What are we looking for?
Bond funds to complement your equity exposure and reduce systematic risk.
The screen
Although the financial crisis is now more than a decade behind us, let’s not forget these sobering statistics: In the midst of the financial crisis, the average Canadian equity fund showed a maximum drawdown (value lost from peak to trough) of 43.6 per cent, while the average Canadian fixed income fund showed a maximum drawdown of only 3.6 per cent.
This is a textbook example of why it is imperative that we as investors have exposure to multiple asset classes (with low correlations to one another) to ensure diversification and reduction of systematic risk, also known as market risk.
In terms of one such asset class, fixed income, individual investors can certainly opt to create their own diversified bond portfolio, but some challenges block this path: 1) the minimum notional value required to purchase bonds directly; 2) the opaque nature of pricing in bond markets; 3) the limited choice in inventory, depending on your broker. An alternative is to look to fund managers who will take care of this for you, for a reasonable fee, one would hope.
This week, I look at Morningstar’s fund database to screen for the best fixed income funds in Canadian and global fixed income categories across two dimensions:
- The Morningstar rating over all, known to most as the “star” rating – a backward-looking assessment of a fund’s net-of-fee risk-adjusted return against similar funds. Ratings range from one to five stars, where funds receiving five stars have outperformed their peers historically, after fees. The star rating is a great starting point to understand which funds have historically performed the best within a category.
- The Morningstar Quantitative Rating, or “medalist” rating – a forward-looking assessment of a fund’s prospective ability to outperform similar funds after fees, based on five factors: people (the quality of the management team); process (the effectiveness and consistency of the investment process); parent (organizational structure and talent retention); performance; and price (fees). Ratings include gold, silver, bronze, neutral and negative.
To qualify, the fund must be rated four or five stars, and must have a medalist rating of silver or gold.
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
What we found
I used Morningstar Direct to pull the relevant information on the funds from the screen, inclusive of their trailing returns, management expense ratios, inception dates and yields. Note that there are two different categories displayed on this table. Canadian fixed income funds must contain at least 90-per-cent bond issues that are denominated in Canadian dollars with less than 30 per cent consisting of foreign issues. Global fixed income funds must have less than 90 per cent of holdings invested in CAD-denominated bonds.
Also note that the funds’ distribution channels are displayed. “Do it yourself” funds charge a lower overall fee because they do not include the cost of advice and are typically made available through a discount broker. Fee-based advice funds are distributed via full service brokerages that charge separately for advice (not included in the management expense ratios, or MERs, shown).
Finally, exchange-traded funds within these categories were also included in the search, however none met the requirements of the screen.
This column does not constitute financial advice. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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Ian Tam, CFA