An investing irony of early 2021 is that in the midst of a highly speculative environment, one of the big preoccupations of investors is what to do about bonds.
Medium- and longer-term bond yields have soared in 2021, depressing prices for both actual bonds and the exchange-traded funds and mutual funds that hold them. (Bond prices and yields move inversely.) The FTSE Canada Universe Bond Index was down close to 6 per cent for the year through mid-March.
This decline has a reader asking whether he’d be better off holding individual bonds rather than bond ETFs. “I guess with holding a bond to maturity, you know exactly what your return will be as compared to a bond fund,” he wrote. “I hold [a bond ETF], and it certainly has had some fluctuations in the past few weeks.”
True that. When you buy a bond from a financially viable company or government, you can be confident that it will be redeemed on maturity, regardless of price fluctuations between now and then. Bond ETFs never mature – they infinitely ride rate cycles over the years and decades.
We’ve had a long period of falling interest rates that generated an annualized total return of 4.1 per cent for the FTSE Canada bond index over the 10 years to Feb. 28. Now, we appear to be entering a rising-rate cycle that is driving bond prices lower. Bonds and bond ETFs will be similarly affected, but bonds are different in that they will deliver investors from volatility when they mature.
You don’t get that stability for free, though. When retail investors buy bonds, they’re stuck paying the prices demanded by their brokers. Generally, these prices are set at levels that lard in profits for the broker. The more you pay for a bond, the lower your yield. Bond ETFs, on the other hand, are stocked with bonds that were bought at wholesale prices and thus offer mildly better yields.
For investors with an eye on the long term, bond ETF fluctuations in the here and now can be shrugged off. You made good money in these funds in 2019 and 2020, you may give some back in 2021, and then we’ll have more up and down cycles to come.
If falling bond-ETF prices would drive you to distraction, actual bonds might help you stick to your ideal allocation of stocks and bonds rather than skimping on bonds. Another thought is to check out your broker’s selection of guaranteed investment certificates from alternative banks. They offer competitive yields but not the liquidity of bonds and bond ETFs. Also, the very best GIC rates come from issuers you have to access directly. They don’t do business with online brokerage firms.
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