Every time a setback for bond funds has seemingly arrived in the past 10 years, a surprise decline in interest rates has saved the day.
Who knows, maybe bond funds will pull out of the slump that began in the first two months of 2021. But in early 2021, with yields in the bond market moving higher, the price of bonds and bond ETFs slipped a bit.
Losses in bond ETFs? Aren’t they supposed to be the conservative part of a portfolio?
This second instalment of the 2021 Globe and Mail ETF Buyer’s Guide will help you navigate whatever comes for bonds by helping you understand the risks posed by higher rates. Bond exchange-traded funds come in many versions, each offering a different balance of risk and return.
The bond ETF categories covered in the guide include broad market funds combining corporate and government bonds of short, medium and long maturities, short-term bond funds and funds holding strictly corporate bonds. Passive index-tracking funds and actively managed funds are included.
A quick tutorial on bond market dynamics:
- Bond and bond ETF prices fall when interest rates rise, and they move higher in a falling rate environment. Note the brief but sharp price decline for all bond ETFs in this survey that happened in March 2020. Bond prices plunged in the financial market panic early in the pandemic, then quickly righted themselves.
- 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.
- The best measure of the yield you can expect from a bond ETF is the after-fee yield to maturity, not the backward-looking yield data you get on stock quote websites.
- Bond returns have two components – price appreciation or declines in the bond or bond ETF 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.
- 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.
- Bond ETFs offer instant diversification and yields that are very competitive with individual bonds, even after fees; the companies managing bond ETFs get better pricing when they buy and sell bonds than retail investors.
The bond ETFs shown included in the Buyer’s Guide have been around for at least five years and are suitable as a core bond holding designed to soften the blow of a stock market decline while also paying at least a modest amount of interest income.
Notes: Market data as of Feb. 22, 2021. Returns to Jan. 31, 2021. Sources: Rob Carrick; Globeinvestor.com, ETF company websites
Here’s an explanation of some investing terms used in the ETF Buyer’s Guide:
Assets: Shown to indicate how a fund has resonated with investors. A $1-billion fund is considered huge, while $100-million is a serious size.
Management expense ratio (MER): The main cost of owning an ETF on a continuing basis; returns are shown on an after-fee basis both here and on ETF company websites.
Returns: The ETF guide shows total returns, which reflect price changes in the bonds that a fund holds as well as interest paid by those bonds.
Launch date: The older an ETF is, the more likely you can look back at a history of returns through good markets and bad.
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