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PORTFOLIO STRATEGY

Bonds? Bond ETFs? Bond funds? Which is best for you? Add to ...

There are so many ins and outs to putting bonds in your portfolio. Bond funds are expensive to own, but convenient to buy. Bond exchange-traded funds look good by comparison, but they lack the singular advantage of owning individual bonds. On maturity, the government or company that issued a bond will hand investors their money back. Bond funds and ETFs never mature.

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Which bond investing vehicle is best for you? Here is The Globe and Mail’s definitive guide to bond investing choices. Bond funds, bond ETFs and individual bonds are examined here in 10 different categories and rated on a scale of one to five for their utility. First, a quick look at how the choices available work:

 

 

Bond Funds

Bond ETFs

Bonds

    

How They Work

 

A portfolio manager looks after the bonds in the fund.

They typically track the returns of recognized bond indexes.

It’s all on you to assemble a coherent portfolio of bonds.

 


 
  

Convenience

 

Widely available with no upfront commissions and low minimum investments. You can buy one of the better bond funds in the country, TD Canadian Bond, by walking into a TD Canada Trust branch and plunking down $100. Some top bond funds have upfront minimums of $5,000 to $10,000.

All ETFs trade like stocks. Once you have a brokerage account set up, you can buy any of the six dozen or so bond ETFs listed on the Toronto Stock Exchange in any quantity you want.

Most online brokers have screening tools that let you browse their inventory for bonds that suit your needs. The technology behind these screeners hasn’t been updated in ages, which means they’re not user friendly. Bonds come and go from the inventory on a daily basis, and there’s no way to create a virtual bond portfolio that you can use as a short list of possible buys for your portfolio.

Score/5

4

3

2

 


 
  

Diversification

 

A well-diversified portfolio of bonds is one of the main benefits of owning a bond fund.

Ditto. ETF holdings can range from 20 or so to several hundred bonds, so you’re well covered.

With many brokers requiring minimum investments of $5,000 per bond, it can be tricky for small investors to properly diversify their bond holdings. When buying bonds from non blue chip companies, a lack of diversification can make you especially vulnerable to the risk of default.

Score/5

4

5

2

 


 
  

Cost to Buy

 

Often available with no upfront sales commissions or redemption fees.

A few online brokers waive commissions on certain ETFs, including some bond products; otherwise, expect to pay $1 to $5 at the low end per trade at an online broker and as much as $29 at the high end.

In most cases, a commission is invisibly added by most brokers to the price you’re quoted when you buy. There is no official disclosure of bond commissions. This will change in July, 2014, when bond commissions start to appear in trade confirmation slips. Bond commissions will also appear in the annual report on fees and commissions that investment firms will start providing clients in 2016.

Score/5

4

3

2

 


 
  

Cost of Ownership

 

At a time when a five-year Government of Canada bond yields 1.3 per cent, the average bond fund management expense ratio of 1.69 per cent is exorbitant. Some bond funds are priced below 1.0 per cent, and they include some top performers.

Much lower than bond mutual funds, with MERs ranging from 0.17 to 0.45 per cent for funds holding Canadian government and corporate bonds. Still, ETF companies don’t seem to compete as much on bond fund fees as they do on the cost of owning equity funds.

None. Once your broker has soaked you on the purchase price, actual bonds are a zero-cost investment.

Score/5

1

4

5

 


 
  

Transparency

 

Poor. Bond funds are clearly aimed at investors who ask no questions. Without doing a lot of online research, it’s difficult to find out about key variables like yield to maturity and duration.

Outstanding. ETF companies offer a full profile of all their products with daily updates. For bond ETFs, you can find data on things like yield to maturity, 12-month trailing yield, duration and the credit ratings of the bonds in the portfolio.

All you get are the basics for any bond you’re considering – price and yield, maturity date and credit rating.

Score/5

0

5

2

 


 
  

Mechanics of Buying

 

Couldn’t be easier – you simply need to choose a fund and decide how much you want to invest. Funds are bought and sold at a unit price set at the end of the trading day.

Bought and sold like a stock, which means you need to know how to submit a trade through an online broker. You can place an order at the current market price for your ETF, or set a lower price and wait to see if your order is filled.

Locate a bond you want to buy and then make sure your broker has sufficient inventory on hand to fill your order. You will also have to pay the seller accrued interest, which is a pro-rated share of the next semi-annual interest payment.

Score/5

4

4

3

 


 
  

Portfolio Building

 

There are six categories of bond fund – Canadian, short-term, long-term, real return, high yield and global. But all funds are run differently, which means it’s difficult to be sure exactly what approach your manager is using.

Bond ETFs are precision portfolio-building tools with clear mandates. The BMO ETF family includes short-, medium and long-term ETFs for federal government, provincial and corporate bonds. In the iShares family, there are ETFs that replicate five- and 10-year bond ladders. You can also add high-yield bonds, emerging market bonds, real-return bonds and more.

Buying individual bonds offers the ultimate in flexibility, but you lack the diversification provided by both ETFs and mutual funds. This is not a concern with government or blue-chip corporate bonds, but it could be if you’re buying corporate bonds with lesser credit ratings.

Score/5

2

5

2

 


 
  

What Happens When Interest Rates Rise?

 

Bonds fall in value when rates rise, and this will be reflected in the unit price of bond funds. When the rising rate cycle gives way to a decline in borrowing costs, bond funds will rise in price. There is no redemption date where you get your initial investment back, as there is with individual bonds.

Same as bond funds.

Can be volatile in price, especially bonds issued by non blue chip companies. But, default risk aside, you get your money back on maturity.

Score/5

2

2

4

 


 
  

Liquidity

 

Funds can only be traded at end of day prices.

Can be traded at any time during stock market hours, with full transparency on the prices that other investors are bidding and asking.

Can be traded at any time during bond market hours, but without detailed pricing information. You’re stuck with the price your broker is offering to sell or buy.

Score/5

1

5

3

 


 
  

Suitability For Generating Interest Income

 

Typically pay interest on a quarterly or monthly basis. Interest payments will vary slightly in their amount.

Often pay monthly, with the amount of each payment varying slightly.

Semi-annual interest is the norm, and you get the exact same amount of cash with each payment.

Score/5

4

5

2

 

 
  

Total Score/ 50

26

41

27

 


Click here for a printable PDF of Rob Carrick's definitive guide to bond investing choices.

 

Coming Soon in Portfolio Strategy: A look at the final piece of the puzzle in choosing bond investments - yield. How do yields compare on bond funds, bond ETFs and bonds?

Read more from Portfolio Strategy.

For more personal finance coverage, follow Rob Carrick on Twitter (@rcarrick) and Facebook (robcarrickfinance).

Follow on Twitter: @rcarrick

 

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