Awful as their returns have been, bond ETFs keep attracting a healthy flow of money from investors.
The reason is that diversified portfolios need bonds, and exchange-traded funds are a great way to access them. For help in choosing a bond ETF suitable for your portfolio, consult this second installment in the 2023 Globe and Mail ETF Buyer’s Guide.
You’ll see in the guide how cheap it is to buy exposure to the broad bond market in Canada, including federal and provincial government bonds, and corporate bonds as well. You’ll also see how weak returns have been in recent years. The ETFs in the guide produced average losses of 4.3 per cent for the 12 months to Jan. 31 and 1.3 per cent for the three-year period.
Some investors have turned to guaranteed investment certificates instead of bonds, which makes sense because they offer a virtually risk-free return of 4 to 5 per cent right now. What bond ETFs offer is the potential for strong total returns when interest rates eventually start to decline.
Just as rising rates have hurt the price of bonds and bond funds, so would declining rates help push prices higher. You’d get the interest paid by your bond ETF, plus an increase in the unit price. This total return is unavailable with GICs, which pay a set rate of interest and don’t fluctuate in price.
Bond ETFs will fall further in price if rates rise from current levels. But the trend for rates over the next 12 to 24 months is very likely down, not up.
The bonds covered in the guide mainly offer broad-based exposure to the Canadian bond market, which means they could be your one and only bond fund. Also in the mix are some short-term bond funds, which are a more conservative way to invest in the bond market. Short-term bonds are less sensitive on both the down and up side to changes in interest rates.
Click here to download an Excel version of the guide.
Notes: Market data as of Feb. 27, 2023. Returns to Jan. 31, 2023. Sources: Rob Carrick; ETF company websites; Globeinvestor.com, TMX Money
Now for a quick tutorial on bonds and bond ETFs that covers some of the terms used in the guide:
Risk: The key measure for evaluating how much bonds and bond ETFs can fall in price if rates rise is duration, which is expressed in years. If interest rates rise by one percentage point, the price of an ETF with a duration of five years would fall 5 per cent (and vice versa if rates fell); the higher the duration, the more risk there is if rates rise. Also, more potential benefit if rates decline.
Yield: The best measure of the yield you can expect from a bond ETF is the after-fee yield to maturity of the underlying bonds, not the backward-looking yield data you get on stock quote websites.
Returns: Bond returns have two components – price appreciation or declines, and interest paid by the bonds in the portfolio; together, they produce the total return that ETF issuers use to document the performance of their products.
Maturity: While individual bonds may fluctuate in price, they are redeemed at their issue price on a set date; the bond ETFs covered here do not mature and pay you your money back, so expect cycles of rising and falling unit prices over the years you own them.
Fees: The measure of how much it costs to own a bond ETF is the management expense ratio (MER); returns are shown on an after-fee basis both here and on ETF company websites.
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