# My year end RRSP contribution --Any thoughts on a bond fund



## 1980z28 (Mar 4, 2010)

This year I will purchase a bond or not,Why?

Do not have any bonds now

Have 12000.00 to put into RRSP it is appox 10% of RRSP total to date
Was thinking of bond fund such as TDB 909
I am 52


----------



## dubmac (Jan 9, 2011)

Consider Mawer Canadian Bond Fund 

https://www.google.ca/finance?q=MUTF_CA:MAW100&hl=en&ei=p5HGUIDQD4WuqQH02gE
low MER 0.78% - anything under 1.00% is good IMO.

also consider ETF's XBB (50%), XCB (25%), XSB (25%)...or any combination therein XLB, XHB etc...


----------



## My Own Advisor (Sep 24, 2012)

XBB is a good all-in-one bond product.


----------



## scomac (Aug 22, 2009)

Do not buy a bond fund! Do not buy a bond ETF! Currently the YTM on XBB is 2.24%. Subtract the .33% MER and that leaves you with an annual return less than 2%. A bond mutual fund will only be worse due to higher expenses. The best thing you could do today is to buy a 5 year GIC. You should be able to source a 5 year GIC paying 2.5% annually from one of the smaller providers through your discount brokerage. Going forward, the 5 year GIC ladder will likely prove out to have been the cheapest, easiest and best performing choice for fixed income allocations.


----------



## dubmac (Jan 9, 2011)

scomac
I, too, use a GIC ladder..but...
1 yr ago XBB was 31.24. today it is 31.59. (Not much change despite a low of 30.43) 
XBB's distribution is $0.08.61 per unit...on average across 12 months.
The yield, based on today's price, is 3.27% - higher than the 2.5% on a 5yr GIC.
The advantage to buying XBB is getting more than a 5 yr GIC, without being locked in for 5 yrs.
At least -that's the way I calculated it.


----------



## Soils4Peace (Mar 14, 2010)

VAB has a lower MER.


----------



## P_I (Dec 2, 2011)

dubmac said:


> scomac
> I, too, use a GIC ladder..but...
> 1 yr ago XBB was 31.24. today it is 31.59. (Not much change despite a low of 30.43)
> XBB's distribution is $0.08.61 per unit...on average across 12 months.
> ...


A very common error. You are considering what iShares calls the distribution yield, not (weighted) yield to maturity. 

From the pop-up information bubbles on XBB Overview - iShares ETFs:
*Distribution yield* - The annual yield an investor would receive if the most recent fund distribution stayed the same going forward. The yield represents a single distribution from the fund and does not represent the total return of the fund. The yield is calculated by annualizing the most recent distribution and dividing by the fund NAV from the as-of date. This figure is net of management fees and other fund expenses.

*Weighted Average Yield to Maturity* - The average YTM is the interest rate that will make the present value of the cash flows from a bond equal to its market price plus accrued interest. The average yield to maturity considers not only the coupon income, but any capital gain or loss that the investor will realize by holding the bonds to maturity. It also considers the reinvestment of the coupons.​
The distribution yield has happened and is *no indication* on what you will receive in the future.


----------



## PuckiTwo (Oct 26, 2011)

dubmac said:


> .........but... 1 yr ago XBB was 31.24. today it is 31.59. (Not much change despite a low of 30.43) XBB's distribution is $0.08.61 per unit...on average across 12 months. The yield, based on today's price, is 3.27% - higher than the 2.5% on a 5yr GIC. At least -that's the way I calculated it.


*Dubmac*, I came to the same conclusion: from Nov 11 - Nov 12 Actual income in % 3.33%. Cap gain+distribution = Total return 4.88%. That's not by a fictitious accounting method but unrealized gains on my account statement plus cash in my pocket, *MER deducted*



P_I said:


> The distribution yield has happened and is *no indication* on what you will receive in the future.


Sure, that's unquestioned. Past returns are no guarantee for future returns - same as with stocks, real estate, etc. I rather take my 3.33% *present* return than a possible 2.5% on a GIC ladder with 5-year locked in amount. As long as I monitor the returns every month I should be able to react in time. Of course, you can't buy and hold forever and forget about it. It's pretty clear returns will be dropping, but so will the "buying power" of your locked in GIC investment. I think the ability to immediately access the cash is worth the risk...but that's a personal decision.


----------



## P_I (Dec 2, 2011)

Going forward your will your return will be the weighted average yield to maturity, less MER. Using the information from the iShares site for XBB, as of Dec 7, 2012, that is 2.24% - 0.33%, or 1.91%. I'd be picking the 5 year GIC at 2.50% vs 1.91% on XBB.


----------



## brad (May 22, 2009)

I'd like to ask a very basic question about this:

Let's say I'm purchasing a bond fund as part of a relatively long-term portfolio (in my case 15-20 years). This is a longer term than any of the bonds currently held in the fund, so what happens as they reach maturity? Are they replaced with new ones, which presumably would have different yields to maturity? I don't care what my bonds return over the next five years, that's not relevant to me. What I care about is growth in value of my shares in the fund over 15-20 years. I'm just trying to wrap my head around why buying GICs, even if their rate happens to be better right now, would make sense over buying shares in a bond fund if I'm planning to hold it for 15-20 years.


----------



## scomac (Aug 22, 2009)

P_I said:


> A very common error. You are considering what iShares calls the distribution yield, not (weighted) yield to maturity.


Thanks to P_I for pointing out the error in logic of my inquisitors. You may want to base your investment choices on what has happened as recently as the past 12 months, but that cannot be extrapolated forward particularly when you know with certainty what your underlying investments are going to yield. Calculating the yield going forward of a bond ETF or bond fund is quite straight forward using the data provided that P_I has highlighted.

The only way you are going to earn more return on a bond ETF going forward is if interest rates rise as bonds are rolled over. You are essentially giving up return today in the hopes of return in the future by opting for the ETF over the 5 yr. GIC. You are already giving up .59%/yr. currently, multiply that by the duration of 6.96 years for XBB and they must be able to roll bonds over at an average YTM of 6.35% for you to break even.

Yield differential times duration plus current yield [(.59 X 6.96)+2.24]=6.35

This is the headwind that you are up against with the ETF versus a GIC.


----------



## brad (May 22, 2009)

Thanks for that explanation. My brain is having a hard time reconciling this with with the widely repeated advice that bond ETFs should be a core component of a diversified portfolio (see http://canadiancouchpotato.com/2010/09/05/why-every-portfolio-needs-bonds/ for example), but maybe it's more an issue that given market conditions right now the argument for bond funds vs. GICs is weaker?


----------



## scomac (Aug 22, 2009)

brad said:


> I'd like to ask a very basic question about this:
> 
> Let's say I'm purchasing a bond fund as part of a relatively long-term portfolio (in my case 15-20 years). This is a longer term than any of the bonds currently held in the fund, so what happens as they reach maturity? Are they replaced with new ones, which presumably would have different yields to maturity? I don't care what my bonds return over the next five years, that's not relevant to me. What I care about is growth in value of my shares in the fund over 15-20 years. I'm just trying to wrap my head around why buying GICs, even if their rate happens to be better right now, would make sense over buying shares in a bond fund if I'm planning to hold it for 15-20 years.


As bonds mature in a fund they are replaced with new bonds that will have different YTM than those that they are replacing. The long term return of a bond fund will be a function of the yield curve over time plus or minus the impacts of the change to that curve (ie. capital gains/losses). We've been in a bull market for bonds for at least 30 years now and this has resulted in stellar returns due to the structural drop in interest rates over that time from near 20% down to the current 2.5% for 30 yr. Canadas. 

For the returns in a bond fund to increase over time, the yields of the underlying bonds must rise going forward. As an investor, you can't take advantage of that until they are rolled over. You're stuck with the return that was locked in when you bought, just as would be the case with a GIC. When the GIC matures, you buy a new one at the prevailing interest rates. If rates have gone up substantially, you get to take advantage of that just as you would by owning the bond fund that was purchasing higher yielding bonds on your behalf during that time. The fundamental thing to understand here is that you cannot make capital gains on bonds in a rising rate environment and a large part of the return of bond funds over the past three decades has been from capital gains in the underlying bonds. No matter how you cut it, in periods such as now when we are faced with minuscule interest rates, every dollar that goes out the door in investing costs is going to have a material impact on your return. Even with a low fee ETF, greater than 10% of your gross return is being consumed by fees. In fact, the ETF option is currently ~25% more expensive than buying a simple 5 year GIC. The longer things drag on the way they are, the bigger the bite will be.


----------



## brad (May 22, 2009)

Thanks, that's a very clear explanation.


----------



## james4beach (Nov 15, 2012)

My view on bond funds is similar to what's already been said. I think you can generally find better deals in GICs than bond funds right now (but at the same time I'll add that neither bonds nor GICs offer 'good' rates... they're all too low).

Also remember that a CDIC-insured GIC has guaranteed principal, whereas a bond fund does not. That risk of loss should be factored in when you compare vehicles. Another thing you should factor in is liquidity... you can trade out of an ETF any time, but generally are locked into a long-term GIC. Combining all these factors is up to you and what's important to you in the context of your planning needs.

For example comparing XBB, which has ytm 2.23 - 0.33 mer = 1.9% yield versus a 3 year GIC at 2.0%

To me the GIC is a clear winner -- higher yield, and principal is guaranteed. The only thing that might give you pause is that the GIC is locked in for the 3 years, whereas XBB is liquid and you could sell the position at any time. For this you have to ask yourself, how much is that benefit "worth" to me. Anyway, my point is that these comparisons are all relative and you have to balance the trade-offs.


----------



## dubmac (Jan 9, 2011)

I have been following this thread - thanks scomac for shining some light on some previously unseen...or rather - misunderstood - aspects of bond funds
Question: I hold units in a bond fund (below) - I rebalance it each year. 
The fund is up 5.75% this year. If the MER is 0.78%. is my return 4.97%?

http://quicken.intuit.com/investing...N674/Sun-Life-MFS-MBU-Canadian-Bond-Fund-Cl-D


----------



## scomac (Aug 22, 2009)

If your fund is up 5.75% on the year, then your return is 5.75% because fund returns are reported net of fees.


----------



## PuckiTwo (Oct 26, 2011)

scomac said:


> If your fund is up 5.75% on the year, then your return is 5.75% because fund returns are reported net of fees.


Scomac, thks for yr marvellous patience and yr detailed explanations. Also to James4beach. It makes sense to me and I see my misinterpretation looking at my returns which are past and not considering future development:rolleyes2:


----------



## dubmac (Jan 9, 2011)

Scomac - 
You present a position where you see GIC's (although rates are presently low) providing a better return than bond funds or bond ETF's. You also point to the past 30 yrs as a bull market for bonds (ergo: bond funds and bond ETF's). May I conclude that you see the bond "bull run" coming to an end in the future? If so, is it inflation that you expect to wreak havoc (and miniimize the spread on the bond yield curves) on bonds?
This is the only scenario that I can think of to explain why bonds may be less attractive than GIC's as a source of fixed income - but, frankly, I don't understand bonds well!


----------



## scomac (Aug 22, 2009)

dubmac,

I don't like getting into the prediction business. That is why I am such a fan of the bond/GIC ladder for fixed income investing because it takes the guess work out of the investing operation as you aren't trying to anticipate which direction interest rates are headed. You simply roll-over the maturing wrung of the ladder and reinvest at the prevailing rate.

Having said the above, rest assured that at some point the bull run in bonds will come to an end. The tricky part of the question is when. Some have been predicting higher interest rates for a decade or more and yet they have continued to decline. The important thing is to focus on what we do know and what our decision making process can have an impact upon, rather than guessing about the unknown.

If we use XBB as a proxy for all total Canadian market bond funds and treat the underlying holdings as a single bond by looking at the 
fundamentals, we see that we are purchasing a bond with just short of 10 years maturity (9.8) and a YTM of 2.24%. From the yield we must deduct our investment costs of .33%. In essence, an investment in XBB today is akin to buying a 10 year bond with a yield of 1.91%. Compare that to a 5 yr. GIC with a YTM ~2.5% depending upon provider. You have liquidity with XBB, but you have no promise of your return should you sell prior to *10* years. It could be higher or lower. You can have confidence that your return will be no worse than 1.91% if you plan on holding for the average maturity of the fund. With the GIC, you have a government backed guarantee on the investment and you know that your return will be 2.5% over the next *5* years from which point you reinvest. 

The big question then becomes; what will happen to the the various options as interest rates change? With the GIC, you are locked in for the term and guaranteed of your return that was set at purchase. When it matures, you roll it over into a new investment at the prevailing rates of the day whether they be higher or lower. But, what about the bond fund?

Fortunately, we can get an idea on how it will respond to changes in interest rates going forward by looking once again at the fundamentals. XBB has a duration of 6.95 years. Duration is a measure of how sensitive a bond is to a change in interest rates. For XBB a change in interest rates of 1% would have an impact on the NAV of the fund of ~6.95% up or down depending upon the move direction. From this we can see that a substantial change in interest rates can have a big impact on the fund's unit value. This has worked in bond funds' favour for 30 years now, but it is important to realize that this principle is not unidirectional, it goes both ways up and down.

The distribution dilemma -- You have pointed out that the distribution of XBB is 3.30% and it is confusing as to why this isn't the return of the portfolio versus the stated 2.24%? The explanation is relatively simple in that many of the bonds currently held in any bond fund will be premium bonds. This describes a bond that currently sells for a premium above face value due to the bond having a coupon rate that is higher than the current rate for a given bond of the same maturity. While these bonds are years away from maturity, they will trade at substantial premiums to face value, but due to their high coupons will have a higher current yield than market conditions warrant to compensate for the capital loss that is built into the bond at the current price. Thus distribution yields, while still comprised almost entirely of income give the illusion of higher returns than the YTM of the underlying because they don't take into account the pending drop in value of the underlying bonds as they approach maturity.

Where do we go from here? I have no idea. But, it might be helpful to make a few comparisons to see where we are to help assess the range of possibilities going forward. Let's look at a few benchmark bonds.


```
JGB 10 yr. .73%     JGB 30 yr. 1.94%
UST 10 yr. 1.71%    UST 30 yr. 2.92%
GoC 10 yr. 1.75%    GoC 30 yr. 2.36%
```
I selected the Japanese Gov't Bond as a comparator for a continuation of the trend we have been on for 30 years now with declining rates. US Treasuries versus Canadas on the long end highlight the anticipated differences in future inflation probabilities. If we assume that we are headed down the Japanese path of grinding stagnation, then there is the possibility of further gains in a bond fund, but it would appear that would be limited to a further 1% drop in 10 yr. rates which would lead to about a further 7% gain in fund NAV. Clearly, the risk is much greater to the downside with bond fund values as there is limited room for interest rates to drop, yet substantial room for them to rise.

With the GIC option, you have a _bird in hand_ so-to-speak due to the higher yields and shorter term. The fund option offers at least $2 to $3 of downside or every dollar of upside. To get a glimpse of what can happen to bond funds when interest rates spike unexpectedly, we have to go back to 1994. In that year the index for all Canadian bonds returned -4.3% while the long bond index returned -7.4%. This was brought about by a jump in short term rates of just 2%.

With the GIC option, I have guaranteed myself at least a positive return over the time frame in nominal terms. With the bond fund, there is no such promise and I maybe faced with not just a negative real return, but a negative nominal one as well.


----------



## P_I (Dec 2, 2011)

:encouragement: scomac, a very worthwhile read. 

An interesting viewpoint about what could happen if/when rates rise -- A Rush for the Exit - Steadyhand Investment Funds


----------



## CanadianCapitalist (Mar 31, 2009)

For those wanting liquidity, XBB is not the only option. XSB or VSB are good choices for those who want to keep their bond terms short and still have liquidity. If you do not care about liquidity, you can earn a premium by investing in a ladder of GICs. As posted up thread, 3-year GICs yield 2.0% compared to just 1.24% for XSB. That sounds horrible except that if you compare 3-year GoC bonds directly say at TDW your yield will be just 1.04%.


----------



## scomac (Aug 22, 2009)

CanadianCapitalist said:


> For those wanting liquidity, XBB is not the only option. XSB or VSB are good choices for those who want to keep their bond terms short and still have liquidity. If you do not care about liquidity, you can earn a premium by investing in a ladder of GICs. As posted up thread, 3-year GICs yield 2.0% compared to just 1.24% for XSB. That sounds horrible except that if you compare 3-year GoC bonds directly say at TDW your yield will be just 1.04%.


If liquidity is of primary concern, then I would offer up the alternative of a HISA versus using a product such as XSB/VSB. While there isn't any particular yield advantage to doing this, I am earning exactly the same return from my CIBC eSavings acct. as I could get from XSB net of fees. If the concern is having adequate liquidity to address rebalancing in the event of a big market move, the maturing wrung of a GIC ladder is usually adequate to accommodate this.


----------

