Topic: ETFs

Two ETFs offer high-quality bonds at low fees

The Bank of Canada increased its benchmark interest rate in January 2018 from 1.00% to 1.25%. That rate could rise further later this year on stronger economic growth and low unemployment. Inflation has also moved up, although it eased somewhat from 2.3% to 2.2% in April 2018.

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 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. In May 2017, the fund dropped its MER to 0.09% from 0.28%.

That index tracks investment-grade government and corporate bonds with one- to five-year terms. The ETF holds 508 bonds with an average term to maturity of 2.80 years. The bonds are 66.9% government and 33.1% 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 iShares Canadian Short-Term Bond Index Fund yields 2.4%; the high yield reflects the fact that some of its bonds 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 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 2.34%. That’s less than the 2.4% yield, but still higher than the 1.64% 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: ETF’s yield to maturity reflects the higher risk of longer-term bonds

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 portfolio’s 1,239 bonds have an average term to maturity of 10.01 years. In May 2017, the fund dropped its MER to 0.09% from 0.30%.

The bonds in the Canadian Universe Bond Index are 71.3% government and 28.7% corporate. Its bond issuers are similar to those of the iShares Canadian Short-Term Bond Index Fund

This fund yields 2.9%, compared to the Short-Term Bond Fund’s 2.4%. Its yield to maturity is 2.74%—0.40 percentage points above the Short-Term Fund’s. 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.

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