Bond ETFs are not at their best in a rising interest rate world.
And yet, the case for filling up the bond side of your portfolio using exchange-traded funds instead of bond mutual funds or individual bonds and guaranteed investment certificates remains strong. You get low-cost diversification in a liquid investment that you can trade any time, unlike GICs.
The knock on bond ETFs is that they fall in price when interest rates are rising. That's exactly the kind of environment we seemed to have in early 2018 as a result of rate increases over the previous six months or so. As you'll see in this second instalment of the 2018 Globe and Mail ETF Buyer's Guide, some bond ETFs have struggled.
The biggest caveat with bond ETFs is that the vast majority of them never mature, like an individual bond or GIC, and hand your upfront investment back. Instead, they motor on in perpetuity through cycles where rate increases drive prices lower and rate declines send prices back up again. All the while, they pay monthly or quarterly interest and provide stability for portfolios being dragged down by falling stock markets.
This edition of the ETF Buyer's Guide focuses on core bond ETFs that have been around for at least five years and generate sufficient trading volumes to make sure you get competitive prices when buying and selling. One or two of these funds is all you need to diversify your portfolio.
Assets: Shown to give you a sense of how interested investors are in a fund.
Management expense ratio (MER): A measure of the main cost of owning an ETF on an ongoing basis; as with mutual funds, published returns are shown on an after-fee basis.
After-fee yield to maturity: This is the best estimate of the yield to expect from a bond ETF looking ahead.
Average 30-day daily TSX trading volume: Another indication of how popular an ETF is.
Top sector weightings: Federal and provincial government bonds offer the least default risk and the lowest yields; corporate bonds offer somewhat more default risk, but higher yields. Note the tendency for corporate bond ETFs to have a heavy weighting in the financial sector.
Average duration: Duration, measured in years, is a standard risk indicator for bonds; if interest rates rise by one percentage point, the price of an ETF with a duration of five would fall 5 per cent (and vice versa if rates fell). The higher the duration, the more risk there is if rates rise.
Returns: ETF companies typically show total returns, or share-price change plus interest payments, or distributions.
Note: Market data as of Feb. 21. Average daily trading volume is for the previous 30 days. Annualized total returns to Jan. 31.