The least damaging way to hold fixed income when interest rates are rising is to stick to short-term bonds.
Long-term bonds fall the most in price when rates rise, a point that is driven home nicely by the performance of the BMO Long Federal Bond Index ETF (ZFL-T). The loss for the 12 months to Feb. 28 was 16.2 per cent, bad enough to drag the annualized five-year result to a loss of 1.8 per cent.
There’s $2.1-billion in ZFL right now, which is a lot. What can investors be thinking?
Here’s what: When interest rates level off and begin to fall, ZFL is an ideal way to play the rebound. We saw this happening on Monday, when bond prices soared in the aftermath of the collapse of Silicon Valley Bank. The reason why ZFL is a prime way to exploit a bond rebound is that its portfolio consists of long-term federal government bonds, which have been the biggest losers on price in the past year or so.
Prior to the SVB collapse, there was already reason for optimism that long bonds have rebound potential. We started 2023 with expectations of lower rates‚ which then turned to concern that inflation wasn’t going away as quickly as hoped. Bonds gained some ground, and then lost most of it. Still, ZFL was up 1.4 per cent for the first two months of the year. That’s better than the broad Canadian bond market, which was up 1 per cent.
ZFL is vulnerable if inflation is sticky enough to require further interest rate hikes. Whatever declines there are in the broad bond market will be magnified in ZFL. But for a total return based on unit price changes plus bond interest, ZFL looks interesting.
By the way, the after-fee yield to maturity for ZFL is about 3.1 per cent. That’s lower than the broad bond market, a quirk resulting from the fact that shorter-term bonds yield more than longer term bonds right now. This inverted yield curve is common when markets worry about recession risk.
A few other established spins on long-term bonds: The BMO Long Provincial Bond Index ETF (ZPL-T), BMO Long Corporate Bond Index ETF (ZLC-T), Invesco Long Term Government Bond Index ETF (PGL-NE) and TD Canadian Long Term Federal Bond ETF (TCLB-T). For a mix of long-term government and corporate bonds, there’s the iShares Core Canadian Long Term Bond Index ETF (XLB-T) and the Vanguard Canadian Long-Term Bond Index ETF (VLB-T).
The reason to consider some corporate long bonds is for extra yield. The after-fee yield to maturity for ZLC is 4.8 per cent.
-- Rob Carrick, personal finance columnist
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Stocks to ponder
Jamieson Wellness Inc. (JWEL-T) This beaten-down dividend stock is down 14 per cent year to date, making it the worst performing stock in the S&P/TSX consumer staples index. The stock is now in deeply oversold territory from a technical perspective. And that might be an opportunity. Historically, dips have represented buying opportunities for this stock. Jennifer Dowty looks at the investment case.
The takeaway for investors from the SVB crisis? Get ready for deflation, more pain in stocks, and a rally in long-term bonds
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The Frugal Dividend portfolio can help investors find stock bargains
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Ask Globe Investor
Question: In February, 2022, I bought 47,500 units of the iShares Canadian Financial Monthly Income ETF (FIE), which provide me with $22,800 in distribution income annually. Unfortunately, the unit price has fallen, and I have an unrealized capital loss of $60,000 (or a net loss of $37,200 if I factor in the distributions already received). My question is: Should I hold the ETF for another year or two so I can make up the capital loss with additional distributions, and then sell my units? Is my thinking rational? I’m a retiree and love the monthly cash flow, but I want to sell without losing too much and get more diversified with individual dividend-paying stocks.
Answer: It’s hard for me to provide specific guidance without having a complete picture of your financial situation and the rest of your portfolio. But I’ll provide some general comments that I hope will clarify matters so you can come to your own conclusion. My full response can be found here.
What’s up in the days ahead
Inflation data on deck for markets hit by worries about Fed, banks
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Compiled by Globe Investor Staff