Low bond yields are the bad-news investing story of 2020 and probably 2021 as well.
You’ve probably heard many times from investing strategists about how low yields call into question whether it makes sense for balanced portfolios to have 40 or 50 per cent of their weightings in bonds. With five-year Government of Canada bonds yielding just 0.35 per cent in late October, it’s hard to argue.
Amid this gloom about bonds, a reader has noticed a disconnect in her portfolio.
“I keep reading how miserable bond returns are, but my bond ETF is doing better than most of my portfolio,” she said by e-mail. “I wonder why it’s not acting like the bonds underlying the fund.”
While bond yields are indeed depressingly low, 2020 has actually been a great year for the bond market. The benchmark FTSE Canada Universe Bond Index produced a total return of 8 per cent for the year through Sept. 30, which includes both interest and capital gains.
Actually, mostly capital gains. When interest rates plunge, as they did earlier this year, the price of bonds and bond funds move in the opposite direction. That’s why the FTSE Canada Universe Bond Index can be up a lot by bond market standards this year, even with paper-thin bond yields.
A sample of returns from broad-based bond ETFs that are like the index in holding both government and corporate bonds:
- BMO Aggregate Bond Index ETF (ZAG) was up 7.85 per cent for the first nine months of the year;
- iShares Core Canadian Universe Bond Index ETF (XBB) was up 7.88 per cent;
- Vanguard Canadian Aggregate Bond Index ETF (VAB) was up 7.82 per cent.
Don’t get used to results like this. Barring economic catastrophe, interest rates won’t fall significantly further. The most likely outcome is that rates continue at current low levels into 2021 and then gradually start to increase. Flat rates suggest you get the interest paid by bonds and not much more. Rising rates suggest capital losses that swamp meagre interest and leave investors with losses.
Now you see why there’s so little celebrating about bond returns in 2020. It’s unlikely we’ll see them repeated any time soon and, if we do, it will only happen if the economy’s in serious trouble.
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