Bond Ladders vs Bond ETF's

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like_to_retire
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Re: Bond Ladders vs Bond ETF's

Post by like_to_retire »

My question is , is a 5 year laddered ETF similar to a actual bond ladder ie will the replacement bonds over the next few years increase the Nav so as to protect my investment.
The distributions alone will continue to fiance my retirement - no need to sell unless it is determined that the bond ETF is a bad investment.
Looks like CBO's cash yield is 5.14% with a YTM of 2.38%, so you know that it contains a lot of premium bonds - not very tax efficient, but that's the nature of bonds after a prolonged interest rate drop.
It appears to have 25 bonds with 5 bonds in each step of a 6 year ladder (with an expected duration of 2.6 years), so yes, it's just like any ladder.

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Re: Bond Ladders vs Bond ETF's

Post by queerasmoi »

Pickering wrote:Read your replies and learned lots. but what happens now. Interest rates are likely to start going up in June or July.
My average cost on CBO is about 20.63 and CLF 20.77 - coming up on the March distribution - CBO looks like it may hold a NAV of about my cost after the distribution, but CLF is likely to close March in the 20.35 range.
I am an income investor, and see no reason to sell if my principle is protected long term.
My question is , is a 5 year laddered ETF similar to a actual bond ladder ie will the replacement bonds over the next few years increase the Nav so as to protect my investment.
The distributions alone will continue to fiance my retirement - no need to sell unless it is determined that the bond ETF is a bad investment.
Will the replacement bonds increase the NAV? I'm not sure where you're going with that.

When rates go up, the NAV will go down. *But* if you have Claymore's DRIP feature enabled, then at lower prices your distribution will purchase more shares of the fund than at higher prices. So long term with reinvested distributions, you would find that your *number of shares* will creep up to compensate for the lower NAV.

Whenever you are getting closer to your withdrawal phase, this is when you'd want to sell the fund and transition to a real bond ladder. The advantage of a real ladder is, you can always stop buying more bonds and let the maturities tick down. The fund does not allow you this choice.
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Re: Bond Ladders vs Bond ETF's

Post by like_to_retire »

queerasmoi wrote:Whenever you are getting closer to your withdrawal phase, this is when you'd want to sell the fund and transition to a real bond ladder. The advantage of a real ladder is, you can always stop buying more bonds and let the maturities tick down. The fund does not allow you this choice.
There are other advantages to a ladder:

You get a defined rate of return and a know principle returned at maturity.
You can control the duration of your holdings.
You control any capital gain liabilities.
Not to mention, why pay someone to do something you can do yourself at less cost.

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Re: Bond Ladders vs Bond ETF's

Post by Peculiar_Investor »

I agree with like_to_retire's list, however there are some disadvantages as well.

Disadvantages for retail bond investor include:

pricing - institutional investors (includes ETF companies) will pay less due to the volumes that they are purchasing. Those buying millions of dollars are sure to have a lower bid/ask spread vs someone buying $5K or $25K of a bond. For retail, the yields will therefore be lower.
inventory - institutional investors have access to a much deeper pool of bonds. Check out the listing of holdings of an ETF vs. the inventory at your broker. There are many bonds held in the ETFs can probably were never made available to retail.

IMHO, each investor needs to weigh their own circumstances when making the choice and a case can likely be made either way depending on the circumstances. Myself, I've done both, started with bond ETFs and more recently have been building a bond ladder to gain further understanding of the actual mechanics and as retirement age is beginning to appear to the horizon.
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Re: Bond Ladders vs Bond ETF's

Post by Shakespeare »

Disadvantages for retail bond investor include:
Risk granularity. Unless you can buy a very large number of bonds, a single default will substantially penalize your returns. Read the threads on Ford and GM/GMAC bonds. Bond funds and ETFs offer much lower granularity.
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Re: Bond Ladders vs Bond ETF's

Post by like_to_retire »

Risk granularity. Unless you can buy a very large number of bonds, a single default will substantially penalize your returns.
Yeah agreed, but if you stick to canadian govenment bonds you don't have to worry a lot about default risk. Myself, over many years, I have removed corporate bonds from my five year ladders, and added prefereds for both the corporate and long term exposure. The lower yield on the govenments is pumped by the higher yield on the long term prefs.

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Re: Bond Ladders vs Bond ETF's

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Shakespeare wrote:Read the threads on Ford and GM/GMAC bonds. Bond funds and ETFs offer much lower granularity.
I have had both Ford Credit and GMAC Canada and never had a default. Also Hydro Quebec. GE Capital. I agree that you get a broader set of holdings. But is it really necessary? Anything above 20 seems to provide good spreading of risk. Of course of you are dealing with a principal below $50K then ETFs are the way to go.
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Re: Bond Ladders vs Bond ETF's

Post by Shakespeare »

Just because defaults didn't occur doesn't mean investors on this board weren't scared they would. Read the threads.
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Re: Bond Ladders vs Bond ETF's

Post by kcowan »

Shakespeare wrote:Just because defaults didn't occur doesn't mean investors on this board weren't scared they would. Read the threads.
I agree. But fear is what makes the returns higher. There is no free lunch (except on Wall Street)!
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Re: Bond Ladders vs Bond ETF's

Post by Bylo Selhi »

Shakespeare wrote:Just because defaults didn't occur doesn't mean...
...that they couldn't have, e.g. if the Bush government had practiced what it preached, i.e. passed on "saving" GM and Chrysler.

Likewise GE Capital didn't go broke but some rather well-known US banks did. What happened to their bonds?
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Re: Bond Ladders vs Bond ETF's

Post by queerasmoi »

I do agree with the issue of retail investors and small amounts of bonds. Of course if you convert to a real ladder in anticipation of your withdrawal phase, then you are you likely pretty near the point in your life when you have the greatest amount of money *ever* to invest in fixed-income. You've saved up for your whole life and your allocation is going to be moving away from equities as you desire to take on less risk. So at this stage, you look at your assets and judge if you will be able to get good deals in the bond market based on the size of your savings.

Also don't forget that when you are constructing your own ladder, depending on your need for liquidity, you can mix and match bonds & GICs. If you have a large amount to put in GICs, you get to shop around and find deals. Ask a GIC broker. (Granted it's easier not to have to shop beyond the confines of your own brokerage when you are dealing with RRSP funds.)
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Re: Bond Ladders vs Bond ETF's

Post by JaydoubleU »

I am investing for a parent and looking for the best, safest, highest yielding bond ETFs with the lowest MER for her RRSP.

Am concerned that rising rates will hit hard. But as yields rise, won't the payouts as well?

My thoughts at the moment are XBB and XSB. Is it worth holding both? Are there better yields available elsewhere without significantly more risk?
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Re: Bond Ladders vs Bond ETF's

Post by scomac »

JaydoubleU wrote:I am investing for a parent and looking for the best, safest, highest yielding bond ETFs with the lowest MER for her RRSP.

Am concerned that rising rates will hit hard. But as yields rise, won't the payouts as well?
Yes.
My thoughts at the moment are XBB and XSB. Is it worth holding both? Are there better yields available elsewhere without significantly more risk?
I don't really think so unless you are deliberately trying to manipulate duration to immunize the portfolio.

With respect to alternatives, CBO might be worth a look, especially if you were planning to hold an ETF for corporate debt exposure in combination with a GIC ladder or equivalent with the objective of keeping maturities short in order to minimize impacts of rising rates.
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Re: Bond Ladders vs Bond ETF's

Post by JaydoubleU »

Thanks Scott!
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Re: Bond Ladders vs Bond ETF's

Post by BRIAN5000 »

This is an article talking about Vanguard Bond ETF's. It was my misconception that most/some of these ETF's actually tried to replicate an index. It sounds like MOST(?) are taking sector bets gov't/corporate/duration. I need to read this more closely.

EG. As of late, four fifths of Vanguard Total Bond Market Index's benchmark was composed of U.S. Treasuries and government-agency debt, so the fund will lag the competition if market sentiment turns against either of those sectors.


http://finance.yahoo.com/news/Vanguard- ... l?x=0&.v=1
This information is believed to be from reliable sources but may include rumor and speculation. Accuracy is not guaranteed
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Re: Bond Ladders vs Bond ETF's

Post by DavidR »

Nice article by Rob Carrick in yesterday's Globe explaining some concepts of Bond ETFs and comparing some of the new entrants to the older iShares issues XCB, XBB, XSB etc.
Let's take a close look at 10 popular bond ETFs listed on the Toronto Stock Exchange to see what they're made of and how they might bear up to rising rates.
http://v1.theglobeandmail.com/servlet/s ... /TPComment
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Re: Bond Ladders vs Bond ETF's

Post by Peculiar_Investor »

Another article by Rob Carrick, Gone fishing ... for top performing bond funds - The Globe and Mail. Two surprises for me,
Rob Carrick wrote:Common to all these funds are management expense ratios that rank miles below the astronomically high Canadian fixed income fund average of 1.72 per cent.
But check out the MERs for the funds found. In the current low interest rate environment, the MERs are going to kill future investors.

Secondly, I'm surprised there was no mention that we've just come through a great bond rally, so definitely past performance is no indication of future results. The benchmark numbers are not even quoted, nor is a comparison to something like the iShares XBB (Management Fee of 0.30 BTW). I predict that in one to three years the follow-up article may appear blaming poor performance of these choices on the low interest rate environment and the high MERs.
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Re: Bond Ladders vs Bond ETF's

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Peculiar_Investor wrote: check out the MERs for the funds found. In the current low interest rate environment, the MERs are going to kill future investors.
Perhaps, perhaps not. It all depends what the fund holds, it's average YTM and its duration. When you factor in that an ETF such as XBB must hold ~50% in federal debt, the increased MERs of an actively managed fund may well be worth it if the manager has tilted the portfolio to take advantage of the risk premia that is being afforded corporate/provincial/municipal credits.

The simple truth is that if you are unable or unwilling to roll your own, you only have so many alternatives. XBB will give the current buyer 2.6% annually going forward over the next 8+ years; GICs look pretty good in comparison. If I must own a bond fund, I'd much rather pony up the extra MER for PH&N than ride the ETF train.
Secondly, I'm surprised there was no mention that we've just come through a great bond rally, so definitely past performance is no indication of future results. The benchmark numbers are not even quoted, nor is a comparison to something like the iShares XBB (Management Fee of 0.30 BTW). I predict that in one to three years the follow-up article may appear blaming poor performance of these choices on the low interest rate environment and the high MERs.
Yes, we are in the midst of a bond rally that has gone on for 30 years now. Many pundits have predicted the end of the bond bull for the better part of 10 years, if not longer. As a result of the credit crisis, we are deleveraging globally. This started in 2008 and will take quite some time to work its way through; 10 years is not unrealistic. Granted, public entities are increasing their use of debt, but not at a rate to soak up all the slack of private balance sheets contracting. Until the creditors are more interested in spending than they are in lending, we are going to be faced with an imbalance of credit supply versus demand. You can't get materially higher rates of interest in that sort of credit environment. Essentially you are looking at the Japan scenario, but on a more global basis. Despite the fact that nominal rates remain low, the real rates of return for fixed income in the near term will continue to be better than people realize. Depending on portfolio construction, it could be more than adequate to off-set the increased fees from active management.
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Re: Bond Ladders vs Bond ETF's

Post by queerasmoi »

scomac wrote:If I must own a bond fund, I'd much rather pony up the extra MER for PH&N than ride the ETF train.
For PH&N, yes, but only if you can get D-series. The advisor-priced units start to become less favourable. And there are some other funds on that article's list with MER 1-1.12%... in a low rate environment could any degree of active management justify that MER?
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Re: Bond Ladders vs Bond ETF's

Post by scomac »

queerasmoi wrote:
scomac wrote:If I must own a bond fund, I'd much rather pony up the extra MER for PH&N than ride the ETF train.
For PH&N, yes, but only if you can get D-series. The advisor-priced units start to become less favourable.
The advisor-priced units are fine if you are getting the advice. You're going to have to add the cost of advice to the MER of an ETF to compare on a level playing field.
And there are some other funds on that article's list with MER 1-1.12%... in a low rate environment could any degree of active management justify that MER?


I believe so. Just look at the spreads which are still out at the high end of the historical norm. If you are forced to own federal bonds -- like you would be with an index product -- you are paying a very steep price for risk aversion and liquidity. It will be costing you a minimum of 100 basis points across the curve. As long as you aren't spending all the additional return in fees, the active management is adding value. But, this will be entirely dependant upon the make-up of the bond portfolio. Any active fund that holds a significant asset base in federal bonds won't be able to compete, but they're really not trying as they are closet indexing.
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Re: Bond Ladders vs Bond ETF's

Post by randomwalker »

In the first few minutes of this clip the speaker suggests people are not understanding risk vs return in the bond market nor do they understand the difference between coupon yield and current yield. Can this be true???

http://watch.bnn.ca/#clip339595
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Re: Bond Ladders vs Bond ETF's

Post by scomac »

randomwalker wrote:In the first few minutes of this clip the speaker suggests people are not understanding risk vs return in the bond market nor do they understand the difference between coupon yield and current yield. Can this be true???
Absolutely! Just look at the preferred share market for confirmation where shares trade on current yield versus yield-to-worst. I don't think the issue is quite that bad in the bond market, but folks may not be adequately appreciating the loss of capital that occurs when a premium bond matures; furthermore, trading interest income for a capital loss is a terrible trade-off in a taxable account.
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Re: Bond Ladders vs Bond ETF's

Post by kcowan »

scomac wrote:... folks may not be adequately appreciating the loss of capital that occurs when a premium bond matures; furthermore, trading interest income for a capital loss is a terrible trade-off in a taxable account.
Amen. Yet it presents an opportunity, albeit small, to invest in individual fixed term bonds versus index funds.
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Re: Bond Ladders vs Bond ETF's

Post by Peculiar_Investor »

In http://www.financialwisdomforum.org/for ... 42#p406942,
Shakespeare wrote:
In this case, a GIC or bond ladder with known cash flows becomes better than using ETFs.
Note that you can sell a bond ETF and buy a GIC or bond ladder of the same duration on the same day with (to a first approximation) no interest rate sensitivity (although there may be credit quality differences).

This suggests that you should match the duration (and possibly the credit quality) of the bond ETF you use in the accumulation phase to the ladder you eventually expect to buy (if you are following this strategy).
Forgive me if I've moved this discussion to the wrong place, but could you please expand on this. I was of the viewpoint that one of the disadvantages of using fixed income ETFs was the lack of control of duration and yield and thus when approaching on in retirement, direct bond holdings with known duration and yield was the more appropriate strategy.
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Re: Bond Ladders vs Bond ETF's

Post by Shakespeare »

The various bond ETFs have a duration that depends largely upon the average term. Duration is a function first of term and second of rate, so it is not affected greatly by modest rate changes, particularly when the average term (and duration) are short.

A five-year GIC ladder - the maximum guaranteed term - has a duration that will be around 2 1/2 years. [3 years is the average term when set up 1-2-3-4-5; just before renewal the sequence becomes 0-1-2-3-4 with an average of 2; mean 2 1/2; the coupons reduce the duration below the term.] XSB has a similar duration (2.6 right now); to a first approximation you can sell XSB in one fell swoop and replace it with a 1-2-3-4-5- ladder with only minor interest rate sensitivity. Of more concern may be credit quality differences, since XSB includes corporates. Of course, you could also use a government bond ETF like CLF if you want to match that.

The point is that you can decide on the ladder structure many years in advance and buy an ETF that matches - using a mix of two ETFs if necessary.
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