If you can stay ahead of developments in the never dull bond market, there's some money to be made in long bonds.
Your attention is drawn to the iShares DEX Long Term Bond Index ETF (XLB), which we'll use as a proxy for investing in government and corporate bonds maturing in 10 years or more. With the stock markets in flux in the early weeks of 2014, XLB had notched a pretty decent gain of 4.5 per cent for the year to Feb. 4. That almost makes up for XLB's 6.6 per cent loss in 2013.
Long bonds are the most sensitive to moves in interest rates. If you want maximum stability from bonds, stick with short-term debt. With XLB, you get a weighted average duration of 13.5 years. In other words, a 1 percentage point move in rates would cause XLB to either rise or fall in price by 13.4 percentage points. Like, ouch.
If you want bonds to diversify your portfolio away from stock market risk – and you should – then steer clear of long bonds. But if you think you have a feel for where interest rates are headed, then XLB could be a way to add a little zing to your bonds through both capital gains and yield. XLB's weighted average yield to maturity after fees is 3.2 per cent, which compares to 2.1 per cent for the iShares DEX Universe Bond Index Fund (XBB). With XBB, you get a stand-in for the entire bond market and a duration of 7 years.
XLB is definitely a short-term hold, not a core position. You almost certainly do not want to be holding this ETF when the stock market settles down and investor attention returns to the U.S. economy and the Fed's tapering program. The better the economy looks, the harder XLB would be hit.
XLB wraps government and corporate long-term bonds into a single package. If you prefer government bonds alone, take a look at the BMO Long Federal Bond Index ETF (ZFL). It has a year-to-date gain of 5.3 per cent, but lost 9.3 per cent last year. Long corporate bonds are a little less rate sensitive, as shown by the BMO Log Corporate Bond Index ETF (ZLC). It lost just 3.8 per cent in 2013, and has made 4.2 per cent this year. ZLC's duration is 12.7 years, compared to 14.1 for ZFL.