# Where is your fixed income?



## Mike59 (May 22, 2010)

I sold all my bond funds in September weary of rising interest rates, and have my fixed-income alllocation stuck sitting in cash or money market funds paying nil. With the CPI at 2%+, it feels like a slow leak waiting to cause some major trouble 

"Investors burned by bonds still wary of stocks (Reuters)"

"Long-term government bond funds have lost 9.4 percent from mid-September through December 7, according to Morningstar. And the price of the iShares Barclays 20+ Year Treasury Bond ETF is down 11.4 percent."

Are most of you holding your bonds and riding the roller coaster, or market-timing to prevent a catastrophic loss? Any backup plans for coming months? Anyone considering real-return bonds, or is the outlook just as dismal?


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## Belguy (May 24, 2010)

I like investment grade corporate bonds as a class of bonds to be invested in at this point.

It doesn't hurt to have a small percentage of your portfolio in real return bonds although the spectre of higher inflation seems to be on the back burner for the moment.

40 percent of my portfolio is in fixed income but that does not match my age. I should be 67 percent in fixed income but I can't bring myself to increase my allocation at this time or in the foreseeable future.

Dividend paying stocks from solid companies with a history of increasing their dividends seems to be the way to go at the moment.


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## slacker (Mar 8, 2010)

I have 10% in XSB (short term bond fund). That was the allocation I started with and I'll stick to it for a while. Since it's short term bond, it won't fall or raise too much either way.


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## larry81 (Nov 22, 2010)

slacker said:


> I have 10% in XSB (short term bond fund). That was the allocation I started with and I'll stick to it for a while. Since it's short term bond, it won't fall or raise too much either way.


i do exactly like this gentlemen


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## Assetologist (Apr 19, 2009)

*Fixed Income*

My 'fixed income' is in my profession/work/job, whatever you want to call it.

My investments are in stocks, real estate and private investments.

I am a big believer in the human capital component of an inclusive investment view.


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## MoneyGal (Apr 24, 2009)

Nowhere. No FI component while I still have a mortgage.


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## Jungle (Feb 17, 2010)

I sold all our bonds back in Sept-Oct (I think?) that were in our retirement and emergency fund, except a tiny bit is stuck in non-redeemable GIC. 

Made a good profit from the run up, switched into the market rally. Left the emergency fund in a money market/cash. Waiting to buy junk bond etf to hold as emergency fund. Willing to take risk, I want to increase net worth.


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## Lephturn (Aug 31, 2009)

After a basically 30 year bull market for bonds, I'm not holding any bond funds. I short them here and there though - but we are in for a long term drift down in bond prices IMO.

That's different than actual bonds - if you bought individual bonds and made a nice bond ladder, the price changes are not relevant since you just ride out the yield to maturity.


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## Greyhound86 (Feb 21, 2010)

Still holding quite a bit of High Yield bonds through etf's and mutuals. Have held them for about 1.5 years on average. I don't expect any more capital appreciation but the yield is still nice. Started selling a bit lately and will probably exit most of them soon. 

Don't currently own any other bonds. Own some preferreds with fixed maturity dates (2-4 years) that I consider fixed income.


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## HaroldCrump (Jun 10, 2009)

Mike59 said:


> Are most of you holding your bonds and riding the roller coaster, or market-timing to prevent a catastrophic loss? Any backup plans for coming months?


I sold my bond funds about 3 months ago to lock in the gains (didn't see too much upside to Canadian investment grade bonds).
All my remaining bond holdings are direct Canadian bonds, which I plan to hold till maturity and then rotate.


> Anyone considering real-return bonds, or is the outlook just as dismal?


No RRBs for me, never have and probably never will.
Unless we get into a Russian style hyperinflation, I don't see the need to hold RRBs at this stage of my investing.
I also believe that the benchmark CPI the central bank uses to set the discount rates on RRB does not provide me adequate inflation protection.
RRBs are for pension funds and life insurance companies.


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## Square Root (Jan 30, 2010)

Nothing other than my pension


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## Belguy (May 24, 2010)

I heard someone ask today on BNN why anyone would be invested in bond funds now when they most assuredly would not make the investor much money going forward and might very well lose a considerable portion of their value for some time to come.

I look after my 90 year old mother's investments and I currently have her money in four different types of bond funds. She has instructed me not to put any of her money in stocks. 

Should I cash out of the bond funds and just put the money in a ladder of GIC's?

Also, when I rebalance my own portfolio in January, what should I do with the 40 percent fixed income allocation that I currently have in bond funds?


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## slacker (Mar 8, 2010)

If it's 100% certain that bonds will lose money, is there a way to profit from this? Can one "short" a bond or bond fund?

Why are people so sure that bonds will lose money anyway? By how much, and in what time frame?


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## plen (Nov 18, 2010)

slacker said:


> If it's 100% certain that bonds will lose money, is there a way to profit from this? Can one "short" a bond or bond fund?
> 
> Why are people so sure that bonds will lose money anyway? By how much, and in what time frame?


I am interested in this question as well. I've heard zero good news about bonds anywhere I look and one wonders if that sleepy portion of my portfolio would be better placed into a 5 year GIC or such.


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## Mike59 (May 22, 2010)

slacker said:


> If it's 100% certain that bonds will lose money, is there a way to profit from this? Can one "short" a bond or bond fund?


Inverse ETFs could fit the bill, but they are wacky...I found this an interesting read: 

"Claymore's (Inverse) Bond ETF comes up short" (Canadian Couch Potato)


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## Belguy (May 24, 2010)

This is a way over my head, but a bond 'expert' was on BNN today and he was recommending going long on some bonds like a 25 year corporate bond and then also going short on a Government of Canada bond at the same time. I failed to understand what this accomplished but maybe someone else here could explain the concept if I have explained it properly.

This whole bond situation going into a period of rising interest rates has got me baffled. Is it better to just adjust all bond holdings to shorter periods or to get out of bonds altogether and go some different route? This is one time when I could use the help of an advisor!!!

For those of you who have advisors, what are they recommending that you do with the fixed income portion of your portfolio?

If CC cares to tell us, it would be interesting to hear his thoughts on the matter. Where is he putting his fixed income investments with interest rates set to rise?


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## atrp2biz (Sep 22, 2010)

Belguy said:


> This is a way over my head, but a bond 'expert' was on BNN today and he was recommending going long on some bonds like a 25 year corporate bond and then also going short on a Government of Canada bond at the same time. I failed to understand what this accomplished but maybe someone else here could explain the concept if I have explained it properly.
> 
> This whole bond situation going into a period of rising interest rates has got me baffled. Is it better to just adjust all bond holdings to shorter periods or to get out of bonds altogether and go some different route? This is one time when I could use the help of an advisor!!!
> 
> ...


This strategy would work if credit spreads converge. 

During a financial crisis, there is typically a flight-to-quality (I use the term quality loosely here!) which results in higher rated bonds outperforming their lower rated counterparts. This occurs because there is a greater risk of default in the lower rated bonds. 

When economic conditions are expected to improve, a possible strategy is to be long lower rated bonds and short higher rated bonds with the hopes of yields tightening (or converging). The analyst you mentioned was probably referring to a strategy like this.

Personally, high-yield bonds represent approximately half of my fixed income portfolio. I have a relatively low fixed income proportion in my portfolio (20%) which I am comfortable with. I am 31 years old.


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## hboy43 (May 10, 2009)

Hi:

No FI here. Especially not now when bank commons yield ~ 4% and FI yields almost nothing.

My concession to current uncertainties is that leverage is down however to about 8% of net worth.

My goal is not to be in the middle financially, but rather to be either wealthy or poor. In this context, my approach has rationality. Plus my wife is a teacher, so the pension will roll in one day.

I may reconsider my FI policy in 15 or 20 years when I am in my 60s.

Cheers

hboy43


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## Belguy (May 24, 2010)

I am no computer expert but, every once in a while, I run into a problem where I am not allowed to post a response. I have been told that it has something to do with my browser. My 'Fundlist' at Globeinvestor also gets whiped out in the process. It is very frustrating but I don't know how to fix it. Anyway, I am able to post on this thread but not on some others. Strange!!

Let me ask this question of some of you younger investors out there. If you were an older investor and already retired and facing the future rising interest rate environment, how much of your portfolio might you have in fixed income at this point in time and what specific investments would you choose for your fixed income allocation?

It is all well and good for a 30 year old to have 80 percent of his portfolio in equities but what if you were approaching 70?


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## Lephturn (Aug 31, 2009)

Belguy said:


> It is all well and good for a 30 year old to have 80 percent of his portfolio in equities but what if you were approaching 70?


If you do not already have a bond ladder built already, I wouldn't be buying bonds with rates this low. If I had some bonds maturing I wouldn't be buying anything long term right now.

I'd be doing mainly the same thing I'm doing now in my retirement account - dividend growth stocks protected with options and generating additional income where possible with options to pay for the protection. There is no way I'm going naked in the markets - I'm protecting all of my money.

But that's me - you need the inclination to learn about options to use those effectively, and it will take some time to learn what you need.

Bond yields are way down and we have already seen the end of a 20 year bull market in bond prices - so bond funds of any sort are going to get killed in the next few years overall as yields rise and bond prices fall. We could well have a 20 year bear market in bonds - and that means stay the hell away from bond funds.

So if you don't already have a bond ladder that was built years ago - well I think dividend growth with protection is about your only solution. That is provided you don't already have a big enough nest egg. If you have more than enough money now you can always buy a big annuity that will pay out a fixed amount until you die. If you are healthy and have enough funds that is probably the safest option.


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## tasamy (Dec 16, 2010)

*Banks*

CTFS and Ally 2%


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## atrp2biz (Sep 22, 2010)

Lephturn said:


> If you do not already have a bond ladder built already, I wouldn't be buying bonds with rates this low. If I had some bonds maturing I wouldn't be buying anything long term right now.
> 
> I'd be doing mainly the same thing I'm doing now in my retirement account - dividend growth stocks protected with options and generating additional income where possible with options to pay for the protection. There is no way I'm going naked in the markets - I'm protecting all of my money.
> 
> ...


No need to build your own ladder. I would never suggest to anyone to buy bonds as a retail investor. CLF has a 1-5 year gov't ladder ETF with a good MER. Yields are currently 4.5%. XSB, a short-term bond fund also provides some exposure to higher yielding corporate bonds. They both have durations of less than three years.


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## Lephturn (Aug 31, 2009)

What happens when the bond market is dropping in price, yields are rising, and investors start pulling out of these bond funds? Will they not be forced to sell bonds and take the capital losses to cover the withdrawals? Am I missing something here? It seems like all the funds are hostage to the money flow in and out of the fund.

It might be difficult to build a bond ladder yourself - but at least you can choose to hold the bonds if the price drops.

Fixed income seems more risky to me than solid dividend growth stocks collared.


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## atrp2biz (Sep 22, 2010)

Lephturn said:


> What happens when the bond market is dropping in price, yields are rising, and investors start pulling out of these bond funds? Will they not be forced to sell bonds and take the capital losses to cover the withdrawals? Am I missing something here? It seems like all the funds are hostage to the money flow in and out of the fund.
> 
> It might be difficult to build a bond ladder yourself - but at least you can choose to hold the bonds if the price drops.
> 
> Fixed income seems more risky to me than solid dividend growth stocks collared.


So what if the fund has to sell bonds to cover withdrawals--it remains fully invested (or pretty close to it). I don't understand your point.


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## humble_pie (Jun 7, 2009)

leph the problem with individual stock collars is that they're too expensive. What the pros do is buy an oex or a spx put for the entire portfolio. These are cash-settled btw.

working out the math for these is not easy esp when investor has a canadian dollar portfolio. The best i ever saw was a yahoo message board poster who had worked out his own equations but danged if i memorized them or noted them down. The amazing thing he was from ed.monton.al.bert.ah.

the coverage will not be iggzact dollar for dollar of course but it will be a whole lot less expensive.


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## Lephturn (Aug 31, 2009)

While I suppose it can be expensive - with a bit of patients I can at least pay for the puts. I've been able to do this so far just by not executing all sides at the same time and by waiting for low vol to buy the puts and then higher vol and a run-up to sell the calls. RBC is jamming me though - right now I'm actually buying the puts in non-reg because for some reason buying puts on shares I own=evil in registered and I actually can't do it. They seem to have no problem with me being naked long stock though.  They tell me management is looking into changing this policy but I may have to pull the chute and go to a broker who doesn't suck.

I suppose I could hedge it with index options. Maybe options on the e-mini futures? I'll have to investigate that - thanks for the good idea.

There is still the danger of single-stock losses with that strategy, but the savings in cost may be worth it.


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## warp (Sep 4, 2010)

My fixed income allocation is getting smaller and smaller.

I dont think buying any bonds or bond funds make sense right now, with the possible exemption of some "high yield' or junk bonds.

I own a bunch of prefs with hard retraction dates. going out 7 years.

I also own JNK...( US high yield ETF)...I like the yields...8% +, and since default rates are dropping and expected to drop again next year, Im happy to hold it.

I have ALLY maxed out at 2%...which Id rather take than buying bonds and taking a capital loss as rates rise,( as they surely will)
You could very easily LOSE money with bonds now,,,and if you buy individual bonds to hold to maturity, the yields are pathetically low.

For the rest I have cash...and am buying good quality dividend payers.....Canadian, US, and international, thru ADR's in New York, 

Personally I think buying quality dividend stocks with global reach makes more sense than bonds right now....think JNJ, PEP, KMB, INTC, etc.

good luck to all


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## humble_pie (Jun 7, 2009)

leph i think the reason they are chilly about selling puts in rrsp is OMG What if You Sold the Stock and Also Exercised the Puts at the Same Time. And the representatives didn't catch it. OMG then you'd be short the stock. And that's not allowed in rrsp. So they solve the potential prob by blocking put buys in rrsp.

of couse no prob with client who is "naked long stock." Was there ever a prob with long stock ?


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## Lephturn (Aug 31, 2009)

I get why they see the risk - they don't have a system in place to prevent exercise of the puts without the stock to cover. Add to that they have an "auto exercise" function in the system that will automatically exercise any option you own just prior to expiration if it is 1 penny in the money.

They actually will let me by a put on shares I own, just not through their web site - I have to call and get an options trader to execute it for me, although to be fair they will do it at the online rate. They will not let me run a collar though - as theoretically I could get the stock called away and then exercise the puts. They just need some system to prevent me from exercising a put when it isn't covered. Force me to sell the put if I sell the stock - I'm cool with that.

Anyway Questrade insists that they WILL let me run a collar in a registered account so I will likely try them out with a TFSA and see how they do. If it works out - fine. RBC is likely to lose my business anyway if TD ever gets Think or Swim up and running as their platform. In the mean time I'll give Questrade a shot here.

It boggles me that the regulators and banks are so freaked about being short and see it as being so risky. They are quite happy to let me write a covered call - but oh no you can't write a put to leg into a stock!


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## humble_pie (Jun 7, 2009)

do you mean can't write a put in registered or can't write a put in margin.

_" It boggles me that the regulators and banks are so freaked about being short and see it as being so risky. They are quite happy to let me write a covered call - but oh no you can't write a put to leg into a stock! "_

ps td is fine for options exen without think or thwim. Right from founding in 1983 td has gone after options business eagerly, has always supported it well w excellent order execution & knowledgeable staff.

royal was never any place for option traders. I'm not sure about questrade. I for one wouldn't go to any privately-owned online house in these parlous financial times. We don't know their financial records, don't know their capitialization, only know that they meet minimum exchange requirements. There's a lot of risk all over the planet right now.

plus i don't know about questrade order execution one hears things. What's the use of a cheap commish or a relaxed option policy if they can't get a trade done in a few seconds.


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## cardhu (May 26, 2009)

> _CLF has a 1-5 year gov't ladder ETF with a good MER. Yields are currently 4.5%. XSB, a short-term bond fund also provides some exposure to higher yielding corporate bonds. They both have durations of less than three years. _


At first glance, CLF's current yield of ~4.5% may seem attractive, but its extremely unlikely that an investor’s rate of return would be anywhere near that, once the fund’s inherent capital erosion is taken into account ... CLF buys bonds at a premium, allows that premium to diminish, and then sells the bond for less than they paid for it ... and they do this cyclically, over and over and over again ... the only thing that can overcome this inevitable capital erosion is falling interest rates, but IMO, there’s not much room for rates to fall any further than they already have. 

I haven’t examined XSB that closely, maybe it has fewer problems ... but most people have a very good chance of doing better with a high-interest savings account than with CLF, for short time periods, and with a GIC ladder for longer time periods. 

CLF is subjected to unfavourable tax treatment in a non-registered account ... much worse than, say, GIC or HISA interest ... so it is really only suitable for holding inside an RRSP or TFSA, if at all.


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## atrp2biz (Sep 22, 2010)

cardhu said:


> At first glance, CLF's current yield of ~4.5% may seem attractive, but its extremely unlikely that an investor’s rate of return would be anywhere near that, once the fund’s inherent capital erosion is taken into account ... CLF buys bonds at a premium, allows that premium to diminish, and then sells the bond for less than they paid for it ... and they do this cyclically, over and over and over again ... the only thing that can overcome this inevitable capital erosion is falling interest rates, but IMO, there’s not much room for rates to fall any further than they already have.
> 
> I haven’t examined XSB that closely, maybe it has fewer problems ... but most people have a very good chance of doing better with a high-interest savings account than with CLF, for short time periods, and with a GIC ladder for longer time periods.


If one wanted to create a ladder, you would purchase bonds from the issuer or the market. Bonds purchased in the market would typically have been purchased at a premium to face value given the decline in interest rates over the past few years. The fact that CLF has purchased bonds at a premium to FV since its inception is no surprise and is a function of the market. In an environment of rising rates, bonds within the portfolio would typically be purchased at a discount (with coupons below the yield). I completely agree that the yield of the ETF of 4.5% is not sustainable and will decrease to the 3.xx% range. At some point, the flip of purchasing bonds at a premium to a discount would occur.

Another feature of buying bonds at a premium (where coupons are higher than the yield) is that the duration is further reduced, thus reducing the risk of increasing interest rates.



cardhu said:


> CLF is subjected to unfavourable tax treatment in a non-registered account ... much worse than, say, GIC or HISA interest ... so it is really only suitable for holding inside an RRSP or TFSA, if at all.


I understand that the higher coupon relative to current yields would result in higher income at the expense of a capital loss on the value of bonds held within the ETF--however it is still taxed as income and wouldn't say it is much worse than other income producing investments. I don't think you can yield the same returns if you compare a short-term bond ladder with a short-term GIC ladder. 

Any and all income producing investments should be held inside of a registered vehicle if at all possible.


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## cardhu (May 26, 2009)

atrp2biz said:


> The fact that CLF has purchased bonds at a premium to FV since its inception is no surprise and is a function of the market....


Agreed ... and the implications of that fact are also a function of the market ... it is those implications I’m referring to... I completely agree that CLF might look like a viable investment 10 or 15 years from now ... it just doesn’t particularly look that way today. 

In an *extended* period of rising rates, bonds within the portfolio would *eventually* be able to be purchased at a discount to par, but that’s not going to happen overnight. The immediate effect of rising rates would be devaluation of the existing bond holdings, which would diminish the rate of return for existing unit-holders ... anyone investing (or invested) today in this fund will have to endure a period of very lousy performance while rates are rising, and would only begin to get back to decent returns once the rates have _stopped_ rising. 

I made no comment one way or the other about sustainability of yield ... I was talking about the rate of return ... yield is only one component of the rate of return, so whether the yield is 5%, 4%, or 3% doesn’t matter that much, and whether its sustainable or not doesn’t matter that much ... at the end of the day, it’s the rate of return that matters .... and in the absence of further falling rates, the rate of return on this fund is not likely to be very much above 2%. There is not a single holding in CLF (per the most recent disclosure) that has a yield to maturity (YTM) exceeding 3.25% ... and the average YTM is 2% ... since the mandate of CLF is to hold its bonds to very near maturity, these values would seem to anchor the overall returns ... it is a mutual fund after all, and the aggregate return of the fund cannot exceed the sum total of all the individual returns of the fund’s holdings, unless the fund is using some kind of derivatives to juice its performance ... and this fund doesn’t.



> _I don't think you can yield the same returns if you compare a short-term bond ladder with a short-term GIC ladder. _


I wasn’t comparing a short-term bond ladder to a short-term GIC ladder ... I was comparing CLF to a short-term GIC ladder ... not the same thing ... CLF itself is a laddered-structure, but an individual investor who buys and sells units of CLF does not get ladder-like performance.

The advantage of a ladder (whether bond or GIC) to an individual investor is the efficiency gained from redeeming only the maturing issues, and of purchasing only the longest term issues ... in addition, there is the ability to hold each and every issue to maturity, and when you hold a bond or GIC to maturity, you know in advance and in detail what your rate of return is going to be ... but an individual investor buying CLF loses those advantages ... they never hold any issue to maturity, and they never buy only the longest term issue ... every transaction involves buying or selling roughly equal increments of all of the 1-yr, 2-yr, 3-yr, 4-yr and 5-yr tiers ... so neither their purchases nor their sales of CLF units are as efficient as they would be for a person running their own ladder. 



> _I understand that the higher coupon relative to current yields would result in higher income at the expense of a capital loss on the value of bonds held within the ETF--however it is still taxed as income and wouldn't say it is much worse than other income producing investments. _


Yes it is much worse ... with a standard GIC, if the stated rate is 2%, then your rate of return is 2%, and you pay tax on 2% ... but that’s not the case with CLF ... in the current interest rate environment, CLF *might* generate a return of 2%, if you’re lucky ... quite a bit less than 2% if rates begin to move up steadily ... but whatever the actual rate of return, you’ll still be paying tax on 4.5% (or whatever amount was actually distributed) at full income rates ... that will be somewhat offset by the capital loss you’ll be able to claim when you sell, but that loss won’t be enough to negate all the extra tax you already paid on that “phantom” return that you never earned ... plus the tax on the phantom return is same-year, while the partial relief may come years later, if you’re holding for an extended period. 

In a non-reg account, all other things being equal, one would pay significantly more tax on CLF’s 2% return, than they would have on a GIC’s 2% return ... therefore, CLF is taxed at “worse than ordinary income” rates. Again, in 10 or 15 years time, this situation may resolve itself, but until then...........



> _Any and all income producing investments should be held inside of a registered vehicle if at all possible. _


Well, that is a matter of opinion ... many feel that the best use of tax-sheltering accounts is to house whichever assets would otherwise face the highest tax bill ... and that’s not always going to be interest ... would you rather pay 40% tax on $100 of interest, or 20% tax on $1000 of capital gains, if they both came from the same underlying amount invested? ... this is an argument that you more often see in connection with TFSAs, but the same principle applies to RRSP to an extent.


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## Lephturn (Aug 31, 2009)

Excellent discussion - thanks for breaking it down cardhu and atrp2biz.

I guess for fixed a bit of JNK or something similar is about all you can do. Building your own ladder these days seems pretty crazy with these rates.

humble: No they won't let me Buy to Open a put in my registered on their web trading platform - even if I own the stock. They say I can do it on the phone but they still won't let me buy a put without owning the stock though I can buy naked calls.

I have a US account with OptionsXpress and although their commissions are higher ($15.00 / trade) they get great execution. I regularly get price improvement and see prices less than the NBBO at the time when using limit orders. I suspect many of the brokerages that are priced much lower are selling order flow - something that seems very common these days what with the Maker/Taker model being hot lately with the exchanges.

Thanks for the tip on TD - I'll take a close look at them.


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## avrex (Nov 14, 2010)

Very interesting discussion. Seems no one wants bonds anymore. It sounds like a lot of members here have exited or severely reduced their bond positions (and moved to: cash, GICs, dividend stocks.)

I am currently at 25% Bonds. I'm moving my bonds funds to shorter terms (and accepting the 3% or whatever return). I just bought CLF in Dec-2010 because the individual bond purchase at my broker (TDW) seems a bit high.


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## atrp2biz (Sep 22, 2010)

So here I am, lying in bed in the middle of night thinking of bond yields. The thought exercise going through my head is as follows:

What happens to a ladder portfolio with a portfolio of bonds with durations of 1,2,3,4 and 5 years (such as CLF) if interest rates rise by 1% for the next two years?

Assumptions:
1. Shape of yield curve remains the same and is simply translated up by 100 bps each year. In reality, in an environment of rising interest rates, the curve will tend to flatten thus mitigating (to a certain extent) the effect of rising interest rates.

2. Use of zero coupon bonds simplifies this thought exercise. In reality, coupons will reduce bond duration thus mitigating (again to a certain extent) the effect of rising interest rates.

Result? (pdf attached) 

Portfolio return in year 1 = 0.4%
Portfolio return in year 2 = 1.4%

Conclusion:
Yes, bonds will be dead money if interest rates rise, but I think the doom and gloom of bonds is overdone, especially if one's exposure is to a short-term ladder.

I will respond to cardhu on another sleepless night. 

Note: YTM in the file is unconventionally used as "years to maturity" instead of the more conventional "yield to maturity".


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## atrp2biz (Sep 22, 2010)

Who am I kidding? Let's continue this discussion now. 

For starters, understanding of circumstances is critical to develop a sound overall approach to one's portfolio. I am clearly in the accumulation phase of my life with no interest in retiring for another 30-35 years.



cardhu said:


> Well, that is a matter of opinion ... many feel that the best use of tax-sheltering accounts is to house whichever assets would otherwise face the highest tax bill ... and that’s not always going to be interest ... would you rather pay 40% tax on $100 of interest, or 20% tax on $1000 of capital gains, if they both came from the same underlying amount invested? ... this is an argument that you more often see in connection with TFSAs, but the same principle applies to RRSP to an extent.


1. This is true, however over the long-term, I do not anticipate that my capital gains will double my interest income as this would be the point of indifference in deciding to hold equities or interest-bearing securities outside of a tax-sheltered vehicle. Certainly over the past decade (perhaps even the past two decades), equities have not outperformed bonds by 2x (understanding that not all of the bonds' yields have been from interest during this time).

2. The beauty of equities is that one can enjoy the benefit of tax-deferred capital growth if the assets are not dispossessed. The securities I hold outside of my RRSP/TFSA are held for the LONG-term. I have no intention of selling them for decades, thus only purchase companies that I believe in for the long haul. More aggressive transactions and churning (shudder) would be done inside my RRSP/TFSA.

Therefore, I feel that my largest present value tax exposure would be to interest-bearing securities and hold these inside of a tax shelter. As a result, I am indifferent to the characteristics of bonds held in the portfolio (discount vs. premium) .



cardhu said:


> In an *extended* period of rising rates, bonds within the portfolio would *eventually* be able to be purchased at a discount to par, but that’s not going to happen overnight. The immediate effect of rising rates would be devaluation of the existing bond holdings, which would diminish the rate of return for existing unit-holders ... anyone investing (or invested) today in this fund will have to endure a period of very lousy performance while rates are rising, and would only begin to get back to decent returns once the rates have _stopped_ rising.


Agreed, but I don't see your point wrt CLF.



> I made no comment one way or the other about sustainability of yield ... I was talking about the rate of return ... yield is only one component of the rate of return, so whether the yield is 5%, 4%, or 3% doesn’t matter that much, and whether its sustainable or not doesn’t matter that much ... at the end of the day, it’s the rate of return that matters .... and in the absence of further falling rates, the rate of return on this fund is not likely to be very much above 2%.


Agree. However, CLF and XSB are short-term funds that minimize (relatively no longer term bonds) exposure to rising rates.




> I wasn’t comparing a short-term bond ladder to a short-term GIC ladder ... I was comparing CLF to a short-term GIC ladder ... not the same thing ... CLF itself is a laddered-structure, but an individual investor who buys and sells units of CLF does not get ladder-like performance.





> The advantage of a ladder (whether bond or GIC) to an individual investor is the efficiency gained from redeeming only the maturing issues, and of purchasing only the longest term issues ... in addition, there is the ability to hold each and every issue to maturity, and when you hold a bond or GIC to maturity, you know in advance and in detail what your rate of return is going to be ... but an individual investor buying CLF loses those advantages ... they never hold any issue to maturity, and they never buy only the longest term issue ... every transaction involves buying or selling roughly equal increments of all of the 1-yr, 2-yr, 3-yr, 4-yr and 5-yr tiers ... so neither their purchases nor their sales of CLF units are as efficient as they would be for a person running their own ladder.


The point of a ladder is to keep duration relatively constant for as long as the ladder is in place--a ladder fund like CLF definitely does this. An individual bond ladder would have fluctuating durations between 2-3 years (for a 1-5 year ladder) if the shortest term bond is held to maturity and then used to purchase a longer term bond (Ignoring coupons, duration would be 2 years just prior to maturity of the shortest-term bond and 3 years just after the purchase of the longer-term bond using funds from the maturity of the short-term bond. During the course of the year, the duration will creep down from 3 years to 2 years). As a result, a ladder fund would be more effective at holding duration constant than an individual bond ladder.


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## cardhu (May 26, 2009)

Yes, understanding of circumstances is crucial ... that is precisely my point. 

You misunderstood my remarks ... I wasn’t referring to you personally, or your specific circumstances at all, and I wasn’t trying to persuade you to shift your allocations around ... I merely pointed out that the statement ... _”*ANY* and *ALL* income producing investments should be held *INSIDE* of a registered vehicle if at all possible” _ ... sounds rather absolute ... many feel that the best use of tax-sheltering accounts is to house whichever assets would otherwise face the highest tax bill ... and that’s not always going to be interest. 

The fact that bonds and bond funds did OK over the past decade or two is no surprise and was a function of the market. That’s what bonds and bond funds do in extended periods of falling interest rates/yields. But how is that pertinent to someone trying to decide what to do with money they have available *today*? 



> _Agreed, but I don't see your point wrt CLF._


My point was that CLF's current yield of ~4.5% may, at first glance, seem attractive, but it is extremely unlikely that an investor’s rate of return would be anywhere near that once the fund’s inherent capital erosion is taken into account ... CLF buys bonds at a premium, allows that premium to diminish, and then sells the bond for less than they paid for it ... and they do this cyclically, over and over and over again ... this is what they do today, and the fact that they might stop doing it at some point in the distant future is not really of very much use to an investor who has money to deploy today. 



> _Agree. However, CLF and XSB are short-term funds that minimize (relatively no longer term bonds) exposure to rising rates. _


Agreed, shorter term bonds will suffer less than longer-term bonds, in the event of rising rates ... and this is true regardless of whether the bond is held within an ETF or an individual ladder, BTW ... Investors in CLF might not lose money, but the point is that they won’t make money either, during any sustained period of rising rates. There’s been only one such period during the existence of CLF, and that occurred in the period of mid-January 2009 to mid-April 2010. During that 15 month period, investors in CLF achieved an average annual rate of return of 0.00%. Dead money is right. 



> _The point of a ladder is to keep duration relatively constant for as long as the ladder is in place--a ladder fund like CLF definitely does this. _


Sure its _“a”_ point ... I don’t agree that its _“the”_ point, though ... Yes, CLF does keep duration relatively constant, but an individual investor buying units of CLF loses certain efficiencies that they’d otherwise enjoy, if they were to build their own ladder, as I explained upthread. When you lose efficiencies, returns suffer. 



> _Ignoring coupons, duration would be ... _


If you’re ignoring coupons, then you’re not measuring duration, you’re measuring term-to-maturity ... they are not the same thing ... and in any event your math is off ... for 5 yr ladder, the term-to-maturity would fluctuate between 2.5 and 3.0, IF (and this is a big “if”) you presume that maturities are always staggered exactly 1 year apart ... but an individual investor faces no such arbitrary limitations ... they can stagger their maturities every 6 months if they wish, or quarterly, or monthly ... its really only a matter of the amount of capital available ... I’ll concede that most individual investors don’t have sufficient capital to practically implement an interval as short as monthly, or even quarterly, so CLF probably does manage to keep its duration to a narrower range of fluctuations than a individual could ... but at the end of the day, the question of who can hold their duration to a tighter range of fluctuation is missing the point. 

The Bottom Line
How this fund ultimately performs for an individual investor depends on what rates (yields) do during the period of time that he or she holds the fund. There are 3 broad possibilities ... (1) rates fall; (2) rates rise; or (3) rates remain unchanged. If rates remain unchanged, capital erosion will be as inevitable as the rising and setting of the sun, and an investor in CLF should expect no more than about 2% return in this instance. If rates rise they’ll get something less than 2%, and if rates fall they’ll get something more than 2%. 

It’s a simple matter to examine various alternatives, within the short-term fixed-income realm, in the context of those same 3 possibilities.


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## funinagg (Jun 10, 2010)

for a more frequent trader it makes sense to sell bonds now and then buy them back later when rates have risen and stablized. for an infrequent trader is it ok to stay put and just leave the matter in the hands of the bond fund manager? managers at say Beutel Goodman and PH&N are supposedly the best in business and they should be able to handle the situation quite well? they did handle the rate increase from 2004-2008 well enough (return consistently over 5%)? and rates and not likely to exceed those 2008 levels anytime soon or perhaps ever? bonds do provide protection if stocks falter (good possibility). with these thoughts i am staying put but would like to listen to your thoughts.


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## atrp2biz (Sep 22, 2010)

This is kinda fun. Something I would argue with a friend about over a pint.



> The fact that bonds and bond funds did OK over the past decade or two is no surprise and was a function of the market. That’s what bonds and bond funds do in extended periods of falling interest rates/yields. But how is that pertinent to someone trying to decide what to do with money they have available today?


Yes, but like I said, even if one were to incur capital gains, even on unrealized capital gains, capital gains must outperform the performance of bonds by 2x. With the ability to defer capital gains by simply holding on to the asset makes the argument of sheltering income more compelling.



> Agreed, shorter term bonds will suffer less than longer-term bonds, in the event of rising rates ... and this is true regardless of whether the bond is held within an ETF or an individual ladder, BTW ... Investors in CLF might not lose money, but the point is that they won’t make money either, during any sustained period of rising rates. There’s been only one such period during the existence of CLF, and that occurred in the period of mid-January 2009 to mid-April 2010. During that 15 month period, investors in CLF achieved an average annual rate of return of 0.00%. Dead money is right.


Absolutely. Last year was the year of the stock. This is a question of where are interest rates going over the next little while. I'm not convinced that rates are going to go up 200 bps over the next year or even the next two years.



> Sure its “a” point ... I don’t agree that its “the” point, though ... Yes, CLF does keep duration relatively constant, but an individual investor buying units of CLF loses certain efficiencies that they’d otherwise enjoy, if they were to build their own ladder, as I explained upthread. When you lose efficiencies, returns suffer.


What the heck are efficiencies? Holding a bond until maturity is more efficient than selling a bond at a discount? All that is relevant is yield to maturity. I would also argue that THE point of a ladder is to keep duration constant.



> If you’re ignoring coupons, then you’re not measuring duration, you’re measuring term-to-maturity ... they are not the same thing ...


Which is why I said to ignore coupons. As you know, coupons complicate duration calculations (reduces duration like I said before). I was simply trying to simplify the example with ZCBs. BTW, I believe ZCBs are excellent bonds to hold in a tax shelter. The demand for these instruments would generally be limited to only those in a tax shelter (since taxes would still be due outside of a shelter on the yield despite no cash flow), however the supply side would be unaffected.



> ...and in any event your math is off ... for 5 yr ladder, the term-to-maturity would fluctuate between 2.5 and 3.0, IF (and this is a big “if”) you presume that maturities are always staggered exactly 1 year apart ...


I believe my math was correct. If one holds five tranches between 1 to 5 years (separated by one year) in my example, the duration would be (1+2+3+4+5)/5 = 3 years. Just prior to maturity of the shortest term tranche, the duration would be (0+1+2+3+4)/5 = 2 years. 

As you pointed out, an individual can stagger maturities to every 6 months, or even every day. However, in reality, one's individual bond ladder would contain a series of more discrete maturity separations than a ladder fund would contain. This reinforces a ladder fund's ability to better control duration of the portfolio. This is absolutely the point of a ladder. Why would you have one otherwise? On the other end of the spectrum, you could purchase a bond with the same duration as the ladder. Why don't you do that?...because you can't control duration as efficiently (Ha! I used your word).



> It’s a simple matter to examine various alternatives, within the short-term fixed-income realm, in the context of those same 3 possibilities.


The Bottom Line(s)

I agree that there are many alternatives.

It's pretty bad when you have to draft forum posts in Notepad.

"Bartender--another Blue Moon please."


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## gemma119 (Apr 6, 2009)

*RRB Questios?*

In light of the GM article about Real Return Bonds this morning. I feel this is miss leading as if I go back and follow XRB or to get a longer time frame TDB 646 fund I find that RR bonds over 5,10,15 years have did very well. Now if the inflation rate seems to be rising does this not speak well for RRB for a buy and hold retired person like Belguy. I have held these for sometime now and have did well and am thinking of adding to XRB. 
PS. I am also retired liked Belguy and enjoy his posts.


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## andrewf (Mar 1, 2010)

RRBs have done well as rates have fallen because they are long duration. That cuts both ways, however, and as rates rise, RRBs will be hurt disproportionately. If you don't care about volatility, this is fine--you can clip your coupons and get your inflation adjusted principle on maturity. If you do care about volatility, watch out!


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