[ssimps]

I read the following article yesterday:

http://www.theglobeandmail.com/glob...en-your-seatbelts-home-buyers/article1419098/

Interesting read, like I find a lot of the stuff Rob Carrick writes is.

In the article he has a section labeled:

''3. Enough with the bond funds already''

My question is whether you agree with his comments on bond funds (well ETFs in my case).

I thought the point of 'laddered' bond ETFs (like CLF and CBO ) was to reduce the problem Rob is mentioning; or if you are really worried, what about buying real return bond ETF like XRB?

 

[HaroldCrump]

In the article he has a section labeled:

''3. Enough with the bond funds already''

My question is whether you agree with his comments on bond funds (well ETFs in my case).

I thought the point of 'laddered' bond ETFs (like CLF and CBO ) was to reduce the problem Rob is mentioning; or if you are really worried, what about buying real return bond ETF like XRB?

I completely agree with point 3. about bond funds.
I've held the TD eSeries DEX bond index fund for many years and the returns are mediocre at best.
In retrospect, I feel I could have bought a 5 year GIC back when they were yielding 4% or so (around 2006) and had better returns and slept better.
The Canadian guru of bonds - Hank Cunnigham - is also very critical of bond funds and ETFs in his writings/books/commentaries for similar reasons as this article.
We also discussed issues with the laddering ETFs like CLF in another thread.
I'm still not clear exactly how these ETFs are "rolling over" the bonds instead of laddering, so I'll appreciate if anyone can describe that problem with ETFs.

I am, however, still a believer in bonds and have modified my approach to buying and holding individual bonds to maturity.
There are issues with doing this approach though, such as:
- Higher risk than holding a bond ETF because unless you have a multi-million dollar bond allocation, you can't replicate the diversification of a bond ETF
- Ineffective laddering: again because of a small portfolio, you can't achieve good laddering. You'll have to make small purchases and sometimes may not have funds available to make a purchase.
- Higher spreads and poor selection: most discount brokerages have a very poor selection of bonds. Your brokerage may not have a bond you want, or may not list it in their online searches or screenings.
If you hear of a bond and wanna buy one, you'll need to talk directly to their trading desk and they'll have to go find it for you.
The spreads you pay are higher as well and often you can't figure out exactly how much spread you are paying.
Sometimes, the person at the trading desk may be forthright with you and tell you exactly what the spread is but they are under no obligation to tell you the exact truth.
And if you buy online, you won't know the spread.
But then the MER of a bond fund/ETF balances out with this, I suppose.
The spread is a one time thing, while the MER is an yearly thing the larger your portfolio gets, the more it starts to be an issue.

 

[ssimps]

I completely agree with point 3. about bond funds.

Thanks for the reply.

What about something like XRB real return bond ETF? I guess it is inflation protected, not interest rate protected, so maybe it is in the same basket?

Besides, what are the alternatives? He suggests buying 1 year GICs (he says hold GICs that mature in 2011), you'll get 1 -2 % from one of those I think; is that even covering inflation?

Maybe the point is to basically increase your cash holding so that you can buy GICs when they have higher rates, or bonds when their yield goes up cuz their price is doing down. If that is the case, maybe instead of cash, get risky and put it in equity ETFs.

I'm concerned about this because right now I have about 50% of my portfolio in a few 'laddered' bond ETFs and am wondering if I should sell now.

 

[HaroldCrump]

What about something like XRB real return bond ETF? I guess it is inflation protected, not interest rate protected, so maybe it is in the same basket?

Sorry, I know nothing about RRB.

Besides, what are the alternatives? He suggests buying 1 year GICs (he says hold GICs that mature in 2011), you'll get 1 -2 % from one of those I think; is that even covering inflation?

IMO, no.
He's suggesting building a GIC ladder, which is fine.
The first step in the ladder, when you start it, is a 1 yr. GIC.
Don't think about covering inflation for that GIC.
By and large, GICs will stay in step with inflation.
GICs are a cash preservation technique and a technique to ensure a stready supply for cash for living expenses.
They are not a growth vehicle.

I'm concerned about this because right now I have about 50% of my portfolio in a few 'laddered' bond ETFs and am wondering if I should sell now.

If you sell, it should be to buy bonds directly.
Don't sell and buy equity ETFs because you'll be changing your asset allocation and it will not be in line with your risk tolerance.
If you cannot, or do not wish to, build a bond ladder yourself then the ETFs are ok, I think.
It gives you easy expose to the bond market and allows you to asset allocate cheaply and with minimal research.
The reason experts (like Cunningham) don't like bond ETFs are because of high fees relative to value delivered and because of they don't provide predictable returns and cash values.
If you are not a retiree or planning to retire anytime soon, those concerns may not matter to you.

 

[OhGreatGuru]

Hard to argue with his position. Interest rates have been in such a prolonged slump that returns on bond funds have fallen. (Returns were unusally high in the 90's dues to falling interest rates and inflation rates.) And rising interest rates will punish returns on bond funds in the short term.

I suspect this year's rush to bond funds is due to investor nervousness after the market crashes of recent years; and because many people are predicting a correction in equity markets in 2010.

However, unless you can tolerate no volatility at all in the income part of your portfolio, it seems to me a short-term bond or mortgage fund will track 5-year GIC returns well with less work than laddering GICs.

 

[ssimps]

If you sell, it should be to buy bonds directly.

The reason experts (like Cunningham) don't like bond ETFs are because of high fees relative to value delivered....

What are the fees associated with buying bonds directly? 0.5,1,2%? I'm asking cuz I have no idea.

The ETFs have an MER of .15% and .25%.

I'm trying to determine how much $ you would need to spend on buying real bonds before they really were cheaper to buy than to pay the MER, even on a yearly basis, since you would be paying the bond fees yearly as well if you were doing your own laddered bond thing as well.

.... and because of they [bond funds] don't provide predictable returns and cash values.

This I get, and is my concern.

Don't sell and buy equity ETFs because you'll be changing your asset allocation and it will not be in line with your risk tolerance.

Fair enough point.

If you are not a retiree or planning to retire anytime soon, those concerns may not matter to you.

I'm working towards financial independence, ASAP, if things keep going as they have been (not my returns on investments necessarily but on my yearly contribution ability), then I hope this to be in 3 - 5 years. Here's hoping it works out.

Thanks again for the input.

 

[ssimps]

1 year GIC vs savings account

Another thought...

On the right side of the article it lets you view the top 1 year GIC rates (highest seems to be 1.75%), as well as top savings account rates (top seems to be 2.1%).

If one assumes (which I do not necessarily) that the 2% savings account rate is not a gimmic and will hold, and if you assume as the article suggests that interest rates will go up this year, then would it not be better to go with the 2% savings account than the 1 year GIC? You can transfer the saving account $ when you want and the rate may actually go up over the year (if interest rates do), instead of being locked into a 1 year GIC at 1.75%.

So even if bond ETF prices are going to fall and therefore you should get out of them as Rob C. is suggesting, would it not be better to move to a 2% savings account instead of a 1 year locked in 1.75% GIC?

 

[HaroldCrump]

What are the fees associated with buying bonds directly? 0.5,1,2%? I'm asking cuz I have no idea.

The ETFs have an MER of .15% and .25%.

I think short term bonds are in the 40 to 50 basis points spread.
Not sure about long term bonds - I don't have any.

So even if bond ETF prices are going to fall and therefore you should get out of them as Rob C. is suggesting, would it not be better to move to a 2% savings account instead of a 1 year locked in 1.75% GIC?

Yes, assuming the 2% is not a teaser rate.

 

[ssimps]

I think short term bonds are in the 40 to 50 basis points spread.

By short term you mean 1 - 5 years ish and it costs about .5% of invested amount for each buy?

If so, then purchase cost is not a significant difference between buying real bonds vs low MER 'laddered' bond ETFs. if you are buying the bonds each year, and paying 0.5% each time, the ETFs may actually be cheaper in terms of investment cost. maybe about the same depending on the specifics.

So we are left with the trade off between a locked in guaranteed investment with known return (laddered real bonds) vs liquid investment that is not guaranteed, but likely not really high risk ('laddered' bond ETFs).

Would you agree with that summary?

Yes, assuming the 2% is not a teaser rate.

That is a good word for it, and a concern I have about them; I mentioned in another post that I've been burned / upset by these 'teasers' before.

Thanks again

 

[HaroldCrump]

So we are left with the trade off between a locked in guaranteed investment with known return (laddered real bonds) vs liquid investment that is not guaranteed, but likely not really high risk ('laddered' bond ETFs).

Direct bonds have varying degrees of liquidity.
Federal bonds are very liquid, esp. if they are benchmark ones, provincial bonds are fairly liquid too.
Munies can be troublesome.
Corporate bonds from well-known issuers like Bell, GWH, POW are fairly liquid.
Below that, you get into liquidity issues.
Smaller issues are very illiquid.
Sometimes the brokerage you bought from may buy it back from you, but at very unfavorable bids.

Interest rate based volatality depends on how committed you are to holding the bond.
Bond ETFs/funds will move as per changes in rates but if you are buying and holding individual bonds, you may not care much about interest rate based volatility on the market bid prices of your bonds.
However, you still have opportunity cost hit every time interest rates increase and you continue to hold the bond.

That is a good word for it, and a concern I have about them; I mentioned in another post that I've been burned / upset by these 'teasers' before.

They are all teaser rates.
I got burned by PCF's teaser rate for TFSA early in Jan 2009 when the TFSA account first came into being.
Scotia played the same dirty game with the internet Power-Savings account.

 

[ssimps]

Scotia played the same dirty game with the internet Power-Savings account.

Yup, that's one I got suckered by.

 

[HaroldCrump]

By short term you mean 1 - 5 years ish and it costs about .5% of invested amount for each buy?

If so, then purchase cost is not a significant difference between buying real bonds vs low MER 'laddered' bond ETFs. if you are buying the bonds each year, and paying 0.5% each time, the ETFs may actually be cheaper in terms of investment cost. maybe about the same depending on the specifics.

One other note, it is easier to think of bond trading commissions as yield spreads.
It is normally expressed in basis points that you lose from the wholesale market yield.
So if your brokerage charges 50 bps markup, your yield is less by 0.50%.
You can express it as a % of the face value by dividing the commission by the face value.
In general, higher the term the higher is the markup.

 

[HaroldCrump]

I forgot to mention upthread one other major disadvantage of holding bonds directly vis-a-vis bond fund.
That is the issue with re-investment and associated risk.
For a small investor, re-investing the coupon payment is very hard to do effectively.
And if you can't re-invest the coupon payments at the same rate, then you won't achieve your YTM.

 

[brad]

I'm interested in this because now that I'm getting older (51 in a few days) I'm starting to pay a little more attention to bonds and GICs and thinking of ways to increase their percentage in my portfolio.

The Couch Potato model porfolios here http://canadiancouchpotato.com/model-portfolios/ still include bond funds; is the current situation serious enough to warrant revisiting that strategy, and if so should these portfolios be proposing laddered GICs instead? What's the best approach for a couch potato investor who wants some balance but doesn't want to put a lot of effort into it?

 

[ssimps]

I'm interested in this because now that I'm getting older (51 in a few days) I'm starting to pay a little more attention to bonds and GICs and thinking of ways to increase their percentage in my portfolio.

The Couch Potato model porfolios here http://canadiancouchpotato.com/model-portfolios/ still include bond funds; is the current situation serious enough to warrant revisiting that strategy, and if so should these portfolios be proposing laddered GICs instead? What's the best approach for a couch potato investor who wants some balance but doesn't want to put a lot of effort into it?

I still vote for bond ETFs (not funds). You can get bond ETFs with MERs of .15%-.4% as the bond part of your portfolio. Go short term for now (1-5 years).

 

[brad]

I still vote for bond ETFs (not funds). You can get bond ETFs with MERs of .15%-.4% as the bond part of your portfolio. Go short term for now (1-5 years).

Does that work out, though, for people like me who do dollar-cost averaging and contribute every month to their RRSP? That's 12 transactions per year, and I wonder if the brokerage fees for ETFs end up losing you money compared with bond funds? The bond portion of my portfolio is only about $30-40K at this point.

My understanding is that ETFs in general make more sense than funds once you get over ~$50K and if you only do a few transactions per year. But if you do lots of transactions and your overall investment in that class is less than $50K then the fund should be fine -- assuming the returns are comparable. Maybe that ("comparable returns") is the piece of the puzzle I'm missing here?

 

[HaroldCrump]

Does that work out, though, for people like me who do dollar-cost averaging and contribute every month to their RRSP? That's 12 transactions per year, and I wonder if the brokerage fees for ETFs end up losing you money compared with bond funds? The bond portion of my portfolio is only about $30-40K at this point.

ETFs do not lend themselves well for DCA because the trading commissions eat up the gains.
TD eSeries are better suited for that.

In general, I would still pick a bond ETF/eSeries over a GIC ladder.
Govt. bonds have an yield spread of at least 1% over GICs and corporate bonds have a larger spread.
In a moderate inflationary environment (like one we will hopefully enter soon) a bond fund ought to beat GICs by more than 1% and in case of corp. bonds, by 3% or more.

 

[ssimps]

ETFs do not lend themselves well for DCA because the trading commissions eat up the gains.
TD eSeries are better suited for that.

In general, I would still pick a bond ETF/eSeries over a GIC ladder.
Govt. bonds have an yield spread of at least 1% over GICs and corporate bonds have a larger spread.
In a moderate inflationary environment (like one we will hopefully enter soon) a bond fund ought to beat GICs by more than 1% and in case of corp. bonds, by 3% or more.

I agree it depends on the amount being traded whether ETF or mutual funds are better. You can always use mutual funds to do your DCA and then move the cash to an ETF when you have enough to justify the commission.

Over the long term, you want lowest MERs though, especially with what bond funds are currently paying.