Bond ETFs in the past year are your portfolio’s version of a hockey defenceman whose team gets scored on a lot.
Exchange-traded funds holding bonds are a cost-efficient, simple way to get diversified exposure to bonds, which almost all portfolios need to limit the downside when stocks plunge. But the returns produced by these defensive holdings have been pretty bad in the past while.
The bond ETFs covered in the second installment of the six-part 2022 Globe and Mail ETF Buyer’s Guide lost as much as 5.1 per cent in the 12 months to Jan. 31. Stocks can lose 5 per cent in a few terrible minutes, so let’s keep this drop in perspective. And if stocks were to fall, bonds can be expected to hold their ground. That’s happened in the stock market volatility caused by the Russian invasion of Ukraine.
But investors still need to take an extra measure of care in managing their holdings of bond ETFs. What’s in your bond ETF, and how vulnerable is it to rising interest rates? The ETF Buyer’s Guide will help you answer these questions for 11 funds, any of which could be suitable for your core bond holding.
Bond ETFs have been around for more than 20 years, a period through which interest rates mostly fell. As a result, there have been many good years for investors who hold these funds and only a few mildly bad ones. Bond market dynamics mean that the price of bonds and bond ETFs rises when rates move lower and fall when rates run higher.
With inflation running hot, it’s expected that interest rates will rise steadily in the next year or so from their pandemic lows. So buckle up, bond ETF holders. Challenging times are ahead for your portfolio’s defence corps.
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.
Notes: Market data as of March 1, 2022. Returns to Jan. 31, 2022. Source: Rob Carrick; Globeinvestor.com, ETF company websites
A quick tutorial on bonds and bond ETFs:
- 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.
- 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.
Stay informed about your money. We have a newsletter from personal finance columnist Rob Carrick. Sign up today.