonds in the portfolio have an average term to maturity of 10.18 years. In May 2017, the fund dropped its MER to 0.09% from 0.30%.

The bonds in the Canadian Universe Bond Index are 72.8% government and 27.2% corporate. Most of the corporate bonds are from high-quality issuers such as Toronto- Dominion Bank, Hydro One, Intact Financial and Canadian Pacific Railway.

The fund yields 2.9%, compared to the Short-Term Bond Fund’s 2.4%. Its yield to maturity is 2.38%—0.53 percentage points above the Short-Term Fund. That reflects the added risk of long-term bonds.

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

For our advice on how to select among the growing number of ETFs, read How to Pick a Top ETF Investment.

For our recent report on one of the best ways to invest in foreign markets, read Two ETFs make it easy to tap into foreign markets.


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