Alfred Lee often hears about investors moving out of bonds and into dividend-paying stocks to find yield in today’s low-interest-rate world. And while he’s biased as a bond portfolio manager at BMO Global Asset Management, Mr. Lee doesn’t believe abandoning fixed-income products is a good strategy for investors looking to balance their portfolios.
“I would use that strategy with caution,” says Mr. Lee, whose BMO Mid Corporate Bond Index ETF (ZCM) won a Refinitiv Lipper Fund Award this year in the Canadian corporate fixed-income category for the three-year period ended July 31.
“When equity markets sell off, dividend stocks are going to behave like stocks, because they are stocks,” Mr. Lee says. “They will offer no diversification benefits. Owning bonds at that time will provide you with more stability and balance.”
It’s advice that some investors would have eaten up when markets plummeted in March but may fall on deaf ears amid the roaring rebound in recent weeks.
Still, those who own the BMO Mid Corporate Bond Index ETF have been rewarded so far this year. ZCM, with a management expense ratio (MER) of 0.33 per cent and 12-month yield of 3.2 per cent, has seen a total return of 8.6 per cent so far this year as of Nov. 17. That’s ahead of the 7.5-per-cent total return of the broader FTSE/TMX Canada Bond Universe.
ZCM’s annualized total return for the past three years is 5.6 per cent and 4.9 per cent over five years, according to Morningstar.
Mr. Lee says the fund benefited from the current “Goldilocks environment” of low rates and tightening credit spreads. The low rates are good for the ETF’s mid-term Canadian corporate bonds with maturity ranges of between five and 10 years, while an improving economic outlook in recent weeks has made corporate credit more attractive. The ETF, which has $1.1-billion in assets, has just over 200 holdings – the top ones include some of Canada’s largest banks as well as Enbridge Inc. and Suncor Energy Inc.
Mr. Lee says some investors buy ZCM if they’re seeking a “yield pickup” from simply holding government bonds and as a way to diversify their bond holdings into corporate debt.
The Horizons Active Canadian Bond Fund (HAD) – another Refinitiv Lipper Fund Award winner this year, for best fund in the Canadian fixed-income category for the three and five years ended July 31 – has also seen a boost from holding corporate credit as well as a mix of longer-term government bonds.
The ETF, with $70-million in assets, an MER of 0.48 per cent and a 12-month yield of 2.1 per cent, saw a total return of 8.7 per cent so far this year and 7.7 per cent over the past year, as of Nov 17.
“The combination of interest rates falling dramatically and corporate bonds doing better produced these equity-like returns,” says Jane-Marie Rocca, vice-president and senior portfolio manager at Fiera Capital, who represents the ETF.
The fund’s annualized total return over the past three years was 6 per cent and 4.5 per cent over the past five years.
About one-third of HAD’s holdings are corporate bonds, while the remainder is a mix of municipal, provincial and federal government bonds with an average duration of about eight years. The fund also has about 4 per cent in cash. About 25 per cent of the fund is liquid, which Ms. Rocca says enables the more active strategy that has been key to the outperformance versus the benchmark.
“I’ve heard for a long time ‘bonds are done,’” says Ms. Rocca, but she says the performance of HAD and some other funds proves otherwise.
“You do need to have fixed income,” she says. “Even though it’s not as glamorous as equities, it’s a part of the world and the movement of capital and allows businesses to be able to grow and investors to be able to have some diversification of their portfolios.”
Read more about the winners of this year’s Lipper Awards