Fixed Income - Bonds, Real Return Bonds, Laddered?

[Shine]

There are more articles I notice discussing inflation and rising rates, so I wonder if it would it be wiser for one, in FX allocation as products come due to simply pick ETF's/Index bond funds - including preferred fund ETF's - and let the professional managers work the portfolio rather than buy some Canadian blue chip bonds from banks and other financials and perhaps utilities?

How can one measure the difference between management fees of index funds against the mark-up of purchasing individual bonds from a broker?

[BC_Doc]

How can one measure the difference between management fees of index funds against the mark-up of purchasing individual bonds from a broker?

Here's a quote from TD Water House for an individual strip bond (after hours from website):

Province of Ontario strip maturing on 2 Dec 2021. Quote for 10 bonds-- price= $74.817, yield= 3.07917, face value= $10,000, settlement= $7,481.70

"Best offer: (based on purchase of 5 bonds)"

bid: 73.185 (yield= 3.31517) ask: 74.977 (yield= 3.05632)

Knowing the bid and ask price, the midpoint is 74.081

So, in order purchase 10 bonds, we are paying $73.60 in hidden commissions ( $7,481.70-$7,408.10).

Duration is roughly 9.5 years so our cost as a percentage is:

73.60/7,481.70*100 or 0.984% over the remaining life of the bond.

Divide this by the approximately 9.5 years duration remaining on the bond we get an annual cost of: 0.104% (versus 0.20% per year MER for VAB).

The same bond from RBC-DI is priced at 75.67 for 10 bonds (semi-annual yield is 2.958%)-- again, this is the after hours price listed on the website.

Cost to purchase 10 bonds is thus $7,567.00 or $85.30 more than from TD Water House.

From RBC DI, we pay $158.90 in hidden commission to purchase the 10 bonds which works out to a 2.10% commission over the life of the bond or 0.22% per year in hidden fees.

I don't know whether there really is an "apples to apples" method to compare fees for purchasing individual bonds to the annual fees bond etfs charge as they also have to pay commissions on their bond purchases (as they are buying larger lots, their commission costs as a percentage will be lower). The mark-up on the bonds from TD Water House are quite low as a percentage. The benefit to buying the actual strip bond is that I know exactly how much it will be worth at maturity. On the other hand, there are definitely some things that I would be giving up by purchasing the individual bond (diversity and liquidity come mind).

Hope this helps answer your question.

BC Doc

[eulogy]

Hi eulogy,

Two worthwhile fixed income reads are:

The Bond Book by Annette Thau (American)

In Your Best Interest by Hank Cunningham (Canadian)

I'll track down these two books and read them. I believe the "In Your Best Interest" is in the reference section on Finiki for bonds. I was reading in what I think was another thread that buying your own bonds and making your own ladder isn't that useful when you're starting out. Someone said if you have below $50,000 in fixed income, you might as well stick with the bond funds.

But I am finding this pretty interesting and I'm going to find these books to read.

[Shakespeare]

Someone said if you have below $50,000 in fixed income, you might as well stick with the bond funds.

Yep. 5*$10K is the minimum. $25K is a better pricing point and 10 is better diversification. That's $250K, which you should have for corporates.

[Shine]

How can one measure the difference between management fees of index funds against the mark-up of purchasing individual bonds from a broker?

Here's a quote from TD Water House for an individual strip bond (after hours from website):

Province of Ontario strip maturing on 2 Dec 2021. Quote for 10 bonds-- price= $74.817, yield= 3.07917, face value= $10,000, settlement= $7,481.70

"Best offer: (based on purchase of 5 bonds)"

bid: 73.185 (yield= 3.31517) ask: 74.977 (yield= 3.05632)

Knowing the bid and ask price, the midpoint is 74.081

So, in order purchase 10 bonds, we are paying $73.60 in hidden commissions ( $7,481.70-$7,408.10).

Duration is roughly 9.5 years so our cost as a percentage is:

73.60/7,481.70*100 or 0.984% over the remaining life of the bond.

Divide this by the approximately 9.5 years duration remaining on the bond we get an annual cost of: 0.104% (versus 0.20% per year MER for VAB).

The same bond from RBC-DI is priced at 75.67 for 10 bonds (semi-annual yield is 2.958%)-- again, this is the after hours price listed on the website.

Cost to purchase 10 bonds is thus $7,567.00 or $85.30 more than from TD Water House.

From RBC DI, we pay $158.90 in hidden commission to purchase the 10 bonds which works out to a 2.10% commission over the life of the bond or 0.22% per year in hidden fees.

I don't know whether there really is an "apples to apples" method to compare fees for purchasing individual bonds to the annual fees bond etfs charge as they also have to pay commissions on their bond purchases (as they are buying larger lots, their commission costs as a percentage will be lower). The mark-up on the bonds from TD Water House are quite low as a percentage. The benefit to buying the actual strip bond is that I know exactly how much it will be worth at maturity. On the other hand, there are definitely some things that I would be giving up by purchasing the individual bond (diversity and liquidity come mind).

Hope this helps answer your question.

BC Doc

Thank you for that excellent analysis BC Doc.

Regards

[ghariton]

Yield record in US Treasury sale:

Investors accepted the lowest yields ever for 10-year paper in a US Treasury auction shortly before the release of Federal Reserve minutes showing a bias towards more monetary easing.

The scale of demand at the auction suggests investors expect US interest rates to remain low for several years. The $21bn sale of 10-year paper sold at a yield of 1.459 per cent, the lowest ever in an auction.

George

[Bylo Selhi]

Yield record in US Treasury sale

Auch in Deutschland.

Germany’s cost of borrowing over 10 years fell to a record low at an auction on Wednesday as investors, worried about the euro zone rescue fund’s effectiveness as a crisis-fighting tool, sought the safety of Berlin’s debt despite negligible returns. The government sold €4.153-billion ($5-billion U.S.) worth of Bunds for an average yield of 1.31 per cent, the lowest ever on record for the maturity. Investors bid for 1.5 times the volume of paper on offer.

[CROCKD]

I need some help on re-deployment of bond capital.
Next month in my LIF I have a maturing Govt. of Canada bond bought in 1997. All other securities in the LIF were transferred to my RRIF under the applicable legislation.

As I am in my 70's I have been trimming back equities in favour of fixed income and intend to reinvest the bond money in fixed income. It is a 6 figure amount and I am considering investing about 2/3 of it in a 5 year GIC ladder. The other 1/3 I want to buy bond ETFs. I already have a very substantial amount of XSB in my RRIF and the monthly spin off of interest is a PITA as BMOIL will not DRIP them.

I have been considering ZCS as I am leery of longer bond funds with the prospect (sometime) of rising interest rates. Being a BMO product I assume they will (or could be) DRIPped.

The next issue is liquidity. Friday's trading volumes were - XCB ca.113,000, XSB ca.162,000 and ZCS ca. 13,500.
The amount I am considering would represent a significant % of the ZCS volume. Also I would need to sell about 20% of the amount each year to provide for mandatory LIF withdrawals as I would expect to rollover a maturing GIC for another 5 year one.

Any ideas, comments, suggestions etc. are welcome.

[ockham]

I need some help on re-deployment of bond capital.
Next month in my LIF I have a maturing Govt. of Canada bond bought in 1997. All other securities in the LIF were transferred to my RRIF under the applicable legislation.

As I am in my 70's I have been trimming back equities in favour of fixed income and intend to reinvest the bond money in fixed income. It is a 6 figure amount and I am considering investing about 2/3 of it in a 5 year GIC ladder. The other 1/3 I want to buy bond ETFs. I already have a very substantial amount of XSB in my RRIF and the monthly spin off of interest is a PITA as BMOIL will not DRIP them.

I have been considering ZCS as I am leery of longer bond funds with the prospect (sometime) of rising interest rates. Being a BMO product I assume they will (or could be) DRIPped.

The next issue is liquidity. Friday's trading volumes were - XCB ca.113,000, XSB ca.162,000 and ZCS ca. 13,500.
The amount I am considering would represent a significant % of the ZCS volume. Also I would need to sell about 20% of the amount each year to provide for mandatory LIF withdrawals as I would expect to rollover a maturing GIC for another 5 year one.

Any ideas, comments, suggestions etc. are welcome.

I don't envy your problem, nor do I have any bright ideas.

But I do have a question. I collapsed my XSB into a 5yr GIC ladder a week or two ago. The effective yld of my ladder is 2.29%. The effective yld of ZCS (net of mer) is ~2%. The effective yld of XCB (net of mer) is ~2.5%. Why not ladder everything?

[AltaRed]

Or include a smattering of Corporate bonds (to complement the 5 yr GIC ladder) in the 2-5 yr range. Yes, you have to go to BBB to get ~3% or better but perhaps 15-30% in those will boost your overall effective yield on FI by 0.2% or so. Check out things like Shaw, Enbridge Income Fund, AltaGas, etc. That is basically what I have done with my RSP and plan to do likewise when I RIF. I have not seen a bond ETF that I can push the buy button on.

[like_to_retire]

Or include a smattering of Corporate bonds (to complement the 5 yr GIC ladder) in the 2-5 yr range. Yes, you have to go to BBB to get ~3% or better but perhaps 15-30% in those will boost your overall effective yield on FI by 0.2% or so. Check out things like Shaw, Enbridge Income Fund, AltaGas, etc. That is basically what I have done with my RSP and plan to do likewise when I RIF. I have not seen a bond ETF that I can push the buy button on.

Agree +1 .....

Forget the bond ETF. If you will be cashing large amounts (as you've stated), it could be inconveniently occuring during an interest rate rise, and you would be hit with a depressed NAV.

ltr

[ockham]

I hold some XIG, which is ishares' US investment grade corporate bond ETF. Its effective yld is ~2.85% (net of mer), but then there's the added cost of the cdn$ hedge, whatever that is. Making me think that I'm gaining little or no advantage over a 5 yr ladder.

[CROCKD]

Thanks to all for your comments and suggestions.

I have a few weeks yet to check it out and consider how I want to proceed.

I was wrestling with this problem when I suddenly realized 'wait a minute, this is one of the reasons I am in the FWF!'

[CROCKD]

As a result of the comments I received on reinvestment of LIF cash I am considering a 5 year GIC ladder for the total amount.
Looking at BMOIL GIC quick picks for August 24 and selecting the best rates the effective yield is 2.27%.
I have a fair amount of non registered money in a couple of these banking institutions.
Am I correct in assuming that the non registered and registered money is considered as separate entities for purposes of CDIC coverage?
Also that registered means LIF + RRIF as I have a small ladder in my RRIF.

Looking at BMOIL corporate bond offerings in the 3 - 5 year range I couldn't see anything that was better than GIC rates.

[Thorn]

I am retired, married, 68. A few observations on the discussion so far:

(1) Fixed income (bonds, which are liquid, as opposed to GICs which are not) are intended to preserve capital and deliver some interest income. Bond funds are equities, not fixed income: they do not provide any level of guarantee of return of capital, they do not mature on a specified date and they do not guarantee the percentage return (coupon) for the period you hold them.

(2) Fixed income ladders demand that you shop around for an acceptable coupon when one set matures each year. One would hope the return would exceed inflation + tax by some amount you find reasonable. Even so, the overall expectation is about a 3.5% return for medium-term investment grade corporate bonds.

(3) A number of participants her appear to be quite young, perhaps 20-30 years from retirement, in which case their appetite for fixed income in sheltered accounts should be quite low, as good quality dividend stocks deliver tax-advantaged dividends and capital gains over extended periods of time.

(4) The asset allocation question (cash/fixed income/equity portions of your total portfolio) rests heavily on whether you need investment income to participate in paying monthly bills. If not, you can continue to hold more equities, even at my age, and ignore the rule we hear so often "fixed income% = age, the rest is equities".

(5) One obstacle in the current bond market is ongoing US and CDN government policy of low interest rates. The effect has been to move bond purchase prices to unacceptable levels, when they have a reasonable coupon. It is interesting to note that your bond agent has a vested interest to be as competitive as possible on price quotations - his corporate bond desk has laid out money previously to buy bonds for resale. This is very different from an equity broker whose company has no skin in the (non-IPO) game, but is focused on competing a trade and collecting his/her commission.

[Shakespeare]

Bond funds are equities, not fixed income: they do not provide any level of guarantee of return of capital, they do not mature on a specified date and they do not guarantee the percentage return (coupon) for the period you hold them.

Bond funds are not equities, they are income. The pricing differences are irrelevant if the holding period is greater than the duration and in any case a bond ladder of the same duration and quality has the same pricing changes. A GIC ladder would have similar changes if the GICs were marked to market.

[scomac]

Looking at BMOIL corporate bond offerings in the 3 - 5 year range I couldn't see anything that was better than GIC rates.

Call their bond desk and ask to speak to a trader. There are corporate bonds out there in your maturity range that yield in excess of 3% provided you're willing to dial up the risk a bit with a BBB -- H&R REIT for example. Even a Bell or Telus bond of that maturity will net you 50 basis point yield premium at an A (low). Make sure you check through the strip listings as well as some corporate bonds are being stripped by the dealers.

[adrian2]

Bond funds are equities, not fixed income: they do not provide any level of guarantee of return of capital, they do not mature on a specified date and they do not guarantee the percentage return (coupon) for the period you hold them.

To reiterate Shakespeare's objection to your statement:
- fixed income means fixed income, not a return of capital or maturity date. The securities held by a bond fund have the income (coupon) guaranteed for their term to maturity.
- the ultimate fixed income is called a perpetuity, which is basically a GIC to infinity. It has no guarantee of return of capital, no maturity and no guarantee for the overall (coupon + price) return.

[Shakespeare]

To put it another way, a bond ladder is a weakly-diversified bond fund and will react in pricing similarly to a bond fund or bond ETF of similar credit quality and duration. A GIC ladder would also react to pricing in a similar manner if the GICs were marked to market. Since in the case of a GIC ladder, as James Hymas pointed out, the renewal rung is at market rates and is of the longest duration, if anything a GIC ladder has greater rate sensitivity than a samed-duration bond fund or ETF. Thus, the perceived pricing differences between ladders and funds or ETFs are a will o' the wisp and largely mental accounting.

[gsp_]

Thorn made the very same claim in his first post to this forum a year ago, got called on it and never aknowledged the replies. Must be something about August weather...
viewtopic.php?f=29&t=113379&p=437015#p437015

[Springbok]

Thorn made the very same claim in his first post to this forum a year ago, got called on it and never aknowledged the replies. Must be something about August weather...
viewtopic.php?f=29&t=113379&p=437015#p437015

I don't blame Thorn for sticking to his guns. Bond funds may not exactly be equities, but they are 'equity like' and my view, to be avoided in the fixed income allocation of a portfolio.

The example adrain2 gave: "the ultimate fixed income is called a perpetuity, which is basically a GIC to infinity. It has no guarantee of return of capital, no maturity and no guarantee for the overall (coupon + price) return." illustrates this. If you bought a perpetual security, you would expect to get a certain coupon rate, but at some point in future you or your estate will need to cash that security. At that time you are at the whim of the markets in same was as if you owned a widows and orphans dividend paying stock like Bell Telephone was in past.

[adrian2]

I don't blame Thorn for sticking to his guns. Bond funds may not exactly be equities, but they are 'equity like' and my view, to be avoided in the fixed income allocation of a portfolio.

Fixed income means the income that you're getting is fixed, nothing more, nothing less. It says nothing about you or your estate cashing in the security.

As Shakespeare has stated, if you're holding a bond fund for at least its duration, you're immunized to any fluctuations in interest rates.

Springbok, please elaborate on what you're considering "true" fixed income.

[like_to_retire]

I don't blame Thorn for sticking to his guns. Bond funds may not exactly be equities, but they are 'equity like' and my view, to be avoided in the fixed income allocation of a portfolio.

I think it's important to distinguish between the definition of fixed income and the various realities.

As Shakespeare said, "if the holding period is greater than the duration of the fund any capital losses will be balanced by income gains." True, but for example, if I hold a bond fund with a long duration (13 year duration XLB) and there's an interest rate shock of 1% and I require money right away, there's little argument that I'm going to lose some capital. That may inspire some holders to decide that bond funds are like equities.

The same is exactly true if I hold a single long term bond (10 year gov't bond) and I require some money and have to cash it in after a rate shock - I'm going to lose money. Do I label a gov't bond an equity? No, just like the bond fund or ETF, it's fixed income with risk of capital loss unless held until maturity (in the case of individual bonds), or past the duration (in the case of funds and ETF's). They all pay fixed income - there's not much argument with that - it's the definition of fixed income. Fixed income simply comes with different levels of risk to your capital. The risk doesn't change that the income is fixed.

ltr

[Springbok]

Fixed income means the income that you're getting is fixed, nothing more, nothing less. It says nothing about you or your estate cashing in the security.

Fixed Income is a term that can be used to describe the part of a person's income that does not vary over time. That appears to be your understanding of the term.

But "Fixed Income" is commonly used to refer to any type of investment under which the borrower/issuer is obliged to make payments of a fixed amount on a fixed schedule, and to repay the principal amount on maturity.

If a security does not meet the above definition, then what is it? A Bond fund doesn't meet the definition. It often trades like an equity and that is why I believe Thorn is partly right in considering it an equity or at least equity-like.

Of course, if you come up with a different definition of what a Fixed Income investment is, then bond funds may fit. But who is to say that one way is right or wrong?

I think most here understand all of this, so why get hung up on semantics?

[AltaRed]

Because the financial industry calls bonds, and by default bond funds and ETFs, Fixed Income and that is the general understanding, and we all know the understanding. Feeding the troll is not helpful.