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Gordon Pape: These ETFs offer ways to diversify your bond portfolio beyond Canada

I recently received the following e-mail from a reader who wants to add to his fixed-income position. It touches on an important issue that is relevant for many income-seeking investors, regardless of age: Bond diversification.

"My portfolio is now about 45 per cent cash after taking some profits. I am 75; my spouse is 65. I would like to have 25 per cent or so in fixed income. Would you see any problem with having the entire fixed income allocation in XBB, or would you suggest diversifying among a number of bond ETFs?"

XBB is the trading symbol for the iShares Core Canadian Universe Bond ETF. It covers the entire domestic bond market, including corporate and government issues of varying maturities. If you only want exposure to Canada, it's a good fund to hold.

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But Canada only represents a fraction of the world bond market. For more diversification, consider adding ETFs that provide exposure to fixed-income securities from the United States and overseas.

Here are two to look at if you want to achieve more global bond diversification.

iShares Core Total USD Bond Market ETF (IUSB)

Current price: $51.28 (U.S.)

Annual payout: $1.36 (trailing 12 months)

Yield: 2.7 per cent

Risk rating: Moderate

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This ETF invests in a portfolio of U.S. dollar-denominated bonds that can be both investment grade and high yield. It has done quite well in 2017 with a year-to-date gain of 4.3 per cent.

Although the portfolio can own high-yield bonds, most of the assets (60.2 per cent) are in triple-A rated securities. Another 29.7 per cent is held in investment grade bonds (BBB to AA), so exposure to the riskier high-yield market is minimal.

The fund has more than $1.1-billion in assets under management and trades an average of more than 84,000 units a day, so liquidity is good. The weighted average maturity is 7.64 years.

The net expense ratio is only 0.06 per cent. The fund makes monthly distributions that are currently running about 12 cents a unit, plus a year-end payment. The distributions are fully taxable, so this fund is best held in an RRSP or RRIF.

iShares Core International Aggregate Bond ETF (IAGG)

Current price: $52.08 (U.S.)

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Annual payout: $1.36 (trailing 12 months)

Yield: 2.6 per cent

Risk rating: Moderate

The mandate here is to invest in a portfolio of investment-grade bonds that are not denominated in U.S. dollars. The main holdings are issues from Japan, France, Germany, Italy, and Britain. All but a small fraction of the bonds are investment-grade (BBB or higher), so credit risk is minimal.

The fund makes monthly distributions, but they can vary significantly in the amount they pay, so don't buy if you require a steady, dependable cash flow. For example, the latest distribution (Sept. 1) was 13.5 cents a unit. But, in February and March, the payment was less than 2 cents.

This is a smaller fund than IUSB, with $450-million in assets. The average daily volume is about 69,000 units, so there is good liquidity. The average weighted maturity is 8.84 years.

The expense ratio is 0.09 per cent. Year-to-date return is 2.1 per cent. Ask your financial adviser whether these funds are suitable for your account.

Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to buildingwealth.ca.

Follow Gordon Pape on Twitter at twitter.com/GPUpdates and on Facebook at www.facebook.com/GordonPapeMoney.

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