Should I buy a Bond ETF?

Published by on

I received a call from an investor who had just viewed an interesting segment on TV. The expert was correct in advising the listeners about proper diversification. He was making the point that using preferred shares for income instead of bonds may get you a better income return but your portfolio is open to higher fluctuations. What was missing was what bonds to buy. This is the problem with TV’s short segments; it leaves the viewer a potential problem. I took the time to watch the replay they had on their website.

There are so many different ways to buy bonds that the viewer was left without guidance; a bad bond purchase could cause more damage than good. The implication in the show was to use an ETF. This investor was thinking the best way to do this safely was with the ISHARES 1-10 YR LADDERED GOV BD IDX ETF (CLG). I brought him through an exercise to see if he knew how this ETF worked. He did not.

It ladders bonds over a 10 year horizon. I looked at their site and they currently have it laddered as follows:

  0-1 Year Maturity     9.98% of the portfolio

  1-2 Year Maturity     9.51% of the portfolio

  2-3 Year Maturity   11.83% of the portfolio

  3-5 Year Maturity   20.72% of the portfolio

  5-7 Year Maturity   23.65% of the portfolio

  7-10 Year Maturity 24.16% of the portfolio

Average: 4.68 Years

Distrubution is higher than the underlying bond distribution

This ETF started in October 2011and it currently pays a distribution of 3.3 %. On the day I wrote this, the average 10 year provincial bond yield was 2.6% and the average Government of Canada 10 year bond yield was 1.69%. The shorter terms paid less. These government bonds make up over 97% of the ETF’s holdings. He started to question how an ETF can pay out more income than the underlying securities pay.

He stated that he feels he is a medium risk investor and he expects his fixed income to be the low risk part of his portfolio. I did a chart of the ETF and from its highest price to its lowest price there was a downward price movement of 6.25% in less than 2 years. He was convinced he would have sold at or near the bottom if his fixed income investment had that kind of swing.

As I have stated before, I don’t have a problem with ETFs. I use them. Understanding the ETF you are looking at and seeing if it meets your risk tolerance is extremely important. He went on to ask about any mutual funds that I use for fixed income.

Mutual Fund Example

We discussed an international fixed income fund I have been using for years (long before I joined Manulife Securities Incorporated). It is the Manulife Strategic Income Fund and has had the following returns for the last five years (as of April 30, 2015 - copied from the Globe Investor):

1 Year          6.46%

2 Year Avg   5.81%

3 Year Avg   7.15%

4 Year Avg   5.77%

5 Year Avg   6.37%

Since Inception (November 25, 2005) 7.03%

That means that you would have had a 7.03% compounded annual return if you bought the fund at its inception and kept it. Remember that there were also ups and downs during that time, but this return to the investor – after all fees – has been stellar. Balancing this with the right equities is a recipe for superior returns, while still holding some bonds.

If you want to see what a truly independent investment/insurance advisor can do for you, call me at 905-846-9060, ext.3838, email me at Terry.McIntyre@manulifesecurities.ca or visit my website at www.terrymcintyre.ca