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Discussion Starter · #1 · (Edited)
Question about short term bond etf (XSB) & DRIP

Hi,

I'm want to but some funds from my RRSP into a safer position and am looking at TSE:XSB(iShares DEX Short Term Bond Index Fund). Now, I was wondering the following: If I have enough shares to get a new share with every dividend payment (in a DRIP), it would "feed" itself and would be a good long term position, too (years) correct? There's nothing that speaks against holding short term bonds for a long time period, is there? I understand that depending on the economic cycle, long term bonds would potentially pay better coupons/dividends but that's about it, isn't it?

What I'm particularly looking to do is, to protect my portfolio from a potential correction within the next 12 or so months.
And I'm wondering if there's downsides in being overweight on short term bonds other than missing out on a potential upside in markets.

Thank you!
Thanks for your answers!
 

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For a bond fund, DRIP is a good way to get the ideal "total return" of the bond ETF. I don't have any experience doing DRIP on ETFs, so you should check to confirm that there are no fees for doing this, but I think it's a good idea inside RRSP.

Short term bonds like XSB (or VSB, VSC, XSH) are all fine for "long term" holdings. The potential down sides are:

1. Underperforming stocks, if in fact stocks continue going up
2. Underperforming more typical bond funds like VAB or XBB if you end up sitting in XSB for a long period like 5-15 years.

If your anticipated holding period is about 1-5 years, XSB and VSB are well suited for that. You might also consider just putting the money in a high interest savings account if your brokerage has one of those available as it provides a steady interest rate, unlike XSB which fluctuates and could potentially have a negative return.

For example if you might be in & out of XSB in just a 6 month period, that's quite a short time and XSB could have a net loss. A high interest savings account will never have a loss.
 

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Discussion Starter · #3 ·
For a bond fund, DRIP is a good way to get the ideal "total return" of the bond ETF. I don't have any experience doing DRIP on ETFs, so you should check to confirm that there are no fees for doing this, but I think it's a good idea inside RRSP.

Short term bonds like XSB (or VSB, VSC, XSH) are all fine for "long term" holdings. The potential down sides are:

1. Underperforming stocks, if in fact stocks continue going up
2. Underperforming more typical bond funds like VAB or XBB if you end up sitting in XSB for a long period like 5-15 years.

If your anticipated holding period is about 1-5 years, XSB and VSB are well suited for that. You might also consider just putting the money in a high interest savings account if your brokerage has one of those available as it provides a steady interest rate, unlike XSB which fluctuates and could potentially have a negative return.

For example if you might be in & out of XSB in just a 6 month period, that's quite a short time and XSB could have a net loss. A high interest savings account will never have a loss.
James,

Thank you for your reply. Let's see, DRIP with ETF works fine with my broker (RBC DI), I've used it with other ETFs, there's no fees associated with it.
1. yes, makes sense
2. yes, if one assumes that interest rates will have returned to normal levels within the time you indicated - I doubt it (North of the border)

Yes, I've been browsing HISAs, too but it's a bit of a pain (not that I'm particularly lazy but...) as I'm having registered accounts & a corporate account that I want to move into more saver assets and since RBC doesn't offer a good saving account option themselves, a short bond ETF with a yield of >2% seems to be an attractive option this time around.
 

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a short bond ETF with a yield of >2% seems to be an attractive option this time around.
Just remember that while Distribution Yield is shown as 2.27% as of Dec 23rd, distribution yield will continue to slowly creep downwards until the current bond yield curve moves up sufficiently to arrest the decline of maturing issues with new issues at higher coupon yield. So be prepared to live with returns that could approach, or be less than, 2% sometime in 2017 or 2018... interest rate changes notwithstanding. Unit price will waver somewhat too depending on bond yield curve sentiment.

Bottom line: A short term bond ETF will yield slightly less than a medium term bond fund, but also be less volatile in unit price movements. I recommend it to a few folks that I provide financial opinions too.
 

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Yup don't get caught up on distribution yield. You really must consider total return. For a high interest savings account, the total return is 0.75% per year.

For XSB it's a bit difficult to forecast but in the ~ 3 year time span the total return will likely be about 1.5% per year, approximately the yield-to-maturity of the fund.

For XSH it's going to be a bit higher, around 1.8% per year in that same ~3 year time span (notice that it's distribution yield is very high at 3% but that's not the total return... look at the yield-to-maturity)
 

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Discussion Starter · #6 · (Edited)
Just remember that while Distribution Yield is shown as 2.27% as of Dec 23rd, distribution yield will continue to slowly creep downwards until the current bond yield curve moves up sufficiently to arrest the decline of maturing issues with new issues at higher coupon yield. So be prepared to live with returns that could approach, or be less than, 2% sometime in 2017 or 2018... interest rate changes notwithstanding. Unit price will waver somewhat too depending on bond yield curve sentiment.

Bottom line: A short term bond ETF will yield slightly less than a medium term bond fund, but also be less volatile in unit price movements. I recommend it to a fewshort term. folks that I provide financial opinions too.
Hi AltaRed,

Thank you for the explanation with the yield curve. What makes the yield curve change & move (downwards from here) and how can these changes be anticipated? In the assumption that interest rates will stay the same for short term.

As for medium term bonds, medium term will (might) bring us back into rising interest rate territory (3 - 10 years) hence I'd like to know, when you recommend that option to the afro mentioned folks.

Thanks,
Ron

I found this: https://www.oanda.com/forex-trading/analysis/economic-indicators/canada/rates/yield-curve which prints the yield curve for Canadian government bonds.
 

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Discussion Starter · #7 · (Edited)
Yup don't get caught up on distribution yield. You really must consider total return. For a high interest savings account, the total return is 0.75% per year.

For XSB it's a bit difficult to forecast but in the ~ 3 year time span the total return will likely be about 1.5% per year, approximately the yield-to-maturity of the fund.

For XSH it's going to be a bit higher, around 1.8% per year in that same ~3 year time span (notice that it's distribution yield is very high at 3% but that's not the total return... look at the yield-to-maturity)

Hi James,
How do you calculate the total return and how do you get ~1.5% for XSB.
I have not considered XSH yet but it looks like an interesting option too (although there's no DRIP for it).

Thanks!
 

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... I don't have any experience doing DRIP on ETFs, so you should check to confirm that there are no fees for doing this ...
While it is always good to confirm in advance, my experience with Canadian ETFs is that if the broker has the ETF on their list, there are no fees.

The main place I have read of fees are US company stock DRIPs. There is always a chance of an exception though.


Cheers
 

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XSB has an average YTM of 1.43%. It also has a MER of 0.28%. Then you have to pay commissions. And you have a price risk. All told you'd be lucky to get a 1% return.

Way better idea to buy the RBC Investment Savings account. You'd also benefit in a potential increase of interest rates.
 

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Hi James,
How do you calculate the total return and how do you get ~1.5% for XSB.
I have not considered XSH yet but it looks like an interesting option too (although there's no DRIP for it).
Bond ETF returns can't be known ahead of time with certainty because it's entirely up to the bond market. The best approximation I'm aware of is to look at the fund's yield to maturity and then subtract the MER.

As Argo points out, for XSB that gives you around 1.1% total return. I forgot about the high fee on it. This is the only estimate we can come up with... bond market conditions might produce better or worse returns than it.

If you want more certainty in the return, then the savings account is the way to go.
 

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Hi AltaRed,

Thank you for the explanation with the yield curve. What makes the yield curve change & move (downwards from here) and how can these changes be anticipated? In the assumption that interest rates will stay the same for short term.

As for medium term bonds, medium term will (might) bring us back into rising interest rate territory (3 - 10 years) hence I'd like to know, when you recommend that option to the afro mentioned folks.

Thanks,
Ron

I found this: https://www.oanda.com/forex-trading/analysis/economic-indicators/canada/rates/yield-curve which prints the yield curve for Canadian government bonds.
The bond yield curve (and its shape) moves on market sentiment regarding a country's fiscal policy, i.e. its debt, its GDP, inflation rate and a variety of other factors. The Central Bank's short term interest rate policy mostly affects short term interest rates, e.g. 1-5 years with less effect on 10 year bonds and potentially no effect on 30 year bonds. Sometimes the yield curve can go inverse (and has in the past) with higher yields on short term bonds due to inflation, but it would be a rare event for that situation to ever happen again.

In my amateur opinion, it is my guess that it is more likely for the current yield curve to flatten a bit more than it is... IF short term interest rates are bumped up 25-100 basis points over the next few years to support the Canadian dollar (and assuming the US Fed continues to bump up US interest rates slowly). By that, I mean increasing yields in 1-5 year bonds in particular with less increases in 10 year bond yields.
 

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Discussion Starter · #13 ·
The bond yield curve (and its shape) moves on market sentiment regarding a country's fiscal policy, i.e. its debt, its GDP, inflation rate and a variety of other factors. The Central Bank's short term interest rate policy mostly affects short term interest rates, e.g. 1-5 years with less effect on 10 year bonds and potentially no effect on 30 year bonds. Sometimes the yield curve can go inverse (and has in the past) with higher yields on short term bonds due to inflation, but it would be a rare event for that situation to ever happen again.

In my amateur opinion, it is my guess that it is more likely for the current yield curve to flatten a bit more than it is... IF short term interest rates are bumped up 25-100 basis points over the next few years to support the Canadian dollar (and assuming the US Fed continues to bump up US interest rates slowly). By that, I mean increasing yields in 1-5 year bonds in particular with less increases in 10 year bond yields.
Thanks AltaRed,
Yes, I've looked up some details on inverse yield curves, flattening yield curves with associated interest changes but I'm still left wondering, what is good and bad...a flat yield curve would essentially be optimal, right? Where the yield paid vs. the term of a bond is in exact linear distribution. What does a "steep" yield curve mean? That 1 year pays significantly less than 2 year or that 10 year pays significantly less than 20 year? It seems very relative to the way you actually plot the data. the curve on https://www.oanda.com/forex-trading/analysis/economic-indicators/canada/rates/yield-curve (bottom) for example seems to be missing a data point between 10 & 30 years - or is that just the "norm"?
 

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Yes, understood, but I was wondering how it exactly moves and how I can understand it and hence AltaRed provided some useful input...!
It moves based on market sentiment, i.e whether shorter term bonds are more favoured (in demand) than long term bonds. Normally, longer term bonds pay higher yield because maturity date is a long time in the future and there is considerable uncertainty in economic/interest rate changes over that time. The yield curve can theoretically change its shape (slope) every day but changes are more subtle than that...weeks or months in normal times.

A steep yield curve would be defined as low yield, e.g. 1%, for short term bonds and perhaps 10% for long term bonds....in other words an unusually steep slope. Unlikely to ever be that steep though.....unless for example, central banks refuse to act to raise short term interest rates to keep inflation low.....and the market then fears runaway inflation 5-10 years down the road.

I believe inverse yield curves existed during times of high interest rates, e.g. early 70's and early 80's when we had double digit inflation and central banks raised short term rates significantly to whackamole inflation. Remember 15% mortgage interest rates at one time? I think even 10-12% yield on long term bonds during that time.
 

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Discussion Starter · #16 ·
It moves based on market sentiment, i.e whether shorter term bonds are more favoured (in demand) than long term bonds. Normally, longer term bonds pay higher yield because maturity date is a long time in the future and there is considerable uncertainty in economic/interest rate changes over that time. The yield curve can theoretically change its shape (slope) every day but changes are more subtle than that...weeks or months in normal times.

A steep yield curve would be defined as low yield, e.g. 1%, for short term bonds and perhaps 10% for long term bonds....in other words an unusually steep slope. Unlikely to ever be that steep though.....unless for example, central banks refuse to act to raise short term interest rates to keep inflation low.....and the market then fears runaway inflation 5-10 years down the road.

I believe inverse yield curves existed during times of high interest rates, e.g. early 70's and early 80's when we had double digit inflation and central banks raised short term rates significantly to whackamole inflation. Remember 15% mortgage interest rates at one time? I think even 10-12% yield on long term bonds during that time.
Alright, yes, I've just heard about these outragous mortgage rates... :) I'm too young to really know about them otherwise.
However, would you agree that, given current market conditions, short term bonds are preferable to long term due to the prospect of raising interest rates (even on this side of the border)? To that, do you think that the US rate hikes will have any effect on our yield curves? I would imagine that it may be a wake up call for some folks in Canada and demand for short term binds may rise slightly? What's your opinion?
 

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Here's a real example with XSB held for 2.888 years. Bought 2014-02-07 and sold 2016-12-28. At the time of purchase, yield to maturity was 1.57%. Subtract MER and this gave an expected annual return of 1.29%

What was the actual return? Total return start to end, annualized, was 1.0477^(1/2.888) - 1 = 1.63% actual annual return

So here the resulting "yield" at 1.63% is higher than estimated at purchase time, by quite a bit.
 

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Probably had something to do with the surprise interest rate decrease in January 2015. I remember I was holding XSB temporarily at that time for a cheeky maneuver I was pulling and got a nice little bonus.
 

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The BoC bond lookup tool can answer that part. On 2014-02-07 the 3 year bond was 1.17% and today it's 0.87% so yes, there has been a decrease in interest rates and that would boost the XSB performance in this case.

To assess what would happen if rates stayed constant, or went up, you could search for a period where the 3 year or 5 year benchmark went the opposite way. I think you'll find that XSB performance is still >= the YTM estimate as long as you hold for 2+ years.
 
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