The arrival of exchange-traded funds has opened up new possibilities in this asset class.Getty Images
There was a time when bond investing was simple, low risk and predictable. An investor would buy some Canadian federal and provincial government bonds – maybe a quality corporate bond or two – sock them away, collect the interest payments until maturity, and then repeat. In today's world of financially engineered products, bonds are charting new territory in terms of complexity, safety, return rate and special features.
The arrival of exchange-traded funds (ETFs), in particular, has opened up new possibilities in this asset class. There are several innovative categories of bond-based ETFs now trading on the Toronto Stock Exchange.
1.Canadian Corporate Bond Ladders
In the current low interest rate world, investors are reaching for yield by climbing the risk ladder and buying corporate bonds. In anticipation of rising interest rates, they also want bonds with short maturities. Several ETFs, which are based on a one- to five-year ladder of investment grade Canadian corporate bonds, fit this bill:
-BMO Short Corporate Bond Index ETF
-Claymore 1-5 Yr Laddered Corporate Bond ETF
-iShares DEX Short Term Corporate Universe + Maple Bond Index Fund
-PowerShares 1-5 Year Laddered Investment Grade Corporate Bond Index ETF .
The relatively new iShares fund (launched in September) has added a foreign twist and additional diversification by also investing in maple bonds. The latter are Canadian dollar denominated bonds issued in Canada by foreign companies.
2.U.S. Corporate Bonds
The United States is home to many successful companies, including those owning such iconic global brands as Apple, Coca-Cola, GE and Procter & Gamble. Its huge U.S. corporate bond market is fertile ground for Canadians seeking quality corporate bonds to add diversification to their bond portfolios. The iShares U.S. IG Corporate Bond CAD-Hedged Index Fund makes it simple to access these bonds without the currency exchange risk.
3.Bonds from emerging Market Countries
Emerging market countries issue bonds to fund the infrastructure and services their expanding economies demand. Canadians who want to own these bonds to diversify their portfolios can choose from two funds, both hedged to the Canadian dollar.
-BMO Emerging Markets Bond Hedged to CAD Index ETF
-iShares J.P. Morgan USD Emerging Markets Bond Index Fund (CAD-Hedged) .
4.High Yield Bonds
High yield bonds. What an enticing name! Who wouldn't want to own some? Scratch below the surface, however, and you discover high-risk, non-investment grade bonds issued by companies that might well default on their debt. The investing premise is that some bonds will fail, but the high interest paid by the remaining bonds will provide a decent return.
The competition in this category among Canadian ETF issuers is robust; something to do with the name, probably. While only one ETF targets the Canadian high-yield corporate bond market, the iShares DEX HYBrid Bond Index Fund , several more focus on the huge American market:
•BMO High Yield US Corporate Bond Hedged to CAD Index ETF
•Claymore Advantaged High Yield Bond ETF , CAD-hedged
•Claymore Advantaged Short Duration High Income ETF, CAD-hedged and unhedged versions are available
•iShares U.S. High Yield Bond CAD-Hedged Index Fund
•PowerShares Fundamental High Yield Corporate Bond (CAD-Hedged) ETF .
5.Convertible Bonds
The Claymore Advantaged Convertible Bond ETF , which was just launched in June, invests in an index of convertible bonds from Canadian issuers. These bonds pay bond-like interest and offer the chance for additional profit if the issuer's stock price rises.
6.Tax-efficient Bond ETFs
Claymore Advantaged Canadian Bond ETF invests in Canadian government and corporate investment grade bonds with a tax-efficient difference. It uses a Forward Agreement with a Canadian bank to re-characterize highly-taxed interest income as lower-taxed return of capital and capital gains. The other Claymore Advantaged ETFs mentioned above use similar strategies.
These ETFs are suited to non-registered accounts where the tax benefits can be realized.
7.Target date maturity bonds
The two Canadian banks in the ETF business, Royal Bank of Canada and Bank of Montreal, each offer a series of Target Date Maturity Bond ETFs. These ETFs seek to track the performance of a portfolio of Canadian corporate bonds with an average term to maturity equal to a specified date. These ETFs are designed for investors, such as retirees, who want their capital returned on the specified date.
8.ETFs that bet on bond price changes
ETFs that speculate on the daily ebb and flow of bond prices are tailor-made for day traders. The objective of the Claymore Inverse 10-Year Government Bond ETF is to deliver the inverse of the daily return of its namesake bond on a non-leveraged basis. The Horizons BetaPro U.S. 30-Year Bond Bull Plus ETF , and Bond Bear Plus ETF seek to return 200 per cent of the daily (Bull Plus) or the inverse daily (Bear Plus) performance of the U.S. 30-Year Bond futures contract for the next delivery month. Both are Canadian dollar hedged and employ leverage.
These three ETFs are highly speculative funds based on the daily performance of the underlying bonds and are not buy-and-hold investments.
Several of the bond-based ETFs discussed in this article are relatively recent additions to the Canadian ETF universe, and have no track record. Only time will tell if they can deliver on their advertised mandates.