# Bond ETFs: Regular vs Long Term



## guillaumevfournier (Dec 1, 2017)

Hi 

When is a good time (is it ever?) to invest in long term bond ETFs such as ZLC & XLB. They seem to have outperformed regular bond ETFs such as VAB and XBB and even the short term bond ETFs (VSB, XSB) through the latest July and September Bank of Canada interest rate hikes.

I understand they're riskier than short term & regular bond ETFs, and have higher MER, but if we look at the last 5 year performance they have done way better than the VAB & XBB. I feel like I’m missing something here! What is the downfall?

I’m looking to purchase a bond ETF as a core holding for my couch potato portfolio in a TFSA and currently hesitating between a regular bond ETF and a long term bond ETF. Obviously the rising interest rate environment is a concern and I’m trying to gain a better understanding to make a decision.

Any input is appreciated!

Thanks!


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## AltaRed (Jun 8, 2009)

Longer term bonds have a higher sensitivity to interest rate changes for that bond's duration. You didn't see much price change of ZLC and XLB due to the recent Bank of Canada interest rate changes, because the BoC interest rate changes were to the short term overnight rates. The overall bond yield curve did not change hardly at all for any bond durations more than 5 years. Long term bond ETF pricing is directly linked to the yield curve for the bond durations in the bond ETF itself. Look at the yields for various length of bonds on the BoC website. 

So there were impacts to short term bond ETFs like XSB and VSB, but not long term bond ETFs.


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## james4beach (Nov 15, 2012)

This comes down to a question of *matching your time horizon*. The long term bonds will deliver good returns and are appropriate for investors with a time horizon of over 20 years, probably more like 30 years. However on shorter horizons, you may not even have a positive return.

The rule of thumb is: the forward return on a bond fund is approximately the yield to maturity at the time you buy, with a time frame of the fund's average maturity.

IMO these long term bonds are only appropriate for long-lifetime entities like trusts and pensions which have horizons like 30 - 100 years.

As mortal human investors, we probably should stick to the regular bond funds like XBB which have average maturity/terms around 10 years. Ten years goes by pretty fast and the 10 year bonds still have plenty of volatility. I don't think I'll ever venture beyond that into long term bonds, unless perhaps we get a serious bond crash that actually gives us juicy yields like 15% on the long bond.

Similarly, if you expect to need this money in just a couple years, then you must match it to something like XSB or XSH because even XBB will be too far out.


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## TomB16 (Jun 8, 2014)

ETFs have more overhead than is belied by their cited expense ratios.

Look at a 5 year price history of any of the short term bond ETFs: XSB, XSQ, etc. You will see a downward slope.

https://ca.finance.yahoo.com/chart/XSB.TO

These short term bond funds are making low yields as they lose money. In the 5 year case of XSB, they have lost significant market equity. For many historic durations, the parasitic losses outstrip the bond earnings. IOW, holding XSB is a money loser.

Long term bond ETFs seem to leak a lot less of their market equity. In the 5 year case of XBB, the price is close to flat plus they have been paying interest during that period. It appears XBB has far lower parasitic losses than XSB. I don't understand this, as daily volumes seem similar between XSB and XBB.

https://ca.finance.yahoo.com/chart/XBB.TO


The point is, we're talking about bonds. They are invariably discussed for their value in being stable and safe. Bond ETFs are discussed as being the equivalent of bonds in terms of safety and stability and yet they are clearly not.

Who would buy a 5 year bond that can be redeemed for less than the purchase price minus interest? XSB owners. That's who.

Look at the holdings of XSB. https://www.blackrock.com/ca/indivi...91/ishares-canadian-short-term-bond-index-etf

By far, the biggest position in the XSB portfolio is Canadian Government bonds. I calculate a blended yield of 1.91% across their current holdings.

On December 2, 2012, XSB closed at $28.94. Today, XSB closed at $27.52. That's a 5.16% total drop over 5 years, or can be expressed as an annual compounded loss of 0.81%

Management fees do not account for these losses. More money is leaking, somewhere. It doesn't appear to be all going to the market makers but certainly some of it is and my insight into this is limited.

Also, it is clear that extreme few people understand the internal mechanisms of an ETF. How many people realize bond ETFs don't own the bonds they say they do? A portion of their portfolio consists of "synthetic" investments and yet these "synthetic bonds" are not cited on the prospectus.

When you read the people who will follow this post with contradictory positions, you will see citings that generally read "the more people buy, the more it goes up while sell-offs will cause price drops". And yet, the argument in favor of bond ETFs is they buy bonds when people buy shares and sell bonds when people sell. This is the job of the market makers. There is a small cash float and a massive fund should blend these factors out, turning them into a close approximation of their core bonds which, was the goal in the first place.

Bond ETFs are dead to me. I've become quite comfortable leaving money in cash for long periods. This brings other benefits, as well.


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## james4beach (Nov 15, 2012)

TomB16 said:


> These short term bond funds are making low yields as they lose money. In the 5 year case of XSB, they have lost more market equity than they've paid interest. For many historic durations, the parasitic losses outstrip the bond earnings. IOW, holding XSB is a money loser.


It's not right to look at share price separately from distributions paid out. Look at total return, and XSB has done fine:

Over 5 years it's returned +1.47% per year
Over 3 years it's returned +1.12% per year

Those are fine returns... I don't see the problem.


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## james4beach (Nov 15, 2012)

TomB16 said:


> Who would buy a 5 year bond that can be redeemed for less than the purchase price minus interest? XSB owners. That's who.
> ...
> On December 2, 2012, XSB closed at $28.94. Today, XSB closed at $27.52. That's a 5.16% total drop over 5 years, or can be expressed as an annual compounded loss of 0.81%


This calculation is not correct. XSB has made money over 5 years, approximately 7.5% total gain including all distributions, which works out to +1.5% annual return. It has made more money than cash, and less than XBB (regular bonds) which is exactly what you'd expect.

As with every other ETF and mutual fund that pays any kind of distribution (whether dividends, interest, or anything else) you must evaluate the performance by looking at total return. The ETF provider web sites, Morningstar, and stockcharts.com all do this.


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## TomB16 (Jun 8, 2014)

james4beach said:


> It's not right to look at share price separately from distributions paid out.


I just calculated distributions paid out by adding all distributions during a specific period, then I looked at the equity loss over the same period. Subtracting gains from losses is also known as "total return".

Are you trying to be contradictory?




james4beach said:


> This calculation is not correct. XSB has made money over 5 years, approximately 7.5% total gain including all distributions, which works out to +1.5% annual return. It has made more money than cash, and less than XBB (regular bonds) which is exactly what you'd expect.


Certainly, at least, one of us is incorrect. I don't dismiss the possibility that it could be me but did you include the equity loss in your calculation?

Also, I suggest you closely observe ex-date cut-offs, when calculating distributions over a given period.


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## GreatLaker (Mar 23, 2014)

As of Nov 30th, XSB has a 1 year return of 0.33%, 5 year of 1.54 and 10 year of 2.96%. Not fabulous, but definitely not negative. Take a look at this link: https://www.blackrock.com/ca/individual/en/products/239491/

Here is a value of $10,000 chart, also from Blackrock's website. It has a long-term upward trend, although with a slight drop since May of this year due to rising interest rates. 








When rates go up, bond prices drop. If the price drop is greater than the interest or income distributions then return will turn negative. But then as older bonds mature and newer bonds are purchased at higher interest rates, the return will again rise. That's how bond funds work. It's also how GIC ladders work, although the effect is less known since most GICs are not redeemable before maturity, and you can't look up GIC prices on Morningstar or the issuer's website.

This misunderstanding about bond ETFs is so prevalent that Dan Bortolotti even wrote a blog post about it:
Bond Basics 2: Why Your ETF Isn’t Losing Money

If you don't like an asset class or investment product then don't buy it. But please don't bash something without backing it up with real facts.

For the OP, as noted in post #3 of this thread the duration of your bond holdings should be matched to your investing timeline and expected time to need the funds. Compare the Value of $10,000 chart for XSB and XLB. The higher volatility of XLB is the price you must accept for the higher returns of a longer term bond fund.
Holding Your Bond Fund for the Duration


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## AltaRed (Jun 8, 2009)

^+1 

I think an issue some people struggle with is near term volatility of, for example, XSB vs XBB, but that is simply a reflection of short term fluctuations in central bankers screwing around with overnight interest rate changes. Yield curves this year have hardly changed for longer term bonds. One could overlay 2017 yield curves on a month by month basis for 1 yr, 2 yr, 5 yr, 10 yr and long term bonds to see near term 'noise'.

The bigger issue is if and when the bond market fears inflation returning longer term. Then a shift in the longer end of the yield curve will really jerk long term bond prices. We are too used to looking at things on a relatively short basis (<5 years).


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## Jimmy (May 19, 2017)

I don't know why anyone would want to buy LT bond ETFs like XBB now for 2.31 % ytm , yields near the lowest ever, when you can get a near similar return w ST ETFS like XSB w a ytm of 1.97%. 

Then wait until XBB starts yielding something significant, like maybe after a few more rate hikes or other indicators of inflation, LT and switch over.


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## james4beach (Nov 15, 2012)

Jimmy said:


> I don't know why anyone would want to buy LT bond ETFs like XBB now for 2.31 % ytm , yields near the lowest ever, when you can get a near similar return w ST ETFS like XSB w a ytm of 1.97%.
> 
> Then wait until XBB starts yielding something significant, like maybe after a few more rate hikes or other indicators of inflation, LT and switch over.


Mainly it's for people who don't want to try timing the market (or like myself who believe it's not possible). Fundamentally, the bond market rewards you with higher returns the farther you go out in time -- that's the yield curve. Over long periods of time, XBB will very likely have a greater return than XSB.

Here is YTD performance by the way:
XSB +0.20%
XBB +2.83% ... _way higher performance in this rising rate environment_

I've been arguing this for years, but here is proof yet again that timing the bond market is not simple. Even though the BoC raised rates twice this year, XBB has actually outperformed short term bonds!

The reverse could happen, rate hikes could stop, and XBB could underperform. Who knows -- it's unpredictable. This is why I just maintain XBB-like exposure continuously. As long as your time horizon is 10+ years, it's the right thing to do.

Can't time the stock market. Can't time the bond market (= bond yields).


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## Jimmy (May 19, 2017)

james4beach said:


> Mainly it's for people who don't want to try timing the market (or like myself who believe it's not possible). Fundamentally, the bond market rewards you with higher returns the farther you go out in time -- that's the yield curve. Over long periods of time, XBB will very likely have a greater return than XSB.
> 
> Here is YTD performance by the way:
> XSB +0.20%
> ...


You shouldn't look at ytd performance figures. The YTM is all that matters. As short term rates rise, long term interest costs will also rise. Investors wont accept the same yields for 2 yr and 10 yr bonds and LT rates will rise eventually. IMO now is not the time to go long on bonds when yields are so poor. Interest rates are only 1% now. They wont remain there for long. Most reports are forecasting another 1% in hikes in 2018. The US will be hiking rates too and they will have to match at least in part or see the $ fall.

Wait a year and then make it worth your while


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## james4beach (Nov 15, 2012)

Jimmy said:


> As short term rates rise, long term interest costs will also rise.


But that's still not necessarily bad for XBB. A gradual rate increase does not hurt bond funds, over time. (Additionally we can't even be certain that long term yields will rise but I'll leave that issue aside.)

It's the short term price fluctuations that concern you, but these are too fast and unpredictable to trade around in the way you suggest (hop between XSB & XBB). Even if the yield on the 10 year bond goes up -- as you fear -- XBB does not necessarily do badly.

Between 2012-06-01 and 2017-10-06 the Canadian 10 year bond yield increased from 1.62% to 2.13% ... it's exactly what you're afraid of. Here were the annualized returns between those two dates:

XSB returned 1.51%
XBB returned 2.50%

Great example here. XBB outperformed XSB. The people trying to hide out from rising rates sat in XSB and forfeited this extra 1% annual return, _even though they were correct in predicting rising rates_.


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## Jimmy (May 19, 2017)

james4beach said:


> Even if bond yields rise (which is not guaranteed), that's still not necessarily bad for XBB. A gradual rate increase does not hurt bond funds, over time.
> 
> I pointed out the YTD performance to show that it's very hard to predict this stuff. Many people in CMF were saying that one should hold XSB instead of XBB during this year because "interest rates were going to rise". And indeed, interest rates did rise, but it turned out that XBB greatly outperformed XSB. That's a lot of performance *forfeited* by people trying to time the bond market.
> 
> ...


I am not talking about a 5 yr horizon. I am talking about the next 1-2 yrs. 

That is a .5% yield change over 5 yrs. You will likely see a 1% change in the next year so you are better to go short term, then in a year switch over. If you could save 1% on your mortgage rate by waiting a year vs locking in you would do that too.


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## james4beach (Nov 15, 2012)

Jimmy said:


> I am not talking about a 5 yr horizon. I am talking about the next 1-2 yrs.


Sorry, I edited and shrunk my post while you were replying.

It's the short term price fluctuations that concern you, but these are too fast and unpredictable to trade around in the way you suggest (hop between XSB & XBB).



> You will likely see a 1% change in the next year so you are better to go short term, then in a year switch over.


It's not the overnight rate that affects XBB, it's the yield of the 10 year bond plus corporate spreads. So your claim here is that the 10 year benchmark yield will increase 1% in a year and corporate spreads will remain about the same.

You're simultaneously making a strong prediction on short term rates (XSB which is avg 3 year bond yield). How can you possibly be correct in simultaneous predictions on:
- the 3 year yield
- the 3 year corp spreads
- the 10 year yield
- the 10 year corp spreads
- the shape of the yield curve
- time frame this all plays out like you predict

You might get lucky but that's a VERY difficult prediction to make.


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## Jimmy (May 19, 2017)

james4beach said:


> It's not the overnight rate that affects XBB, it's the yield of the 10 year bond plus corporate spreads. So your claim here is that the 10 year benchmark yield will increase 1% in a year and corporate spreads will remain about the same.
> 
> You're simultaneously making a strong prediction on short term rates (XSB which is avg 3 year bond yield). How can you possibly be correct in simultaneous predictions on:
> - the 3 year yield
> ...


I didn't claim that but as ST rates rise, LT rates will rise too (but maybe by not as much) to attract investment. Why would you invest LT if there is little difference in yield? You wouldn't. 

Here is an explanation of this w a normal yield curve. We are in a period of rising interest rates and economic expansion now.



> A normal or up-sloped yield curve indicates yields on longer-term bonds may continue to rise, responding to periods of economic expansion. When investors expect longer-maturity bond yields to become even higher in the future, many would temporarily park their funds in shorter-term securities in hopes of purchasing longer-term bonds later for higher yields. In a rising interest rate environment, it is risky to have investments tied up in longer-term bonds when their value has yet to decline as a result of higher yields over time.


https://www.investopedia.com/terms/y/yieldcurve.asp


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## james4beach (Nov 15, 2012)

I'm not ruling out speculation and trading around interest rate changes, I just think it's very difficult to get right. And again if you look at the history of what people have said on CMF, nobody here has gotten it right so far. For many years people here have said it's better to stay in short term bonds and avoid things like XBB. All of us (including myself who believed the same thing) have been wrong.

Here's a good paper from Vanguard about this
https://personal.vanguard.com/pdf/s807.pdf

Myself, I've settled on static, couch potato allocation to XBB/VAB/equivalent because (a) my time horizon is 10+ years and (b) I don't think I can time the bond market and (c) over long periods the returns in XBB are guaranteed to be higher than short term bonds


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## Jimmy (May 19, 2017)

james4beach said:


> I'm not ruling out speculation and trading around interest rate changes, I just think it's very difficult to get right. And again if you look at the history of what people have said on CMF, nobody here has gotten it right so far. For many years people here have said it's better to stay in short term bonds and avoid things like XBB. All of us (including myself who believed the same thing) have been wrong.
> 
> Here's a good paper from Vanguard about this
> https://personal.vanguard.com/pdf/s807.pdf
> ...


I see your pt and that is a good article. I have some LT bond holdings I am leaving alone too. But for more recent asset purchases, I will likely go XSB just given we are at a period of record low interest rates and switch over in 1-2 yrs to XBB. Though it is never certain, many bank and other economic outlooks are forecasting interest rate hikes for next year.


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## paulw789 (Dec 8, 2017)

*Check Market Value and Volume FIRST on ETFs*

I was looking into a few ETFs offered through my bank (as in one of the majors).

But there was just hardly any market cap in most of the funds. I would have owned 20% of the units in the majority of them at the amounts I was looking at.

Furthermore, there was just very low volumes of trades in the funds. At most, I could sell $25,000/day when I was thinking of being able to do many multiples of that with no lags.

In other words, "liquidity" is a big problem in the majority of the ETFs right now. You have to be able to dump $500,000 or something and not move the market by yourself or be stuck owning an ETF that almost noone wants to buy on the day you want to trade it.

I can tell that many individuals are stuck in this quandary right now.


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## AltaRed (Jun 8, 2009)

You have not been looking at the AUM (assets under management) from the likes of BlackRock, BMO and Vanguard then. Most have very significant liquidity


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## james4beach (Nov 15, 2012)

Maybe you're looking at the wrong bond ETFs. Both XSB and XBB hold billions of $ in assets and you absolutely can buy or sell large amounts.

XSB trades an average 350K shares daily, so it trades approx $10 million dollar volume
XBB trades an average 300K shares daily, approx $9 million dollar volume

Some brokerage interfaces only show the TSX volume whereas these funds also trade on electronic exchanges (ECNs) in Canada, where more shares trade hands. Your brokerage will automatically route the orders to any of the exchanges to take advantage of this. I think these figures in the 300K realm (that's # of shares) are a pretty good measure of total daily volume in Canada.

There's a good reason to use these particular funds ... they are the beasts in Canada. You could probably trade $1 million worth of either one in a day without affecting the market at all. There are always buyers, even during the worst times of the financial crisis.


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## james4beach (Nov 15, 2012)

Notice what happened today. The US Federal Reserve increased the overnight interest rate. But look at AGG and IEF, which are bond index funds around the 10 year average maturity.

Those bond funds went UP today in reaction to the rate hike. Overnight interest rate up, medium term interest rates down.

This is yet another demonstration of why you can't just apply simple reasoning such as "avoid bond funds since the central bank will hike rates". That's really not how it works. The central bank does things at the overnight rate, the short end of the curve, but the rest of the bond market reacts to different factors.

Thinking that you can outsmart the bond market by simply going to short term bonds during "rising interest rates" is unrealistic.


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## like_to_retire (Oct 9, 2016)

james4beach said:


> Thinking that you can outsmart the bond market by simply going to short term bonds during "rising interest rates" is unrealistic.


Agreed, but, if the overnight rate increases, and increases, and increases, as we expect it will, eventually the entire curve will move up, including the long rate. At the low end, at least you pick up those higher rates faster. No?

ltr


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## james4beach (Nov 15, 2012)

like_to_retire said:


> Agreed, but, if the overnight rate increases, and increases, and increases, as we expect it will, eventually the entire curve will move up, including the long rate. At the low end, at least you pick up those higher rates faster. No?


First let's remember that it's not a guarantee that the central bank will still be raising rates in a year or two. But let's assume they will.


 Scenario 1 is that the short end shifts upwards, and then eventually the entire yield curve shifts up - yes.
Scenario 2 is that the short end shifts up until the yield curve is flat or inverted, possibly followed by a recession and the central bank reducing the short end again. This is what happened leading up to 2008.
Scenario 3 is that the curve remains somewhat flat, and all shifts upwards, but very gradually over time. In this scenario you still get the highest return with exposure to the mid part of the curve (like XBB).

It can play out many different ways. If you stick to the short end of the curve, there's also the opportunity cost as you forego the higher returns from farther down the curve. My argument is that it's a very difficult speculation and timing to successfully pull off, though you certainly can get lucky and make the right bond speculation.


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## Mike-RetireEarly (Feb 28, 2016)

The 10 Year bond rate went down 2.3% today, see https://ca.investing.com/rates-bonds/u.s.-10-year-bond-yield


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## doctrine (Sep 30, 2011)

like_to_retire said:


> Agreed, but, if the overnight rate increases, and increases, and increases, as we expect it will, eventually the entire curve will move up, including the long rate. At the low end, at least you pick up those higher rates faster. No?
> 
> ltr


Or, the yield curve flattens or goes negative. It has happened before. I would suspect that if the longer term yields do not increase, the Fed may be forced to stop increases. The delta between 10 year and overnight is less than 1%; the 10 year was at 2.3% when the fed rate was 0% in 2014, now three years later and five interest rate hikes and the 10 year is again at 2.3%.


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## Jimmy (May 19, 2017)

doctrine said:


> Or, the yield curve flattens or goes negative. It has happened before. I would suspect that if the longer term yields do not increase, the Fed may be forced to stop increases. The delta between 10 year and overnight is less than 1%; the 10 year was at 2.3% when the fed rate was 0% in 2014, now three years later and five interest rate hikes and the 10 year is again at 2.3%.


The US10 yr yield did fall to 1.6% in 2016 eventually after the earlier rate cuts. Now it is at 2.3% after rate hikes from .5 to 1.5%.

The yield curve was sloping upwards even when growth was stagnant in that period. Now there are signs of growth, hence the hikes, it seems unlikely the curve will flatten or invert. Don't think they are expecting a recession anytime soon.


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## james4beach (Nov 15, 2012)

The yield curve has already flatted pretty substantially. This article from November describes it, and the curve has only flattened more since then: https://www.bloomberg.com/news/arti...curve-is-flattening-and-here-s-why-it-matters

One might say that the central banks are expecting growth, but the bond market is not.

Doesn't mean much for a bond investor though. Just pick the average target maturity that suits you, and stick with it.


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## AltaRed (Jun 8, 2009)

james4beach said:


> One might say that the central banks are expecting growth, but the bond market is not.
> 
> Doesn't mean much for a bond investor though. Just pick the average target maturity that suits you, and stick with it.


I'd suggest "the central banks are expecting some inflation due to continued GDP growth, but the bond market is not.....because of Fed tightening". The bond market is happy that the Feds are putting on the brakes enough to help keep future inflation lower than it might otherwise be, and flattening of the yield curve is highly predictable in circumstances such as these.


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## Jimmy (May 19, 2017)

The curve is flatter than historically but is still sloping upward. New 10 yr bond coupons are set at the RF ( risk free rate ) + some inflation premium. Unless bond issuers and investors think there is no expectation of inflation, there will always be some premium and coupons on 10 yr bonds will always be higher than on 2 yr. It looks like inflation is in the 1.5% range, so new issues should have 1.5% + 1.5% overnite rate = 3% coupons, yields should rise to similar levels.

It just takes time to move the yield for the entire group but as more and more new bonds are issued at increasingly higher coupons, it eventually pushes up the yields up on the entire 10 yr group


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## like_to_retire (Oct 9, 2016)

Jimmy said:


> It just takes time to move the yield for the entire group but as more and more new bonds are issued at increasingly higher coupons, it eventually pushes up the yields up on the entire 10 yr group


Exactly.

ltr


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## james4beach (Nov 15, 2012)

The things you describe are why XBB is guaranteed to return more than XSB over the long term. You get rewarded with higher return for going farther down the yield curve -- that's literally what the normal yield curve is.

What happens in the shorter term is just price volatility, noise. In my experience that seems to turn off people from targeting the 10yr (XBB) even though the higher returns are guaranteed.

The "gradual" boost to bond yields makes a particularly strong case for XBB. Those are optimal conditions, as long as the curve stays normal. So Jimmy, I think you are making the argument for XBB exposure


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## AltaRed (Jun 8, 2009)

Duration of XBB is actually about 7.4 years, almost exactly between a 5 and 10 year bond, i.e. called a 'medium' term bond ETF.


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## like_to_retire (Oct 9, 2016)

james4beach said:


> The "gradual" boost to bond yields makes a particularly strong case for XBB. Those are optimal conditions, as long as the curve stays normal. So Jimmy, I think you are making the argument for XBB exposure


Of course you're correct, but that's as long as you hold on for the required average duration. I suspect everyone would agree.

ltr


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## james4beach (Nov 15, 2012)

AltaRed said:


> Duration of XBB is actually about 7.4 years, almost exactly between a 5 and 10 year bond, i.e. called a 'medium' term bond ETF.


That's the duration, which is a measure of volatility and price sensitivity. The average term (or weighted average maturity of the bonds in the portfolio) is 10.28 years.

I think that if you want to compare interest rate sensitivity to other things, duration is the right measure to use. If you want to look at its exposure on the yield curve, I think average term/maturity is the right one.

For example you can look at the government 10 year benchmark and compare that yield to the XBB yield because both point to the 10 year maturity on the curve. The difference between the two is attributable to the additional yield of corporate bonds and provincials.


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## AltaRed (Jun 8, 2009)

True but it doesn't mean much beyond knowing that 'acquisition' yields of all the bonds were originally about 10 years... just like the average effective maturity of a 5 year GIC ladder is about 5 years. That said, I suppose it is directional of the trend.


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## Jimmy (May 19, 2017)

james4beach said:


> The things you describe are why XBB is guaranteed to return more than XSB over the long term. You get rewarded with higher return for going farther down the yield curve -- that's literally what the normal yield curve is.
> 
> What happens in the shorter term is just price volatility, noise. In my experience that seems to turn off people from targeting the 10yr (XBB) even though the higher returns are guaranteed.
> 
> The "gradual" boost to bond yields makes a particularly strong case for XBB. Those are optimal conditions, as long as the curve stays normal. So Jimmy, I think you are making the argument for XBB exposure


Yes I know we have had good debate.  . Over the long haul it is a good core fund. Note XBB fell from a peak of 31.97 to 31.26 from June to now or 2.2%. There will be some ST cap losses as interest rates rise but you still have the dividend yield. Some model portfolios like just either ST bonds or corporate bonds now but others like a mix of varying maturities ( ishares portfolios). They have another ETF called XQB CAN Quality Bond ETF now too which looks similar

https://www.wealthsimple.com/en-ca/details

Actually I have a small % in a reset preferred ETF HPR that will rise when int rates rise - they 'reset' the dividend to yield ~2% above the 5 yr bond yield. Not bad. ~ 3.5% yield now. They are more correlated to the market so are not as safe as real FI investments but ok for a small holding or a hybrid.


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## james4beach (Nov 15, 2012)

AltaRed said:


> True but it doesn't mean much beyond knowing that 'acquisition' yields of all the bonds were originally about 10 years... just like the average effective maturity of a 5 year GIC ladder is about 5 years. That said, I suppose it is directional of the trend.


I thought the ETF's maturity measure is average maturity that remains, not the original. In other words they are maintaining constant exposure to the 10 year point of the yield curve. When applied to a GIC ladder, I think that gives avg maturity = 3. I'm reasonably certain this is how it works because when running a bond fund, you keep buying longer maturity bonds such that your portfolio's average maturity stays constant at X years.

That's part of the magic of bond funds actually, maintaining _constant_ avg maturity over time. Therefore you perpetually get the yield offered by that point on the yield curve.

I think a 5 year GIC ladder is like XSB, both with average maturity 3 years -- both maintain constant 3 year exposure.
XBB is like government 10 year bond (plus corporate spread), maturity 10 years.


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## james4beach (Nov 15, 2012)

Jimmy said:


> Yes I know we have had good debate.  . Over the long haul it is a good core fund. Note XBB fell from a peak of 31.97 to 31.26 from June to now or 2.2%.


In total return, XBB is up +0.7% from June 14 to December 14.


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## Jimmy (May 19, 2017)

Not to hijack the thread but many 2018 outlooks are out now from the ETF providers.

Many see the US as overvalued , CAN fair and EAFE and EM undervalued so adjust the weights accordingly. Seems to make sense US market has been way up for the past 3 yrs. EAFE up ~ 20% this year isn't a bad option for another year. EM too risky for me.


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## AltaRed (Jun 8, 2009)

james4beach said:


> I thought the ETF's maturity measure is average maturity that remains, not the original. In other words they are maintaining constant exposure to the 10 year point of the yield curve. When applied to a GIC ladder, I think that gives avg maturity = 3. I'm reasonably certain this is how it works because when running a bond fund, you keep buying longer maturity bonds such that your portfolio's average maturity stays constant at X years.
> 
> That's part of the magic of bond funds actually, maintaining _constant_ avg maturity over time. Therefore you perpetually get the yield offered by that point on the yield curve.


You may be right. Without doing more thinking, I don't know and I am fresh out of desire to do any more thinking about it.


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## james4beach (Nov 15, 2012)

james4beach said:


> First let's remember that it's not a guarantee that the central bank will still be raising rates in a year or two. But let's assume they will . . . It can play out many different ways. If you stick to the short end of the curve, there's also the opportunity cost as you forego the higher returns from farther down the curve. My argument is that it's a very difficult speculation and timing to successfully pull off, though you certainly can get lucky and make the right bond speculation.


What fun, now we're seeing how it all plays out. Does everyone remember when bonds seemed really scary because interest rates were about to soar?

Here's XBB with price adjusted for total return: http://schrts.co/ubnQfvKC

As you can see, there's been no catastrophe in bonds. What seemed like the obvious trade at the time -- hiding out in short term bonds due to better risk/reward -- turned out to be the wrong trade, and instead the highest returns have been in XBB... _the complete opposite of consensus thinking_. This is why I kept pointing out that it's very hard to time the bond market and arguing for the passive asset allocation approach where you simply stick with your bond exposure target instead of trying to get fancy by speculating on the yield curve.


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## Argonaut (Dec 7, 2010)

I'm worried about bond yields and a possible Japanification of our economy. The Canadian 10 year bond yield is 1.59%, with yields all the way down to the 1 year either flat or inverted. Meanwhile, my daughter's RESP has a 30% weight in the TD Bond e-Series fund, which has a 0.50% MER -- compared to the current bond yields that makes me sick.


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## AltaRed (Jun 8, 2009)

james4beach said:


> As you can see, there's been no catastrophe in bonds. What seemed like the obvious trade at the time -- hiding out in short term bonds due to better risk/reward -- turned out to be the wrong trade, and instead the highest returns have been in XBB... _the complete opposite of consensus thinking_. This is why I kept pointing out that it's very hard to time the bond market and arguing for the passive asset allocation approach where you simply stick with your bond exposure target instead of trying to get fancy by speculating on the yield curve.


True if one is really looking out long term. But your chart is data mining in that one would expect XBB pricing to take off with the sudden collapse of the yield curve. If that yield curve stays where it is for 3-5 years, XBB pricing will again start to collapse as the old bonds roll off and new bonds bought at higher prices come into the ETF. I don't take kindly to these kinds of posts.

Argonaut may well have good reason to be concerned about the TD bond e-series fund in his daughter's RESP...if for no other reason than RESP withdrawals are relatively inflexible. Depending on whether the first withdrawal is 2 years out, or 5 years out, he could very well hit bad timing in having to crystallize some of that bond fund. If it is 10 years out, there is less reason to worry, but even then a yield under 2% being carved up by a 0.5% MER is pretty disheartening. As counter to long term investing as it may seem, this may be a time to take advantage of the boost in market pricing to get out and build a 5 year GIC ladder. Of course, GIC rates are plummeting now too but at least they are not subjected to relentless MERs.

It is a tough call. My ex has a significant holding in XSB and while today's boost in market prices look good, it will be headed back to the high $26 range if this swoon in low yields lasts too long.


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## james4beach (Nov 15, 2012)

You don't take kindly to these kinds of posts? I'm saying that it's hard (or impossible) to time the bond market or predict the movements of the yield curve and I'm showing the last 2 years as an example of that.


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## Argonaut (Dec 7, 2010)

My daughter is 1 year old, so I'm not concerned about withdrawals or timing right now. Just the bad optics of relatively high MER compared to interest rates. I want to keep the RESP fairly conservative and it's annoying with the current interest rate situation.


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## AltaRed (Jun 8, 2009)

Argonaut said:


> My daughter is 1 year old, so I'm not concerned about withdrawals or timing right now. Just the bad optics of relatively high MER compared to interest rates. I want to keep the RESP fairly conservative and it's annoying with the current interest rate situation.


The yield curve will change multiple times between now and ~17 years from now. Just stop looking at it and cut the grass instead.


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## james4beach (Nov 15, 2012)

Argonaut said:


> My daughter is 1 year old, so I'm not concerned about withdrawals or timing right now. Just the bad optics of relatively high MER compared to interest rates. I want to keep the RESP fairly conservative and it's annoying with the current interest rate situation.


Well yeah that MER is too high versus the new normal for interest rates. This is an unfortunate situation, but this is what the Bank of Canada has done to you. They are deliberately re-pricing cash and safe returns in an attempt to force you into more risk-taking. A big reason they maintain near-zero interest rates is to manipulate you... err apologies, "inspire you"... to take more risk than you normally would, or should.

I think it's best to decide on your risk tolerance or asset allocation, and then stick with the plan, no matter how much the central banks try to change your behaviour. If you've decided you want a conservative asset allocation, stick with it.


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## AltaRed (Jun 8, 2009)

james4beach said:


> You don't take kindly to these kinds of posts? I'm saying that it's hard (or impossible) to time the bond market or predict the movements of the yield curve and I'm showing the last 2 years as an example of that.


James, look at what you wrote


> hiding out in short term bonds due to better risk/reward -- turned out to be the wrong trade, and instead the highest returns have been in XBB... the complete opposite of consensus thinking. This is why I kept pointing out that it's very hard to time the bond market and arguing for the passive asset allocation approach where you simply stick with your bond exposure target instead of trying to get fancy by speculating on the yield curve.


What highest returns? Just because of the ramp up of the last 4 months? You've data mined 4 months to asset 'highest returns in XBB'. There are NO highest returns in XBB unless you have just market timed by selling today. Three months from now, pricing may be back to $29 and all one has are the distributions (yield). If you had simply stuck to your last statement in what I have quoted, you would have a wave of agreement.


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## james4beach (Nov 15, 2012)

Let's try a few round number time frames and let's see based on the data (all below are cumulative total returns)

Trailing 1 year total return, using http://schrts.co/bFEBXYYS
XSB +3.6%
XBB +5.6%

Trailing 2 year total return
XSB +3.2%
XBB +7.2%

Trailing 3 year total return
XSB +4.3%
XBB +8.8%

Trailing 4 year total return
XSB +4.6%
XBB +8.0%

Trailing 5 year total return
XSB +8.7%
XBB +19.6%

What do you think, am I data mining? Or do you want to disregard these calculations because you think today's bond prices are invalid?

I will make the same assertion I've made for years, which is that over long periods, XBB _will_ outperform XSB as this is virtually guaranteed by the nature of the bond market and yield curve.


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## james4beach (Nov 15, 2012)

Here's another illustration which should convince you that XBB generally outperforms XSB, although there is of course volatility along the way and changes to the yield curve which reverses the relationship sometimes.

This graph shows, in total cumulative returns (all interest included), the ratio of XBB:XSB. When the line is declining, XBB is underperforming short term bonds. When the line is going up, XBB is outperforming short term bonds.

http://schrts.co/AZajSHqf

Notice the recessionary periods like 2001 and 2007-2009 where XBB has underperformed short term bonds (yield curve inversions). And what we're talking about recently is the 2016-2019 period where the relationship of the two has gone sideways and XBB was not outperforming. This is when many people concluded that short term bonds present a better proposition.

However I think this *big picture* illustration shows that XBB generally outperforms short term bonds XSB. The cumulative effect over many years is substantial.


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## Argonaut (Dec 7, 2010)

In most cases, longer term bonds will outperform shorter term bonds because they have higher yields. But now the yield curve is flat or inverted, so short term or cash looks more attractive to me at this point in time.

Doesn't mean I'm going to radically change my investment strategy -- my RESP is just starting and is fairly small, and I don't own any bonds personally right now. But I can still complain about the situation.


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## AltaRed (Jun 8, 2009)

James, I am not asserting that XBB does not have a better return than XSB at all. Never once even mentioned that and I am fully aware XBB will outperform XSB on a multi-year basis. 

I am asserting you cannot make a case for the grand performance based on a chart that specifically includes the last 4 months. That is purposely selected as the point of your original post, which is what media pundits do. If you want to make a sound case, use calendar year returns instead. In any event, I think we are now talking past each other and we probably should go back to regular programming.


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## james4beach (Nov 15, 2012)

Ah, I see AltaRed. You disagreed with the style/construction of argument I used -- fair enough.

I used recent results as a counter example: I wanted to how something that seems obvious in bonds (one or two years ago) turned out to be wrong. There seems to be a sense among retail investors that bond matters are easy to predict and can strategically be traded around, and I was trying to show that in fact this is much harder than it looks.


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## like_to_retire (Oct 9, 2016)

james4beach said:


> I wanted to how something that seems obvious in bonds (one or two years ago) turned out to be wrong.


Yeah, I certainly read many opinions on the forums from those recommending going short with bonds since it was a slam dunk that rates would be rising and you sure did not want to go long term.



james4beach said:


> There seems to be a sense among retail investors that bond matters are easy to predict and can strategically be traded around, and I was trying to show that in fact this is much harder than it looks.


Yep, for sure. Predicting bond rates is a fools game. That's probably the best way to lay it out. Any short term graphs or examples probably doesn't work the best. Myself, I'm a big fan of ladders, and even though it's sometimes tough to renew rungs when you really feel it's the wrong way to go, I always bite the bullet and renew. 

ltr


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## AltaRed (Jun 8, 2009)

As do I. Remain disciplined and re-invest on schedule. We may be in for a stretch of years of yield volatility that we have never seen before.


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