My favourite Canadian bond ETFs
I said last week: while dividend-investing takes some time and effort, investing in some ETF products in my opinion, does not. Just like you can construct the Canadian equity portion of your retirement portfolio with ease, I think you can do the same with bonds.
Why bonds?
My opinion is 98% of investors should have bonds in their portfolio. The well-known Canadian Couch Potato thinks it’s a good idea and my friend who is a Millionaire Teacher thinks it’s a great idea. Those guys are worth listening to. The other 2%? Well, these investors might be diversified enough via tens of holdings of dividend-paying stocks but even then, I’ve talked to a few savvy DIY investors and they’ve got a bunch of GICs to mitigate equity risk instead. While passive dividend-income is nice, so is fixed-income.
For me, maybe it’s because the market is up and down all over the place of late. Maybe it’s because bonds are one of the first things I learned about when I opened my investing account close to 13 years ago. Even when I have 20, 30 or 40 dividend-paying stocks churning out dividends month after month, I’ll probably always have bonds as part of my retirement portfolio. For me, it just makes sense: bonds help me digest any spoiled fare Mr. Market serves up. Over time, while it’s my plan to be diversified with a robust basket of dividend-paying stocks, I’m also focused on keeping part of my retirement portfolio, my RRSP in particular very lazy. Part of my lazy RRSP portfolio strategy is to hold a few exchange traded-funds (ETFs) to keep my investment costs super low, achieve near-market returns and offset a whack of active management risk. Canadian bond ETFs are definitely part of that equation. I hope this post today helps you consider bonds as part of your strategy.
The list below identifies my favourite Canadian bond ETFs, why I like them, and if and when I plan to hold them.
For the last couple of years, I’ve held the iShares DEX Universe Bond Index Fund in my RRSP. I think this ETF is an excellent product to own. Why? Here are my reasons:
- It tracks the widely followed DEX Universe Bond Index.
- It has excellent diversity; almost 500 holdings.
- Almost 50% of XBB holdings are short-term (1-5 years); less subject to interest rate fluctuations in the short-term.
- Average maturity of holdings is just over 6 years.
- Management Expense Ratio (MER) is low, just over 0.30%.
- Yield to maturity is about 2.3%.
- 10-year return is over 6%.
Given the DEX Bond Index consists of a broadly diversified selection of high-grade Government of Canada, provincial, corporate and municipal bonds, to me this is a great all-in-one bond product for your portfolio.
Disclaimer: I own XBB and don’t plan on selling it anytime soon.
If you like XBB, except you like to keep your bonds shorter, you’ll love XSB. This guy seeks to provide (monthly) income by replicating, to the extent possible, the performance of the DEX Short Term Bond Index, less expenses of course. The MER for this ETF is 0.26%. The average maturity of holdings is about 2.7 years, much better for spikes in interest rates (if and when they occur). It holds about 55% federal bonds; read in, safety. 93% of its holding are within 1-5 years. Again, safety. It has 271 holdings, a broadly diversified basket of investment grade federal, provincial, municipal and corporate bonds. The downside? The yield to maturity is about 1.4%. You can make more than that today with a high-interest savings account. The historical performance is a better story: the 10-year return is just over 5%. Much better.
Disclaimer: I don’t own XSB and don’t plan on owning it. I own XBB and I’ll take the incremental risk of owning of longer-bonds which often yields higher returns.
If you like bond ladders, move this one to the top of your selection list. The Claymore 1-5 Yr. Laddered Government Bond ETF seeks to provide a return before fees and expenses of the DEX 1-5 yr Government Bond Index.
What is a bond ladder?
- Money is split into equal portions and invested into fixed-income holdings with variable terms/maturities.
- As each term expires, the released cash is re-invested into another, longer term, another “rung up the ladder” if you will.
Bond ladders are excellent strategies to allow investors, like me, who want to protect capital and stay invested in the highest fixed-income products of the day, based on the ETF objectives. Unfortunately, in this uber-low interest rate environment, there aren’t juicy coupons/interest from the bonds being provided. Other than that, there’s lots to love with this product:
- Provides monthly income.
- Yield to maturity is about 1.4%.
- Average maturity of holdings is just over 3 years.
- 3-year return of the ETF is 4.77%. Long-term, ETF performance should be close to the index it follows, about 5%.
Maybe the best part? CLF has a dirt-cheap MER of about 0.17%. That’s low! Since fees are forever (unless you don’t pay any fees of course) I prefer keeping more of my money: CLF is a winner. Why else do I like CLF? CLF holdings, government bonds, are pretty much as risk-free as it gets. The government can raise taxes or create additional currency in order to redeem the bond at maturity and cover its IOU. Sure, you might be thinking what about the U.S. debt crisis? OK, some governments have defaulted on its debt (Russia, 1998) but this is a very rare event my friends. The U.S. is not going to default on its debt and neither are we in Canada; although both countries have tons of work to do! Government debt is about as safe as it gets. I like that security blanket.
Disclaimer: I own CLF and don’t plan on selling it anytime soon.
This another stellar laddered product from Claymore, but focused on corporate debt instead of government debt. The MER for this ETF is higher than CLF, at 0.28% and like CLF, it provides monthly distributions. This is great – because you might already know – I love to take advantage of the power of compounding! The yield to maturity is about 2.2%. Average maturity of holdings is just over 3 years. In my opinion, if you own good chunks of CLF and CBO in your portfolio you probably don’t need XBB or XSB.
I like CBO, very much so, but corporate bonds do mean some equity-like risk exposure. Remember, you’re holding company debt afterall. Since I already have exposure to equity risk via other holdings, dividend-paying stocks, other equity ETFs, I’d rather keep part of my portfolio as safe as possible – holding CLF over CBO is my preference but others might feel differently.
Disclaimer: Although a very good product, I don’t own CBO and don’t plan on owning it in the short-term.
Here are some very good products to consider but these don’t rise to the top for a couple of reasons outlined below.
The iShares DEX All Corporate Bond Index Fund seeks to provide income by replicating the performance of the DEX All Corporate Bond Index. This is a good product, don’t get me wrong, but because I’m more of a fan of government debt than corporate debt; I don’t own this one. Also, the MER is a little higher (0.42%) than I would like in a bond ETF. Recall I’m paying less than that for a great all-in-one product and twice as less for my CLF holding. More MER does mean more potential for returns.
Disclaimer: I don’t own XCB and don’t plan on owning it.
This is another interesting product from iShares. The iShares DEX Real Return Bond Index Fund seeks to provide income by replicating, as close as possible, to the performance of the DEX Real Return Bond Index less expenses. The DEX Real Return Bond Index is a market capitalization index consisting primarily of Canadian federal and provincial real return bonds. What are those?
Real Return Bonds (RRBs) are Government of Canada bonds that pay you a return that is adjusted for inflation. Unlike regular bonds; RRBs help maintain purchasing power by paying interest a) semi-annually based on an inflation-adjusted principal and b) at maturity in inflation-adjusted dollars. Kinda cool. The inflation-adjustment does come with some considerations, you know it would! While the 5-year return of this fund is rather solid to say the least, over 6%, over 40% of the bond holdings are held in maturities that exceed 25 years. That’s a looooong bond. Personally, I prefer my bonds short and because this one is at the other end of the spectrum, it’s not for me. In our current interest rate environment, long bonds and this bond in particular is doing its magic: YTD return of XRB is almost 8%. For real.
Disclaimer: I don’t own XRB and don’t plan on owning it.
Some folks ZIG, other folks ZAG, and I can see why. The BMO Aggregate Bond Index ETF has been designed to replicate, to the extent possible, the performance of the DEX Universe XM Bond Index. ZAG invests in a variety of debt securities primarily with a term to maturity greater than one year, owning investment-grade debt, consisting of Government of Canada (including Crown Corporations), Provincial and Corporate bonds. Low MER, 0.28%, lower than one of my favourites XBB. Weighted average yield to maturity is good, given our climate today, almost 2.5%. The only reason I don’t own it? The weighted average bond maturity is over 9 years, just a little too long for my liking.
Disclaimer: I like ZAG but I don’t plan on owning it.
Recognizing there are many more Canadian bond ETFs that I didn’t mention above, from other companies than those above, I hope my list of favourites was an excellent starter your own research into this space. Some ETFs I love and a few not as much but all of these should be considered for your retirement portfolio. Do you own research, make choices in line with your own invesetment objectives and personal finance goals. Personal finance is after all, personal.
Stay tuned for my last post on this theme, my favourite international ETFs within another week or so 
What do you think of my favourite Canadian bond ETFs?
Did I leave any of your favourites out?
Do you own any Canadian bond ETFs yourself and if so, which ones and why?
For further reading about bond ETFs, check out these sites and articles:
Claymore ETFs – product list.
iShares – fixed income product list.
The Dividend Ninja – think short term when buying bonds.
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Thanks for reading and sharing this article.
@My Own Advisor
Your right, we are not in any dire situation here in Canada, but it would have been difficult for the Greek investor to foresee this coming apocalypse 5 years ago.
Bond Alternative: Hideout in a high interest savings account and wait for better opportunities. If you can get a 2% interest rate (that should increase as rate rise) it would probably be better than the 1.4% YTM on XSB.
Re: “Asset Rich, Cash Flow Poor”: Suppose John Doe (age 70) fires his financial planner and sells all his mutual funds. John becomes “His Own Advisor” and decides to allocate 70% of his portfolio to Government of Canada / Province of Ontario bonds. John is going to need a massive nest egg to eke out a meager income. To add insult to injury, as his bonds reach maturity, John ends up with less and less capital to reinvest because he had to pay a premium to buy his bonds since at today’s prices they are all trading above par ($100).
Cheers
@TD,
Good points about the HISA over the XSB. Man, savers are getting killed in this interest rate environment. Spenders get rewarded, I don’t like that!
As for Asset Rich, Cash Flow Poor, this is why I believe, firmly, in a duel-pronged approach to investing: dividend investing and indexing.
With dividends, over time, I get rising income and in some cases for me, tax-free income via TFSA. I don’t need to convince or tell you more, this stuff you know inside and out and sideways.
With indexing, because my dividend-payers take some work, with a few simple selections, I get market returns. I can almost, not quite, but almost set and forget part of my retirement plan. I like that.
The bond situation is very concerning. I mean, CLF and CBO aren’t earning much. XSB is low. XBB isn’t bad thanks for some longer durations and coupons, but still low returns. Quite frustrating actually. As a 70-year-old with no company pension and only a bunch of GICs or bonds, I’d be worried if I didn’t have some other cash flow, like cash from dividends. Scary environment. I guess we need inflation soon don’t we?
Thanks again for your comments, I enjoy these discussions!
@My Own Advisor
Your right, we are not in any dire situation here in Canada, but it would have been difficult for the Greek investor to foresee this coming apocalypse 5 years ago.
Bond Alternative: Hideout in a high interest savings account and wait for better opportunities. If you can get 2% interest rate (that should increase as rate rise) it would probably be better than the 1.4% YTM on XSB.
Re: “Asset Rich, Cash Flow Poor”: Suppose John Doe (age 70) fires his financial planner and sells all his mutual funds. John becomes “His Own Advisor” and decides to allocate 70% of his portfolio to Government of Canada / Province of Ontario bonds. John is going to need a massive nest egg to eke out a meager income. To add insult to injury, as his bonds maturity, John ends up with less and less capital to reinvest because he had to pay a premium to buys his bonds since at today’s prices they are all trading above par ($100).
@My Own Advisor
I think the key takeaway from that Vince Farrell comment is to put yourself in the shoes of a Greek Investor. Your “safe” investments just tanked.
Here are two other “big picture” ideas regarding low interest rates:
1) With these low interest rates, most people’s financial plans are now broken. When John Doe sat down with his financial planner he was told he could retire with $$$ assuming he earns a rate of return of X%. Going forward, the bond portion of his portfolio won’t meet his target return requirement.
2) Many retired people are “asset rich but cash flow poor”. A million dollar fixed income portfolio doesn’t produce much cash flow these days. The risk here is that people have to sell assets to meet their expenses and might out-live their nest egg.
@Think Dividends,
Yes, the Greeks are in trouble. Could it happen here? Maybe, eventually, but not short-term.
Based on these low interest rates, you’re right that the bond holder-only plans are defunct. I’m earning very little on my bonds. I’m not losing anything, but I’m not making anything either; zero probably in terms of real returns. John Doe is likely freaking out if he was all bonds.
So, what is the alternative? GICs? Inverse products? Dividend-paying stocks? High-yield flyers? Momentum investing?
Your comment about asset rich and cash flow poor is well taken, which makes my questions above all the more important for many investors trying to avoid this paradigm.
More thoughts?
First off, awesome post! I couldn’t wait for the bond and international threads and I wanted to take the time to review them thoroughly.
Although I currently fall within the 2% camp as well, I totally agree with you that bonds and/or fixed income are crucially important for one’s portfolio. I have simply placed GICs higher importance on the safety side of my portfolio until I reached my comfort zone; however I am now looking to diversify further with low cost bond funds.
As you and Think Dividends have mentioned, I’m refraining from investing in bonds right now because of the prices and I’ll wait another while yet until I see better entry points. It’s a great time to do research!
I agree, it’s fine and dandy to own dozens of dividend-paying stocks, but if you don’t have a balanced portfolio, the rain will fall hard during market swings and your portfolio will feel it like a bad case of hemorrhoids.
You provide an excellent list to readers to choose from. I really like XBB and it’s low MER. If I’m not mistaken, this ETF has about a 30% corporate bond mix, correct? Regardless, as you mention, this fund offers an excellent way to have an all-in-one exposure to bonds.
Despite the low yield to maturity, I like the safety of XSB and seems like a great ETF to own if the investor is seeking more diversity within bonds.
As you already know from a previous comment on your site a while back, I’m a fan of CLF and I can definitely see myself investing in this ETF over time. Man that MER is low! When interest rates rise, I plan on eventually creating my own self-directed GIC ladder.
ZAG also peaks my interest and I don’t recall reading a whole lot about this ETF until this post. It has a reasonable MER and it’s something I could revisit, despite the generally longer weighted average bond maturity of 9 year.
A great job on this ETF series Mark. Like Ninja mentioned, this article will prove to be a valuable resource for many, and I’m sure I’ll be referencing this source in my future posts.
@TWC,
Wow, thanks for the great compliment. Not only do I hope these posts help others, this research also formalizes my investing thesis or helps change it!
At least I’m learning, and that’s always a good thing.
Yeah, I figured you might fall into the 2% camp! You and Think Dividends, which is a good because you’re already so well diversified or very risk tolerant. I would think it’s the former for both of you.
There is absolutely no problem with GICs, I guess I’m just a little more lazy than you, to be honest, since I don’t mind paying some (low) fees via ETFs and creating some bond ladders, holding bond ETFs, etc. I don’t know if that is such a good thing? I’m a little lazy? GICs might be making more in returns and costing less in fees…especially these days. This economic environment is very deflating to savers. Ugh.
Your comment about a bad case of hemorrhoids was pretty funny! LOL.
You’re right, again
, XBB has about 30% corporate bonds – which is enough for me. I love the all-in-one exposure it provides.
XSB, while very low yields right now, are a great satety net.
My plan is to own CLF for quite some time. I love the built-in laddered approach. Even if folks don’t follow a built-in product, like CLF, a self-directed, DIY GIC ladder is a very good thing to do I think. I don’t need to convince you about that, you’re a pro!
Thanks for your comment and contribution to my blog. You always have great insights!
That’s what I meant too… Bonds are pricy atm and are not so appealing to me. I find them boring and therefore I am in the 2%! Might reconsider this when the stock market crash though.
@Lazy,
Bonds are definitely pricy now. I wouldn’t make a bulk buy of them now, but it might make sense to sell a bit in favour of some equities. I know of some savvy DIY investors who have done that in the past:
http://andrewhallam.com/2010/05/beating-the-market-with-bonds/
Thanks for your comment!
Yea, I agree. When XIU is falling this much, I would not buy XBB. If I am not wrong, it would be better to buy XBB when equities go up, so that the price drops and yield is higher. Someone correct me if I’m wrong.
Now I wonder why it is different with insurance companies, like Sunlife (SLF)? The consensus is that because they hold so much bonds in their portfolio, and yield is low, their stock is suffering (stock also suffering because of their wealth management holdings). But with low yield, havn’t the bond prices gone up, to offset the low yield? I’m thinking something like SLF may be an okay buy currently (unless markets fall due to Europe).
@Peter,
You got it: when equities go up on a big tear, buy bonds like XBB. When equities crash, buy XIU or something like it.
Insurance companies, like Sunlife (SLF), Manulife and others, are sensitive to interest rates, especially low rates – they are not good for them. Combine that with a poor, overall, equity climate, and you have a recipe for a low, insurance company stock price. This does not mean however, there is any change in the business model, or even earnings in the short-term for that matter. So, the price has changed, but the company and its earnings have not. Hummm, for me, when companies like SLF have a low stock price, its time to buy them.
Low interest rates aren’t just bad for savers.
For every borrower who’s getting a great deal on a loan, there’s a lender having to accept a smaller return as a consequence. Insurance companies rank among those hardest-hit – because, they accept up-front premium payments in exchange for coverage over a specified period. Often, no loss will occur, and so the insurance companies will be able to count the entire premium as pure profit. Moreover, when an accident or other adverse event does occur, there’s often a significant lag time before the company has to pay out a claim.
Given many insurance companies prefer to invest in less volatile assets like bonds, when bond rates are low, the income those insurance companies have come to expect dries up, hurting their bottom line.
“Monday saw ten year government bond yields of “safe” nations fall yet again. Switzerland’s ten year yield is, unbelievably, below 0.95%. Japan is around 1% and the US, Sweden, and Germany are below 2%. As an aside, Spain is around 5.2% and Italy 5.4% or so. Not good, but far from disaster, and by no means indicating imminent collapse. Oh, Greece’s ten year yield is over 18%.” — Vincent Farrell, Ticonderoga-Soleil Securities
@Think Dividends,
Greece is definitely going to default. What do you think this means for us here in Canada? Thoughts?
@My Own Advisor
I just want to emphasize that at the right price, I’d own a whole whack of bonds in my portfolio. At today’s rates, me and Mr. Market are miles apart.
@Think Dividends,
Very fair comment.
Yeah, I’m not buying any new bonds for my portfolio now, I’ve got enough. I’m only obtaining more bond units via synthetic DRIPs with XBB and CLF.
XIU down 0,50$ in 1 Day.
Time to buy some XBB bonds.
@Lazy,
I find XBB a little pricy right now actually, although I love the bond ETF
I’m trying to buy more equities. XIU would be a buy since it’s closer to its 52-week low than high
http://tmx.quotemedia.com/quote.php?qm_symbol=XIU&locale=EN
I guess I am in that 2% camp. I currently don’t own any fixed income investments as there is nothing out there that currently meets my minimum required rate of return for the given risk (although I am looking at Aecon convertible debentures (ARE.DB) should they fall below $100).
P.S. I doubt European investors that own a large amount of government debt in their portfolios are feeling very secure today.
Just my 2 cents… Otherwise, great post detailing all of the options out there.
@ThinkDividends,
You must (still) own a whack of dividend-paying stocks, if not holding bonds. If you’re well diversified, hold many stocks across many sectors, I personally see no problem with that. I’m just not there yet to do that with my portfolio. Further still, as long as you are investing in line with your risk tolerance, objectives, etc., then there is definitely no problem with holding no bonds. I would think though, you’re in the small minority if you don’t hold any bonds.
The European debt situation concerns me a bit, since it will bring Canada down along with it when in fact things do collapse/correct. Canadian government bonds are still a very safe place to be IMO.
Thanks for your comment and support of the blog!
MOA spectacular post! Well done my friend. When I build my resources page (sooner than later) these ETF posts will be the resource I refer readers too!
Thanx for the mention
@Ninja,
I’m glad to help! No sweat about the mention, your post was excellent.