Canadian Bond and ETF Options

I Like Bonds

Perhaps it's because they're the first thing I learned, or perhaps it's because they saved my skin through both the 2000 and 2008 bear markets. I like sticking to what works, and bond investments have worked the best – consistently – for at least the last 13 years.

Warning: selecting bonds is a very complex process. I'm not telling you to buy them. Do your own analysis: risk, interest rate forecasts, and the math!

Assuming that you want to buy bonds, here are my opinions on the available options and the popular ETFs. This is written from a Canadian investor's perspective, with a focus on government bonds.

Big reasons to consider government bonds

Best option: buy bonds directly from discount brokerages

I think it's best to buy bonds directly, when possible to do without high fees. My favourite approach is to buy individual bonds and hold them to maturity. Whenever you cut out a middleman in banking, you come out ahead.

Many Canadian stock brokerages offer bonds. I'm not familiar with all of them, but I have compared prices (fees) and availability at most of the major brokerages. Among these, two noteworthy ones stand out to me:

TD Waterhouse: TDW has a pretty good offering of both government and corporate bonds. The fees are baked into the quoted price, but the resulting yield isn't too much worse than wholesale. For a long time TDW was the only place to buy bonds without getting ripped off by the broker, but this is changing now as many brokers are reducing their bond fees.

Scotia iTrade: Has a competitive fee structure and nice transparent fee schedule (the bond price is quoted separately from all fees). The same government bonds are available at both TDW and iTrade. Spot checking a few, I found slightly lower fees (= higher yield) at iTrade, but I can't tell if this is consistently true.

Taxes can get a bit tricky if you buy bonds individually. I suggest doing all this within an RRSP or TFSA, and then you don't have to worry. In a non-sheltered account, the coupon payments are taxable income and there may be a capital gain/loss at maturity or disposition.

Another option: use a bond ETF

I'm not even going to talk about bond mutual funds, because ETFs (exchange traded funds) have lower fees and the benefit of greater transparency/exchange pricing. In general though I'm less keen on bond funds because an investment bank money manager is making the decisions, charging fees, and often doing riskier things than I like.

Here are the TSX-listed bond ETFs that have major government bond components. I have monitored these products for many years, with the exception of CLF which is newer:

XSB: Currently 69% government (57% federal, 12% provincial) and average maturity around 3 years. MER 0.25%. These short term bonds are lower risk and less sensitive to interest rates. Overall, XSB offers a pretty good trade-off and, from my records, higher yield than buying the 3 year government bond directly.

CLF: Currently 83% government (29% federal, 54% provincial) and average maturity around 4 years. MER 0.16%. Although the MER is incredibly low, the numbers don't convince me this is a good investment. The federal component is too low, and more importantly the yield-to-maturity is less than a similar maturity federal government bond at a discount brokerage. It's not worth buying at the current price.

XBB: Currently 68% government (44% federal, 24% provincial) and average maturity around 9 years. MER 0.30%. I don't like the risk/reward trade-off on XBB. For example, the current yield-to-maturity of 3.15% is actually less than the same maturity government bond at a discount brokerage (3.18% yield). You're better off buying the government bond directly, meaning there's zero reward for the significant extra corporate risk in XBB!

XGB: Currently 94% government (61% federal, 33% provincial) and average maturity around 9 years. MER 0.35%. XGB is pure government and less risky. But just like XBB, the yield-to-maturity is less than what you'd get buying a government bond directly (currently 0.3% less). This one may be appropriate if you feel comfortable paying such high fees for what you could do yourself. Paying 30 basis points on a 300 basis point yield is a lot, but if interest rates were much higher this could be attractive.

XLB: Currently 75% government (31% federal, 44% provincial) and average maturity around 23 years. MER 0.35%. I can't imagine ever buying it: federal component is too low, the maturity is incredibly long, and fees are high.

XRB: Currently 99% government (84% federal, 15% provincial) and average maturity around 21 years. MER 0.35%. These are real return bonds, which have been in fashion at times. They have very long maturities and as with XLB, I can't imagine buying those long durations. Real return bonds have a pay-out that is supposedly indexed to inflation, but I think the danger of the long term to maturity trumps any benefits.

Among these, I only like XSB. For all the others, I think you're significantly better off buying government bonds directly. This can change as prices change. I don't own any of these ETFs myself, because I pick bonds individually and do the same job as a bond fund manager.

Just be aware we're in a Bond Bubble

I still think that bonds are in a bubble (the same credit bubble as before, plus central bank stimulus). This inflates bond prices across the board, but especially corporate and long duration bonds. I wouldn't dream of buying either at current prices.

However, everyone needs bond/GIC investments. To mitigate risk:

- Perpetual Bull,