No matter what your interest rate outlook, there’s a bond ETF for you.But just try and find it. With its manic slicing and dicing of the bond market and its copycat products, the exchange-traded fund industry is overwhelming investors who just want to pick a nice bond ETF or two for their portfolio.
It’s these investors that the fifth and final instalment of The Globe and Mail ETF Buyer’s Guide is aimed at. Here we look at core bond funds that, either alone or combined with a few others, can cover off all your bond needs.
Bond ETFs are a highly efficient, low-cost way to get diversified exposure to government and corporate bonds of all types. The only real hitch is that, whereas an actual bond matures and repays your principal, the typical bond ETF never matures. Instead, it rides interest rate trends over the years, increasing in value when interest rates retreat and falling in value when rates rise.
There are roughly 75 bond ETFs listed on the TSX, far too many to cover here. So we’ll look at some of the largest ETFs by assets – the most popular funds, in other words – along with some others that were hand-picked because they offer an interesting option for investors seeking core bond funds.
A key variable in choosing bond ETFs is yield, which can be measured in a few different ways. Used here is yield to maturity after fees, which is the best estimate of what yield you can expect looking forward. Do not use the yield figures shown in stock quotes for bond ETFs. These distribution yields can fool investors into thinking they’ll get higher returns than they actually will. (consult the Portfolio Strategy bond ETF user’s guide for more on this).
Here’s some explanation of other terms you’ll find in the ETF buyer’s guide:
Assets: Shown to give you a sense of how interested other investors are in a fund; unless they’re new, the smallest funds may be candidates for delisting.
Management expense ratio (MER): The main cost of owning an ETF on an ongoing basis; as with virtually all funds, published returns are shown on an after-fee basis.
Average 30-day daily trading volume: Trading of less than 10,000 shares per day on average tells you an ETF isn’t generating much interest from investors.
Top sector weightings: Federal and provincial government bonds offer the least default risk and the most interest rate risk; corporate bonds offer more default risk and somewhat less rate risk. Note the heavy weighting in the financial sector that many corporate bond ETFs have as it mirrors the heavy financial weighting in many dividend ETFs. Be cautious about overexposure to financials, or any other sector.
Average duration: Duration, measured in years, is a standard risk metric for bonds; if interest rates rise by one percentage point, the price of an ETF with a duration of five would fall five percentage points (and vice versa if rates fell).
Returns: ETF companies typically disclose total returns, or share price change plus interest payments, or distributions.