# Bond Funds - or?



## PeeBee (Jun 21, 2010)

Being a bit older - my husband just retired - we have between 30-40 of our money in bond funds - stuff like TD Core +Bond, or Income Advantage (which also has some dividend stock) or CI Cdn bond. Wondering if these can tank - my advisor says they'll just 'slow down'. Are there any alternatives to these for fixed or less volatile investments? Are any of the market GIC's worth looking at?


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## OhGreatGuru (May 24, 2009)

Because central bank interest rates have been at a historic low for so long, there are no really good choices in fixed income investments.

IMHO market-linked GIC's are not worth it. If the market goes up, you only gain a portion of the index increase; and if the market goes down the guaranteed part of your return is less than you would get with a fixed GIC.

I see that you only have 30-40% of your portfolio in bond funds anyway, so suggesting that you increase your equity allocation is probably not appropriate.

PS. The Income Advantage Fund is already a portfolio fund with a diversified assortment of bond fund types, plus about 20% equity.


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## Belguy (May 24, 2010)

Good luck with your question because many older and retired investors would dearly love to know the answer for which, apparently, there is not a definitive one. From everything that I have gathered so far on this forum, the consensus seems to be to simply invest your fixed income allocation in a five year ladder of GIC's or, if you don't want to lock it up, invest it in a HISA.


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## Spidey (May 11, 2009)

"Tank" might not be the right word but they can go down in value. However, part of what you want in portfolio construction are non-correlating assets. Bonds tend to be one of the least correlated investments to equities. I've heard it said that if you don't have part of your portfolio that seems to be under-performing then you don't have a very balanced portfolio. Given your worry over bonds dropping in value (a valid worry), you may want to divide your fixed income half in bond funds and half in either short-term GICs or HISA.


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## My Own Advisor (Sep 24, 2012)

The only thing I could suggest is a laddered bond. 

http://ca.ishares.com/understand_etf/fixed_income/bond_ladders_versus_etfs.htm

There is no perfect solution here unfortunately.


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## james4beach (Nov 15, 2012)

PeeBee said:


> Being a bit older - my husband just retired - we have between 30-40 of our money in bond funds - stuff like TD Core +Bond, or Income Advantage (which also has some dividend stock) or CI Cdn bond. Wondering if these can tank - my advisor says they'll just 'slow down'. Are there any alternatives to these for fixed or less volatile investments? Are any of the market GIC's worth looking at?


I think it's helpful to look back at the 2008 environment to see what happened. Using globefund I can see that the worst losses for the funds you mention were around a 10% decline. So it can certainly happen.

Obviously if such a -10% bond fund loss were to occur, you would be better off in plain old GICs.

It didn't happen back in 2008, but if interest rates were to rise you can also suffer bond fund losses. The typical bond fund has a 'duration' of around 7 currently. This means roughly speaking, if interest rates were to rise 1% then your bond fund would decline 1 x 7 = 7%. If interest rates went up 2%, then the bond fund would drop 2 x 7 = 14%. These kinds of decline are independent of the 'credit risk' losses, such as those in 2008... so they are additive risks.

So all in all, taking a worst case scenario based on two percent interest rate rise and credit/default losses, I would say that your bond funds could fall by 10% to 20% absolute worst case scenario


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## james4beach (Nov 15, 2012)

Also to address the question, *Are there any alternatives?*. I would say:

1. Savings accounts (which have the advantage of being cash)
2. GIC ladder, which typically earns you higher interest rates
3. "Short term" or "short duration" bond funds... these are less sensitive to rising interest rates

So whereas the standard bond funds could have worst-case losses of 10% to 20% that I outlined above, short term bond funds have significantly less interest rate and credit risk danger. Their worst case scenario is more like 5% decline

Problem with #3 is that with current rates, you will earn more in #2. Personally I think the best options (currently) are #1 and #2 for fixed income investors.


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## james4beach (Nov 15, 2012)

I will add that if you are very close to retirement (sounds like you are), then I strongly recommend you reduce your exposure to the standard bond funds. As I've shown above, they are far too sensitive to rising interest rates. If that were to happen, you could face major losses right before retirement. For all that danger you face, they don't even pay you extra interest. In other words it's "all risk, no reward"

For example, one of the best bond funds in Canada (XBB) yields just 2.1% after fees. Yet it could tank by 10% to 20% if interest rates shot up, or credit losses picked up.

Let me show you what a horrible deal that is. You would earn about the same interest rate in a 5 year CDIC-insured GIC ladder or mix of savings account and GIC. With the GIC option, there is no possibility of 10% to 20% losses. So that leaves the question, what is the bond fund doing for you? Why would you settle for the same interest rate in a bond fund, when you also have the possibility of enormous losses?


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## My Own Advisor (Sep 24, 2012)

I would only add, depends how badly you need the fixed income. 

If you can't afford to lose any money, and the fixed income is truly fixed income, then a GIC ladder is likely as good as anything even with the crappy yields of today.


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## CanadianCapitalist (Mar 31, 2009)

It is important for OP to first understand the role of bonds in their portfolio. Why do they own bonds? It looks like OP is elderly, so chances are OP holds bonds to provide income in retirement. If that's the case, the motivation for holding bonds is different from younger folks here who hold bonds as a ballast in their portfolios. i.e. to reduce risk in the equities portion. Retirees have a risk with their bonds that younger people don't have: the risk that when reinvesting maturing bonds, the yield is lower than that of the maturing bond. To mitigate this risk, it seems to me that it is perfectly reasonable for retired folks to have a ladder of bonds with duration comparable to XBB or even longer.


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## james4beach (Nov 15, 2012)

CC, what you say makes sense for someone holding bonds specifically for the income, as long as the retired bondholders realize the possibility they may see the value of their bond portfolio decline (perhaps substantially)


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## Belguy (May 24, 2010)

I would appreciate anyone's thoughts on the First Asset DEX 1-5 Year Laddered Government Strip Bond Index ETF (BXF) as described below:

http://canadiancouchpotato.com/2013/06/05/a-new-etf-of-strip-bonds/

http://www.firstasset.com/products/...Year+Laddered+Government+Strip+Bond+Index+ETF


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## CanadianCapitalist (Mar 31, 2009)

james4beach said:


> CC, what you say makes sense for someone holding bonds specifically for the income, as long as the retired bondholders realize the possibility they may see the value of their bond portfolio decline (perhaps substantially)


Think about this from a retiree's point of view who cares about income from their laddered bond portfolio. A decline in portfolio value of their bond holdings makes no difference to their income. But it does mean they are able to earn a higher interest rate on the bonds they are rolling. That is a good outcome for a retiree.


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## Belguy (May 24, 2010)

I have decided to turn over the management of the fixed income portion of my portfolio to CC!!:encouragement::tickled_pink::cool-new::cool2:


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## Guban (Jul 5, 2011)

OhGreatGuru said:


> IMHO market-linked GIC's are not worth it. If the market goes up, you only gain a portion of the index increase; and if the market goes down the guaranteed part of your return is less than you would get with a fixed GIC.


Don't forget that the increase in market yields interest income, not a capital gain with these GIC's! May be important if held outside of a non-registered account.


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## Retired Peasant (Apr 22, 2013)

*Market-linked GICs*

Although the principle is guaranteed, the market increase is capped and also a bit of a gamble. It's not based on any compounding increase in the market, but just two data points - opening day and gic maturity day. I just reviewed one that received 8.4% - had the dates been one day later, it would have been a 9.7% increase (over three years).

As Guban says, all the yield is treated as interest income, and unlike a regular GIC where you report earned interest in each year, with the market linked GICs there is nothing earned each year, so you report the full interest in the final year - could have an impact on OAS clawback if large enough.

If one really likes the idea of protecting their principle, but wants to participate in market increases, they are better off implementing their own.

Take your principle amount and invest whatever portion you need in a GIC at an interest rate that will grow to that principle in 5 years. Take the difference and invest in an index fund. The earnings are taxed more favourably (capital gains/dividends) and your gain isn't capped.


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## fatcat (Nov 11, 2009)

CanadianCapitalist said:


> Think about this from a retiree's point of view who cares about income from their laddered bond portfolio. A decline in portfolio value of their bond holdings makes no difference to their income. But it does mean they are able to earn a higher interest rate on the bonds they are rolling. That is a good outcome for a retiree.


when you say "ladder" are you speaking of laddered funds like CBO ? 

as a retail investor every attempt i made to build a decent bond ladder met with frustration since the offerings at retail simply don't measure up to what is available to the institutional buyer .. the retail buyer essentially gets leftovers

this seems to me to be the best reason to buy funds (along with the simplicity)

i have phn340 (with an equal part of 280) and have been very happy with it ... 

as you say, it goes down when rates rise but i reinvest my returns so i am reinvesting regularly at the "theoretical" prevailing higher rate


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## CanadianCapitalist (Mar 31, 2009)

fatcat said:


> when you say "ladder" are you speaking of laddered funds like CBO ?


No, I'm talking of an actual ladder of bonds. CBO, despite its name is essentially a bond fund where bonds are constantly purchased and sold. I confess that I don't have any experience buying bonds directly. All my fixed income purchases thus far have been GICs and bond ETFs. Did you look into Scotia iTrade, which charges $1 per $1000 of face value? That may be reasonable for long bonds. GICs can play the role of bonds for maturities from 1 to 5 years.


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## HaroldCrump (Jun 10, 2009)

CanadianCapitalist said:


> Did you look into Scotia iTrade, which charges $1 per $1000 of face value? That may be reasonable for long bonds.


There is a minimum commission of $25 under this program.
Therefore, you need to buy $25,000 of face value for this to be truly worthwhile.
For lesser amounts, you should compare the ask YTM from Scotia iTrade vs. the ask YTM for the same bond at another large bond brokerage such as RBC DI.
For regular FI investors, it helps to have more than 1 discount brokerage account for comparison shopping bond inventories.


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## CanadianCapitalist (Mar 31, 2009)

I did a quick check on TDW. Canada bond, maturity 6/1/2023, coupon 1.5%, has a bid-ask spread of $93.63-$94.69, a cost of $0.50 per $100. If you amortize that cost over 10 years, it looks acceptable to me compared to ETF expenses. It doesn't seem all that difficult to build a ladder of bonds. TDW has a very good inventory of Govt bonds across all maturities including one maturing in 2045 that is yielding 2.67 percent! Imagine investing your money now and in 32 years, it won't even have doubled!!


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## CanadianCapitalist (Mar 31, 2009)

HaroldCrump said:


> There is a minimum commission of $25 under this program.
> Therefore, you need to buy $25,000 of face value for this to be truly worthwhile.


Harold, you are right of course. The previous example I posted at TDW will cost $25 per bond ($5,000 value). The cost is the same with Scotia but if you purchase more, it starts getting worthwhile. A $25K bond purchase at TDW costs $125 but it's still only $25 at Scotia.


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## HaroldCrump (Jun 10, 2009)

CanadianCapitalist said:


> I did a quick check on TDW. Canada bond, maturity 6/1/2023, coupon 1.5%, has a bid-ask spread of $93.63-$94.69


I ran the same quote on Scotia iTrade's platform and the ask YTM is 94.043, therefore about 41 bps higher than TDW.
Buying $25K of this would indeed be worthwhile at iTrade vs. TDW at this time.


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## james4beach (Nov 15, 2012)

CanadianCapitalist said:


> I did a quick check on TDW. Canada bond, maturity 6/1/2023, coupon 1.5%, has a bid-ask spread of $93.63-$94.69, a cost of $0.50 per $100. If you amortize that cost over 10 years, it looks acceptable to me compared to ETF expenses. It doesn't seem all that difficult to build a ladder of bonds. TDW has a very good inventory of Govt bonds across all maturities including one maturing in 2045 that is yielding 2.67 percent! Imagine investing your money now and in 32 years, it won't even have doubled!!


I regularly buy Government of Canada bonds directly, both at TDW and iTrade. I ladder them and hold them to maturity.

If you hold to maturity the net fees (as basis points off yield) are very very cheap ... we're talking 5 to 8 basis points fees, in terms of yield. That is just a fraction of the MER you pay in an ETF... you can do the same job as the ETF, for about one-fifth the fee!

It's worthwhile doing for even just 5k, provided you hold to maturity. The spread is not the issue in that case. A simple yield to maturity calculation will show you what a good deal it works out to be.

I'll share my calculation (iTrade) based on the 2023 bond that I bought last week... you would get a better price buying it today obviously. I got a quote from TD Waterhouse too and they were identical, within a dollar after fees.


```
CUSIP 135087A61	Government of Canada 1.50% coupon maturing 2023-06-01
Price 93.942 + commission 24.99 = $4,722.09 (ACB book value) + accrued interest $2.67 = $4,724.76 total cost
after-fee yield to maturity 2.126% ; wholesale yield 2.18%
Net fees = 2.18% - 2.126% = 5 basis points, or so
```
If you were to buy this today, with the market yield at 2.25%, you would be getting something like 2.25% - 5 bp = 2.2% yield to maturity after fees.

Much better than any bond ETF. This is why I have such trouble recommending bond funds, the fees are just so high.


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## My Own Advisor (Sep 24, 2012)

XBB is pretty close james4beach, no? YTM = 2.43% - 0.33% MER. Distribution yield is about 3%.


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## james4beach (Nov 15, 2012)

Well I was focusing on the fees part, the MER.

The ETF (XBB or whatever) MER is around 33 basis points
And buying directly the "MER" is around 5 to 8 basis points - both at iTrade and TD Waterhouse


My Own Advisor: XBB which includes riskier corporate bonds, ends up yielding *less* after fees than the pure 10 year government bond. Shows you how bad the fees on XBB are. That higher yield you get from the corporate bonds is wiped out by the higher fee.

Would you rather own XBB for 2.1% ytm, or
10 year government bond for 2.2% ytm ? Personally I'd pick the gov bond: higher yield *and* lower risk.


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## james4beach (Nov 15, 2012)

CanadianCapitalist said:


> That may be reasonable for long bonds. GICs can play the role of bonds for maturities from 1 to 5 years.


CC, this is exactly what I have been doing for over a decade. I have a big fixed income ladder that stretches out a decade or so.
Shorter maturities are GICs, and longer maturities are government and provincial bonds.

I keep looking for good deals to fill in my ladder. Obviously I was a bit early buying the government bond last week, but you can never time these things perfectly. The point is to keep filling in the ladder.


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## fatcat (Nov 11, 2009)

i read hank cunninghams book in your best interest and i see the value of building a bond ladder with individual bonds

but i could never come up with anything at tdw that looked worthwhile (i was always looking at corporates not government and always got the feeling that all the best issues went to institutional clients) ... perhaps scotia is better

i have accepted the tradeoffs that bond mutual funds present and am happy with what i have

mutual funds now present a new tax reporting problem and so perhaps i need to think about bond etf


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## My Own Advisor (Sep 24, 2012)

Fair points James. I intend to keep XBB for another 20 years, so not too worried about the current climate, although it is a painful one.

With XBB, I'm also paying for convenience. I recall the corporate bonds of XBB constitute about 30% of the product (?)

I suppose you're not a fan of CLF?

.


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## CanadianCapitalist (Mar 31, 2009)

james4beach said:


> I regularly buy Government of Canada bonds directly, both at TDW and iTrade. I ladder them and hold them to maturity.


Makes total sense for your investing strategy. I'll try and explain why it isn't for me. I don't hold any bonds at present because I have a mortgage and I can handle market risk comfortably. But not very long ago, I did hold some fixed income to reduce portfolio volatility. For that purpose, it is important to have liquidity for rebalancing purposes. So, GICs are ruled out. But bonds with shorter maturities than 10 years are not as cheap. It looks like a 5-year bond costs about 17 bps in fees at TDW (at this point, I'm only interest in fixed income maturing in 1 to 5 years). That's not wildly cheaper than ETFs and if you happen to sell fixed income, ETFs will probably come out ahead.

I hadn't looked at bonds in a long time and I have to say I'm quite surprised to see spreads on long maturities are really low. Therefore, when I move close to retirement, I'll be looking to build a ladder of bonds instead of holding ETFs. For maturities of 5 years or less, GICs are an excellent choice. GoC 5-year yield is 1.6%. Best GIC yield is 2.4%! Of course, one gives up liquidity but still, the spread between GICs and GoC bonds is really wide.


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## james4beach (Nov 15, 2012)

@fatcat: for corporate bonds I _would_ actually use a bond ETF. To do corps properly you need to buy a large number of them for diversity and I wouldn't be able to do that buying them individually.

@My Own Advisor: no problem with paying for the convenience. In my case I like doing the work buying (government) bonds. CLF has some good things going for it, but at current rates I'm not interested. Avg maturity 2.6 years and the yield is much lower than GICs. In fact at 1.44% - 0.17% = 1.27% ytm it looks like you're better off in a high interest savings account.

@CC: Your strategy makes sense too given your circumstance. If GICs are ruled out due to liquidity needs, that totally changes things. And I agree that it's not worth buying the short maturity bonds. Just about everything I have bought is over 5 years.



> I'm quite surprised to see spreads on long maturities are really low. Therefore, when I move close to retirement, I'll be looking to build a ladder of bonds instead of holding ETFs. For maturities of 5 years or less, GICs are an excellent choice.


Yeah that's the same conclusion I arrived at. For shorter maturities, GICs are best (and they're CDIC insured only up to 5 years anyway). At longer maturities, government bonds are very cheap to ladder into your portfolio.

And the government of Canada bonds really are amazingly liquid, at least currently. If you bought & sold out of a position you're more or less just losing the $25 per trade. One additional benefit is that because the GoC bonds are top quality assets, brokers treat them as near-cash... they have an incredible 96% loan value, versus 70% for a stock/bond ETF. So if your circumstances allow you to build up a GoC bond portfolio I think there are many real benefits besides the ETF route, including margin-related benefits!


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