Oct 292018
 

Short Term VS Long Term Bond Funds

Earlier this year I put together a list of high quality bond funds for readers to check out. There was a lot of good feedback, but some people questioned why I didn’t include any short term bond funds in my list. More recently reader Carla also asked about my indifference to them.

Well, to be Frank, I would have to change my name. 😎 But rather than doing that I will answer Carla’s question. 🙂

Retirement portfolios are usually associated with long term planning. Short term bonds tend to be less volatile and less sensitive to interest rate movements. But since I don’t plan to sell any time soon, short term volatility doesn’t really affect my bottom line. On the other hand, long term bonds pay a higher interest rate (or coupon) which more than compensates for the higher volatility in the long run. For evidence of this, let’s compare 2 bond funds with different durations.

Comparing Returns of ZCS and ZLC

For consistency purposes we’ll isolate the duration variable and look at the following 2 funds.

  • BMO Short Bond ETF (ZCS)
  • BMO Long Bond ETF (ZLC)

Both funds are from the same company, and hold corporate bonds. The only key difference is the duration of bonds they hold. Below shows the annual total return of these funds from Morningstar, highlighted in yellow.

bond fund comparison between short and long

As we can see, over the last 5 years the short term bond index fund (ZCS) returned only 2.21% per year. The latest inflation rate number from Statistics Canada is 2.2%. So holding a short term bond fund such as ZCS would have earned an annual real return of 0.01%. I think we can all do better than that. 🙂

Meanwhile the long term bond fund (ZLC) returned 6.21% per year on average. Even the 1 year return shows that long term bond fund ZLC came out ahead. Keep in mind this is during a rising interest rate environment, which should hurt long bond funds more. But short bond fund ZCS currently has a weighted average coupon of only 2.91%, while ZLC’s is at 5.29%. The longer investment time horizon we have, the bigger the difference in returns we should see between ZLC and ZCS. 🙂

Continue reading »

Jan 222018
 

Why Bonds Are So Important

A fundamental skill to successfully managing wealth is knowing how to diversify our assets. This means we must own both equity and fixed income, with the correct weighting and balance. There isn’t a single solution that fits everyone’s situation. But in general bonds help to protect our wealth against volatility when the stock market goes crazy, which it tends to do once in awhile.

Some kind of mix between safe assets such as bonds, and growth assets such as stocks, has proven to work very well in good economic times and bad. For example, a mix of 80% stocks and 20% bonds in a diversified portfolio would have returned about 8% on average over the past decade, which is not bad since that includes the stock market crash of the 2008 financial crisis.

Financial problems are often cited as the number one reason for divorce. But having some solid bond exposure can bring stability to a relationship. It’s clear that couples are more likely to stay together if they have strong bonds. 😎

The Best Bond Exchange Traded Funds

So what’s the best way to buy bonds? Personally I like to invest in bond ETFs, which hold individual bonds so I stay diversified within this asset class. The following funds are the best Canadian bond ETFs to buy for investors looking at a medium or long term time horizon. I’m no expert but these funds are the best in their categories that I can find. 🙂

  • BMO Aggregate Bond Index ETF (ZAG) 
    A broad index fund that holds both government and corporate bonds. Very diversified.
  • BMO Mid Corporate Bond ETF (ZCM)
    An index fund that holds only corporate bonds with maturities between 5 to 10 years.
  • iShares Canadian HYBrid Corporate Bond Index ETF (XHB)
    Holds lower quality corporate bonds (Mostly BBB rated) with a minimum maturity of 1 year.
  • Horizons Active Corporate Bond ETF (HAB)
    Actively managed corporate bond fund that seeks moderate capital growth and generate high income.
  • BMO Long Corporate Bond Index ETF (ZLC)
    An index fund that holds only corporate bonds with maturities over 10 years.

Here’s a table so you can easily compare all of them. 🙂

Comparing Bond ETFsZAGZCMXHBHABZLC
Price/unit on Jan 2018$15$16$20$11$18
Gov’t / Corporate %72 / 280 / 1000/ 1000 / 1000 / 100
Net Assets (billions)$3.4$1.4$0.5$0.6$0.4
MER (fees)0.14%0.34%0.51%0.60%0.34%
Weighted Avg duration7.5 years6.3 years5.9 years6.2 years13.3 years
Annual yield3.00%3.10%4.00%3.10%4.10%
Avg YTM2.50%3.30%4.00%3.20%3.90%
% Credit AAA410020
% Credit AA3213051
% Credit A173303861
% Credit BBB1054805138
% Credit BB or Lower002000
1 year total return1.5%1.2%3.3%2.6%5.9%
3 year avg return1.4%2.3%3.3%2.5%3.4%
5 year avg return2.7%3.6%3.9%3.2%5.1%
Additional informationMorningstar: 4

Federal 37%
Provincial 35%
Corporate 28%
.
.

Avg coupon: 3.2

$6,300 to DRIP

Morningstar: 5

Energy 31%
Financial 26%
Real estate 12%
Commun 12%
Other 19%

Avg coupon: 3.5

$6,300 to DRIP

Morningstar: 3

Energy 30%
Commun 23%
Industrial 17%
Financial 13%
Other 17%

Avg coupon: 4.7

$6,200 to DRIP

Morningstar: 5

Financial 43%
Energy 18%
Infrast 16%
Commun 10%
Other 13%

Avg coupon: 4.0

$4,200 to DRIP

Morningstar: 5

Infrast 43%
Energy 33%
Commun 10%
Financial 7%
Other 7%

Avg coupon: 5.4

$5,600 to DRIP

 

  • The Average duration refers to how sensitive the ETF is to changing interest rates. Longer duration bonds offer higher yields, but are also more sensitive to interest rate movements.
  • The weighted average yield to maturity (YTM) includes the interest payments and any capital gain or loss that the investor will realize by holding the bonds to maturity.
  • The Credit rating is how risky a bond is. The lower the rating, the more likely the company is to default on its debt obligations.

Continue reading »

Jan 052017
 

Narrowing Down the Choices

Most bond ETFs have pulled back meaningfully over the last few months. Now is probably a good time to consider buying some bonds in your TFSA. There are over 60 bond ETFs on the TSX to choose from. So which is the best one? Rob Carrick wrote an article about bond ETFs for the Globe & Mail back in 2011. I’ve narrowed the list down to the following 5 exchange traded funds which I think are the most appropriate for Canadian retail investors!

  1. Vanguard Canadian Aggregate Bond Index ETF (VAB)
    A favorite fund among couch potato investors. The default go-to bond ETF. Portfolio manager Justin Bender recommends it in his model ETF portfolio.
  2. Vanguard Canadian Short-Term Bond Index ETF (VSB)
    This is similar to VAB, but contains shorter maturing bonds. Very safe and steady. Popular with conservative index investors.
  3. iShares Canadian Universe Bond Index ETF (XBB)
    This one has been around for a long time. It’s the largest bond ETF here by net asset value. Great track record overall.
  4. iShares Canadian Corporate Bond Index ETF (XCB)
    Holds corporate bonds only. Withstood the great recession very well. Relatively high management fees though.
  5. BMO Mid Corporate Bond Index ETF (ZCM)
    Similar to XCB, but more diversified and lower fees.

Honorable mentions: Horizons Active Corp (HAB), iShares Canadian HYBrid Corp (XHB), TD e-Series Bond Mutual Fund (TDB909)

Maybe there’s a bond fund I didn’t include above that is a better fit for you. Check out Rob’s article to see a more complete list of funds. The following table breaks down the five bond ETFs into categories so we can compare them. 🙂 You can read my previous post about what bonds are if you need a refresher. (Bond table below)

Breakdown of the Top Five Bond ETFs

Comparing Bond ETFsVABVSBXBBXCBZCM
Price per unit as of Jan 2016$25$24$31$21$16
Government / Corporate mix %77 / 2371 / 2969 / 310 / 1000 / 100
Net Assets$1.1 billion$0.8 billion$2.1 billion$1.7 billion$1.2 billion
MER (annual fees)0.13%0.11%0.34%0.45%0.34%
Average duration7.6 years2.7 years7.4 years6.1 years6.2 years
Annual yield2.75%2.45%2.80%3.19%3.18%
Avg yield to maturity2.0%1.2%2.1%2.7%2.8%
% Credit rating AAA45%57%41%4%0%
% Credit rating AA37%23%27%26%22%
% Credit rating A9%11%21%33%26%
% Credit rating BBB8%10%11%38%52%
1 year total return1.2%1.3%1.3%3.2%3.6%
5 year average annual return3.0%1.9%2.9%3.7%4.8%
Morningstar ETF Rating4 stars4 stars4 stars5 stars5 stars
Sector breakdownGov’t 77%
Financial 12%
Industrial 8%
Utilities 1%
Gov’t 71%
Financial 19%
Industrial 8%
Utilities 1%
Gov’t 69%
Financial 12%
Infrastructure 4%
Energy 5%
Industrial 2%
Utilities 1%
Others 8%
Financial 42%
Energy 18%
Infrastructure 16%
Communication 10%
Industrial 7%
Real Estate 6%
Energy 28%
Financial 25%
Communication 15%
Real Estate 13%
Industrial 10%
Infrastructure 9%

 

 

How to Decide Which Bond ETF to Buy

Let’s go down the list of categories one at a time, starting with the government/corporate bond mix. Government bonds in Canada are considered very safe investments. Low risk means low reward. The current yield on a 10 year Canadian bond is only 1.7%, which leaves much to be desired.

However, a 10 year corporate bond can go for roughly twice that yield, reaching between 3.0% to 3.6% return. Here are a couple of corporate bonds I’ve found using my broker’s online web interface – Brookfield Asset Management and Bell Canada bonds. 🙂

As we can see, Brookfield and Bell Canada have investment-grade credit ratings of A- and BBB+ respectively. Both companies are very financially sound, and are well known among stock investors as blue-chip, large-cap stocks (BAM.A) and (BCE).

Bell is literally the largest telecommunications company in the country, worth over $50 billion, and is a full fledged dividend aristocrat. So although there’s a chance BCE could go bankrupt in the next 10 years, the risk of that happening is really low. Government bonds are the safer variety. But after adjusting for risk, I still prefer corporate bonds like Bell that yields 3.2%, over Canadian government bonds that only pay a disappointing 1.7%. Seriously – even GICs offer higher yields than 1.7% right now. 😄

Since I’m comfortable with a 100% corporate bond portfolio, my bond ETF choice is between XCB and ZCM. This is not to say all government bonds are bad. I just think there are better alternatives at this time, given my personal risk tolerance. Continue reading »

Oct 272016
 

Received My SolarShare Bond Certificate!

If you meet someone new, start talking about global warming. It’s a real icebreaker! 😄 Climate change is very real and as a concerned citizen I want to help however I can. According to top scientists, earth is the only known planet with bacon. This is why I care so deeply about protecting the world.

So about a month ago I purchased $10,000 of bonds from SolarShare, which is a renewable energy company that allows investors to earn a competitive return while doing something good for the environment. I am finally stepping up and doing my part to save the planet and the next generation of food animals. 😉

Well this week I received a letter from the President of the company along with a certificate that looked so awesome I decided to frame it and hang it up. 🙂

16-10-solarshare-bond-certificate-copy

The small words on the certificate say that SolarShare “acknowledges itself indebted and promises to pay, in Canadian money, to the Investor….” This piece of paper represents my $10,000 investment. But it’s actually a copy. The original certificate is securely kept with SolarShare for safe-keeping. It feels good to have someone else owe me money for a change, haha. 😉

2 Ways to Invest

The future looks green, and I’m not just talking about money. 😛 SolarShare offers 2 types of bonds that investors can buy; a 5-year bond with 5% return, or a 15-year self-amortizing bond with 6% return.

16-10-solarshare-options

The 5 year bond has a lower minimum investment so folks who don’t have a lot of money can still take part investing in solar energy. But I bought the 15-year bond because I like the higher interest rate. 🙂 In either case, interest is paid semi-annually to an investor’s bank account via electronic fund transfer, or by direct deposit into a registered account.

The 5-year option works just like any other bond, which I’ve explained in the past. But the 15-year bond I purchased is self-amortized which means it works more like a mortgage. Every 6 months I will receive a payment made up of both principal and interest. This will continue for 15 years, or 30 payments in total, until all my principal is paid back in full.

So how much will I receive each payment? I know there’s a way to calculate the amount, but unfortunately math is not my strong suit. If I had a nickel for every time someone said I’m bad at math, I reckon I’d have 47 cents. But thankfully SolarShare sent me a customized payment schedule so I don’t have to do any math. Phew. 🙂

16-10-solarshare-payment-plan

As we can see, every year I’ll earn $1,020.40 of income from this bond. By the end of the 15th year, I will have received over $15,000 for my initial $10,000 investment.

Continue reading »

Aug 012016
 

Stock Markets Reach Record Highs… Again 

Both the Dow Jones and the S&P 500 indexes have climbed to all time highs in late July. 🙂 But corporate earnings have been stagnant and economic growth remains weak. Restaurant sales have slowed. The U.S. economy only grew a disappointing 1.2% in the second quarter, well below expectations. 😕

So what’s producing so much excitement in the stock market? In short, I believe it’s largely caused by Negative Interest Rate Policies (NIRP). For example, in Europe the benchmark lending rate is negative 0.4%. Usually the bond issuer pays interest to the investor. But with negative rates, the investor pays the issuer. Currently about 1/3rd of the world’s government bonds are producing negative yields. Investors can’t get rich by holding these securities anymore. So in this kind of environment bonds really hold people down.?

As a result of NIRP, more investment capital has moved from the bond market to relatively stable stocks. These tend to be companies that operate gas pipelines, railways, utilities, telecommunication services, and other infrastructure that are recession resistant. Last year I wrote about how to easily make $75 of annual income without using any of my own savings by using leverage to buy shares of TransCanada Corp (TRP.)

16-08-financial-advice-dog-bonds-tennis-balls

I purchased TRP stocks for $42 per share. I mentioned at the time that analysts had an average price target of $57.50 per share. This doesn’t always happen, but sure enough TRP is trading at roughly $60 per share today. 😀 So not only am I making $75 a year in dividends, but I’ve also made $1,800 in unclaimed capital gains so far. 😉

In normal circumstances this kind of price movement in a large cap, blue-chip company wouldn’t happen. But due to a lack of viable investment alternatives, an influx of additional buyers has pushed up TRP and many other relatively safe stocks.

Increasing Valuations and Risk

Unfortunately, NIRP produces asset bubbles and may cause the markets to behave precariously. The chief executive of DoubleLine Capital, who oversees more than $100 billion in assets, recently said that many asset classes look frothy and his firm continues to hold gold, which has also climbed due to NIRP.  At the end of July gold reached $1,350 per ounce, the highest monthly close in years! Stock investors have entered a “world of uber complacency,” said Jeffrey to the media. “The stock markets should be down massively but investors seem to have been hypnotized that nothing can go wrong. Continue reading »