Some of the happiest investors in the years ahead will be those who in 2022 bought guaranteed investment certificates paying 5 per cent.
But GICs aren’t ideal for everyone. They can’t easily be bought and sold unless you buy a cashable variant with lower returns, they may not offer the very highest yields and they offer no potential for capital gains if interest rates peak and then turn lower. For all of those benefits, consider corporate bonds purchased either directly or through exchange-traded funds.
Corporate bonds were singled out by Kurt Reiman, BlackRock’s senior strategist for North America, in a recent Q&A on the investing outlook for the second half of 2022. “The corporate bond market has priced in a recession outcome,” Mr. Reiman said. “You’re now getting a [higher] yield on corporate bonds that’s equivalent to what you would have found, say, 20 years ago. That’s a tactical opportunity that we are taking over six to 12 months to augment returns.”
Success in bonds this year is judged by how little you lost, rather than how much you made. On that count, corporate bonds have outperformed mildly while offering better yields.
The FTSE Canada Universe Bond Index (including government and corporate bonds) dropped 12.2 per cent for the first six months of the year, while the FTSE Canada All Corporate Bond Index fell just under 11 per cent. The universe bond index yield in late July was 3.6 per cent, while the corporate bond index had a yield of 4.6 per cent.
The term “corporate bond” is understood to mean bonds issued by companies with an investment-grade credit rating, which means BBB and higher. High-yield bonds are also issued by corporations, but the credit ratings are below investment grade and thus present more risk of default along with higher yields.
You can buy corporate bonds individually through a full-service or online broker. Bond yields fell sharply this week, which meant corporate bonds yielding 5 per cent over five years were pretty much unavailable by Friday. However, one particular online broker’s inventory of corporate bonds earlier in the week included a five-year Primaris REIT bond yielding 5.3 per cent and a six-year RioCan REIT bond yielding 5.2 per cent. Financial markets are volatile these days, so don’t give up on the idea of bond yields climbing back some.
Corporate bond ETFs offer much better diversification than owning a few individual corporate bonds, but there’s usually no maturity date when you get your principal back. Bond ETFs ride the economic cycle over the years, rising in price when interest rates fall and losing value when rates rise.
If interest rates were to stop rising and then head lower, the price of both bonds and bond ETFs would rise. It’s possible investors might be able to sell at a profit at some point, though the point of bond holdings in general is to generate income and hedge against stock market plunges.
Short-term corporate bond ETFs, with holdings that mature in no more than five years, are a kind of sweet spot for bond investing in 2022. They’re down about half as much as the FTSE corporate bond index, yet you give up almost nothing in yield. Expect something like 4.3 per cent from a short-term corporate bond ETF these days.
This includes target date corporate bond ETFs, which are unique in having a date when they mature. For example, the RBC Target 2025 Corporate Bond Index ETF (RQN) had a yield of 4 per cent lately and a termination date on or about Nov. 30, 2025.
We’re talking here about after-fee yield to maturity, which is the best measure of the yield to expect looking forward when you buy any bond ETF. ETF companies include yield to maturity in their online fund profiles – subtract a fund’s management expense ratio for the net yield.
Yields in GIC-land are holding up better than in the bond market. At the end of July, there were about 10 alternative banks and credit unions offering 5 per cent yields on five-year GICs. The safety level for these GICs is high because issuers are all members of Canada Deposit Insurance Corp. or provincial credit union deposit insurance plans.
Consider GICs if you want a worry-free but illiquid investment that offers yields not seen in decades. Corporate bonds are for more active investors looking for much superior liquidity, potentially higher yields, and the possibility of price gains when we get to the other side of today’s cycle of rising interest rates.
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Rob Carrick