With assets of close to $1.8-billion and a history going back more than a decade, the iShares Canadian Corporate Bond Index ETF (XCB) is a well-established option for the fixed income side of a portfolio.
But in a rising rate world, this and other bond ETFs are dead weight in a portfolio. Hence, this query from a reader: "I own [XCB] and I am curious if you consider it a loser," he wrote. "It has been flat for a long time."
Another reader recently asked about moving money out of bonds into "impact investments," which in this case means technology-based startups in areas like health care, education and food systems. "Bonds are doing nothing and impact investments look very good," this person wrote.
The ties that bind us to bonds are loosening, which is understandable. It goes against human nature to include something in an investment portfolio that everybody knows is under pressure right now and quite likely to produce losses. But bonds aren't as bad as people think. Let's use XCB as an example.
To start, this ETF delivered a total return of 2.9 per cent last year (interest plus share price changes) and an annualized 3.2 per cent over the past five years. You might consider XCB a loser if you look only at its share price performance, which this week showed a five-year decline of 0.2 per cent. But that's an incomplete picture.
XCB isn't the most cost-efficient ETF, with its management expense ratio of 0.4 per cent. But it does provide diversified exposure to bonds issued by the likes of the big banks, Enbridge and Rogers Communications at a much lower cost than any mutual fund. Corporate bonds are thought to be somewhat more resistant to rising rates than government bonds, so the exposure to blue chip companies is important in portfolio construction right now.
Bonds and bond ETFs keep paying you interest on a monthly or quarterly basis, regardless of where interest rates are. But the main reason to keep holding them is to act as a hedge against a stock market correction. Government bonds will do a better job of this than corporate bonds, but both will be a better place than stocks when the current bull market stalls.
After a long bull market, bonds are essential as a portfolio shock absorber. It's hard to accept this when rising interest rates are pushing bond and bond ETF prices lower, but that's diversification in action. Done properly, it means there will often be something in your portfolio that you consider a loser.
In an upcoming column, we'll look at GICs as an alternative to bonds in a rising rate world.