Among the financial oddities of the past few years, almost nothing stands out like the two consecutive money-losing years for bonds.
Bonds are supposed to stabilize investment portfolios, not blow a hole in them. But the benchmark FTSE Canada Universe Bond Index fell 2.5 per cent in 2021 and 11.7 per cent in 2022. A recovery began in 2023, and it has more room to run. For ideas on how to participate in this turnaround, consult this second instalment of the 2024 Globe and Mail ETF Buyer’s Guide.
Bonds were sabotaged by inflation, which subsided last year and is expected to decline further in 2024. Therein lies a big benefit of holding bonds, especially in a well-diversified, low-cost ETF format. Declining inflation clears room for lower interest rates, which in turn mean higher prices for bonds.
Rising bond prices combine with the interest bonds pay to create total returns that can be quite attractive in some years. The FTSE Canada Universe Bond Index made 6.7 per cent in 2023, with a 10-year average annual gain of 2.4 per cent. More gains for bonds could be driven by falling inflation and rates or by a sharp stock market pullback.
A simple and cost-effective way to add bonds to a portfolio is to pick an aggregate bond ETF, which covers the broad market of government and corporate bonds with an investment-grade credit rating. The guide offers a wide variety of aggregate bond ETF picks, plus several short-term and corporate bond funds for investors who like to tweak their bond exposure. Short-term bonds are less volatile than the broader bond market, while corporate bonds add a bit of extra yield and risk.
Now for a quick tutorial on bonds and bond ETFs that covers some of the terms used in the guide:
Risk: The key measure for evaluating how much bonds and bond ETFs can fall in price if rates rise is duration, which is expressed in years. If interest rates rise by one percentage point, the price of an ETF with a duration of five years would fall 5 per cent (and vice versa if rates fall); the higher the duration, the more risk there is if rates rise. And more potential benefit if rates decline.
Yield: The best measure of the yield you can expect from a bond ETF is the after-fee yield to maturity of the underlying bonds, not the backward-looking yield data you get on stock quote websites.
Returns: Bond returns have two components: price appreciation or declines and interest paid by the bonds in the portfolio. Together they produce the total return that ETF issuers use to document the performance of their products.
Maturity: While individual bonds may fluctuate in price, they are redeemed at their issue price on a set date; the bond ETFs covered here do not mature and pay you your money back, so expect cycles of rising and falling unit prices over the years you own them. There is a small subset of bond ETFs that do mature – they’re called target maturity funds.
Fees: The measure of how much it costs to own a bond ETF is the management expense ratio (MER); returns are shown on an after-fee basis both here and on ETF company websites.
Download the source excel here.
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Rob Carrick