bonds ETF or bond fund

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optim
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bonds ETF or bond fund

Post by optim » 11 Sep 2017 14:45

looking to decrease stock allocation and increase fixed income which I think means more bonds

am debating a bond ETF like VAB (-1.92 1 year return) or bond mutual fund like TD Canadian Bond Index Fund - e (-1.89 I year return)

negative returns always make me sad
should I wait a while and sit on cash instead of buying bonds or buy a 1 year GIC or high interest savings account with these current negative performances?

BRIAN5000
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Re: bonds ETF or bond fund

Post by BRIAN5000 » 11 Sep 2017 17:54

Right or wrong I think I have made a compromise all registered accounts are at one brokerage where Gic rates are horrid so most fixed income there is in ETFs - VAB, ZCM + 10% cash(HISA for market timing)

All non registered fixed income is in Gic's + 10% cash(HISA for market timing) with linked online access to several providers with a dart throwing approach to picking the duration. Most recently got as much as I could at 5 year 3.25%. Total ladder, as best as I can approximate, is only yielding 2.28% very sad.
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SoninlawofGus
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Re: bonds ETF or bond fund

Post by SoninlawofGus » 11 Sep 2017 18:24

BRIAN5000 wrote:
11 Sep 2017 17:54
Most recently got as much as I could at 5 year 3.25%. Total ladder, as best as I can approximate, is only yielding 2.28% very sad.
Oaken five-year at 3.25%? I did the same.

My GIC five-year ladder (which in truth is not always reinvested at 5 years) is at 2.33%, but only 2.16% if I include cash. I'm still beating inflation though. I hold no bond ETFs or bond funds.

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AltaRed
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Re: bonds ETF or bond fund

Post by AltaRed » 11 Sep 2017 18:36

optim wrote:
11 Sep 2017 14:45
should I wait a while and sit on cash instead of buying bonds or buy a 1 year GIC or high interest savings account with these current negative performances?
Problem is that one does not know when/if BoC will continue to raise overnight interest rates...which will have some influence on raising bond yield curves, especially those of shorter terms. Some speculate BoC will raise rates 3 times next year for a total of 75bp, but that will only put the overnight rate to 1.75%. A long ways from the 'historical normals' of 3% or better.

It could be a long painful process spread out over a number, e.g. 5 years, OR we could head into another recession causing BoC to run for the hills and lower rates again. It's a mug's game. Over time, bond ETFs should be fine. You just need to be prepared to hold for the long term to get the benefit of YTM and duration.

In recent years, a 5 year GIC ladder has been the most rewarding of the FI alternatives. Probably still is based on current 5 year rates of 2.5-2.6% through brokerages. Takes some time to manage it though. HISA rates of 1.2-1.7% just don't have much sex appeal and should only be used as a cash reserve position.
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Re: bonds ETF or bond fund

Post by Thegipper » 11 Sep 2017 19:09

If you are going in this direction I would suggest a short term corporate bond ETF. The one with the lowest mer. I think history shows that short term bonds don't get hurt as bad in a rising interest rate market. I invest in laddered corporate bonds in the US. I like laddered fixed income going may-be 8 years out. Personally I ladder most of my Canadian fixed income with corporate bonds. It has served me well over the last 15 years. It would be hard to get me to invest in any mutual fund especially a bond fund. It's hard to make any gains when the fund grabs a fair share of any return.

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Re: bonds ETF or bond fund

Post by AltaRed » 11 Sep 2017 19:14

Thegipper wrote:
11 Sep 2017 19:09
It's hard to make any gains when the fund grabs a fair share of any return.
Agreed a ST corporate bond fund with 'lowest' MER may be the best bet, although they are not all created equal. Stick with investment grade bonds of BBB or better, i.e. not a high yield bond ETF.
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Re: bonds ETF or bond fund

Post by Thegipper » 11 Sep 2017 20:49

AltaRed wrote:
11 Sep 2017 19:14
Thegipper wrote:
11 Sep 2017 19:09
It's hard to make any gains when the fund grabs a fair share of any return.
Agreed a ST corporate bond fund with 'lowest' MER may be the best bet, although they are not all created equal. Stick with investment grade bonds of BBB or better, i.e. not a high yield bond ETF.
In total agreement.

longinvest
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Re: bonds ETF or bond fund

Post by longinvest » 11 Sep 2017 21:02

VAB's duration is 7.5 years. As I intend to keep my portfolio for more than 7.5 years (I guess my horizon should be much longer than that, as it spans until my hopefully far-away death), I invest into it and ignore its mild fluctuations. As far as I know, bonds will continue doing their job of dampening the volatility of stocks in a portfolio.

GICs and short-term bonds will fluctuate less. GICs don't fluctuate at all, like we expect from cash investments. Short-term bonds fluctuate a little; VSB's duration is 2.8 years, so it would be a good place to put money needed within 3 to 5 years from now. It's impossible to predict whether a GIC ladder or short-term bonds will outperform over a future time frame. The GIC ladder is less liquid, but doesn't fluctuate; short-term bonds fluctuate a little bit, but are easy to liquidate.

A lot of people have bet against VAB/XBB using short-term bonds and GICs for years, and lost most of the time. Here's a post I recently wrote about total-market bonds and short-term bonds:
longinvest wrote:
21 Aug 2017 15:51
VAB includes bonds of all maturities: short, intermediate, and long.
VSB only includes short bonds.

Some people don't like the volatility of VAB, so they prefer VSB. But, personally, I think that it doesn't make much difference in a portfolio with a significant allocation to stocks. Here's a historical growth chart of three ETFs:
  • Blue: XSB which is similar to VSB
  • Red: XBB which is similar to VAB
  • Orange: XIC which is similar to VCN
xsb-xbb-xic.png
(Source: Portfolio Visualizer)

Look carefully to see how XBB (red) went down a little in 2008-2009, while XSB (blue) remained steady. That's the difference between a total-market bond ETF and a short-term bond ETF. Meanwhile, stocks (orange) had a real ride. :wink:
As for your initial question: I would go with an ETF, instead of a bond fund, because of the much lower MER of the ETF.
Last edited by longinvest on 11 Sep 2017 21:18, edited 1 time in total.
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AltaRed
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Re: bonds ETF or bond fund

Post by AltaRed » 11 Sep 2017 21:14

You do good work Longinvest, but you are looking into the rear view mirror in what has been the biggest bond bull in years. Interest rates have cratered over the 15 year period you have charted. That simply can't be repeated any time soon given we are starting near zero .

I dare say bond performance in the next 15 year chart will make a grown man cry. We need to put some context into this. We are in a deep valley at the current time and just starting the climb out after a wild and wonderful toboggan ride down the opposite slope. The heavy lifting is ahead of us.
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longinvest
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Re: bonds ETF or bond fund

Post by longinvest » 11 Sep 2017 21:33

AltaRed,
AltaRed wrote:
11 Sep 2017 21:14
Interest rates have cratered over the 15 year period you have charted.
XBB's returns would have been higher had interest rates not cratered. Somehow, GIC ladder investors intuitively understand this.

The financial porn press has succeeded at completely confusing people about bonds. They've convinced them that low interest rates mean high returns, and high interest rates mean low returns! The reverse tendency is simply an immediate impact of interest rate changes on price, not a long-term impact.

As I wrote, what's important is the duration. If one has a longer horizon than the duration, one wishes for interest rates to go up, like a GIC ladder investor would.

Betting on future interest rates is a form of market timing. I don't know about others, but I know that I'm very bad at it, so I've decided to embrace index ETFs and accept market returns, whatever they happen to be.
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AltaRed
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Re: bonds ETF or bond fund

Post by AltaRed » 11 Sep 2017 22:08

I fully understand but the bond bull has allowed longer maturity bonds in VAB to 'front run' (support) ETF returns as yields slid. But as those longer maturities matured and were replaced by lower yielding long bonds, ETF return performance began to slide. It is starting to show in the last few years of your XBB and XSB curves as the trend rolls over.

It is an important point when discussing bond ETF returns. We are now in the valley where bonds in the ETF that have not yet matured will suffer negative returns as interest rates rise. It is simple math. The next 15 year chart (from today) will NOT stand up quiite as well even as/if we continue a multi-year climb back to historical rates. The lag will be the drag.

Thus why I always find it necessary to 'warn' that bond ETF peformance will drag on the way back up. Near term performance of bond ETFs will not be a pretty sight relative to the 15 year comparison you just posted. You understand it and know you are in it for the long term and won't waver. However, we now see many posters who are beginning to fret over negative one year performance. I submit that negative experience will be around for a bit longer if yields continue to climb....until the sheer leverage of higher interest rates a year or two from now (hopefully) actually pulls the ETF out of negative territory.

P.S. I work a 6 year bond/debenture/GIC ladder that technically has a duration circa 3 years though I don't necessarily try to have equal value rungs for each year. I simply pick the best of the lot when a maturity comes up. I dare say I may not have yet reached the 'low' in my aggregated yield because of that duration, but at least I am now renewing maturities at slightly higher rates than the few pieces of circa 2.1% yielding crap I 'had to buy' in the past year and currently have in the ladder. Another 1-2 years and momentum should return.
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longinvest
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Re: bonds ETF or bond fund

Post by longinvest » 11 Sep 2017 23:46

AltaRed,

I see what you mean; I'll stop using that chart. What I wanted to show (in the quoted post) wasn't the comparative performance; it was the comparative fluctuations.

I really think that people who hold a big allocation to stocks worry way too much about a possible temporary mild negative return of total-market bonds. Total-market bonds simply can't lose anything close, over one year, to what stocks can lose over a few days or weeks.
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Re: bonds ETF or bond fund

Post by AltaRed » 12 Sep 2017 00:28

longinvest wrote:
11 Sep 2017 23:46
I see what you mean; I'll stop using that chart. What I wanted to show (in the quoted post) wasn't the comparative performance; it was the comparative fluctuations.
The chart does work for your purpose but can be misunderstood too. Too bad you don't have an easy source that would just show 3 lines without them all having the same starting point to make that message more clear.
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longinvest
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Re: bonds ETF or bond fund

Post by longinvest » 12 Sep 2017 09:01

To get back to my main message, I think that an investment into the total bond market is fine for someone who understands that bonds have a fluctuating market value and who can tolerate the mild volatility of a bond ETF with a duration of 7.5 years.

I wouldn't choose between the total bond market and short-term bonds/GICs based on interest rate predictions; I would make the choice based on my general preference for the chosen asset class and stick with my choice for the long term, regardless of interest rate movements.

There are people who really dislike bonds. It's better for such people to use a GIC ladder and be comfortable with their portfolio, than use bonds and dump them exactly at the worst time, when they're cheaper.
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Re: bonds ETF or bond fund

Post by longinvest » 12 Sep 2017 09:30

One last comment. I would avoid using stocks language such as bear and bull to describe bonds.

I ask those willing to continue using these terms to identify these so-called bear and bull markets on the following chart.

The chart displays the (nominal) marked-to-market growth of a U.S. Treasury bond fund (1871 to 2017) working similarly to a 10-rung bond ladder with all coupons reinvested, except that it only has 9 rungs where the shortest rung is sold when reaching one year before maturity. Such a fund has a similar average duration to the total U.S. bond market. It was reconstructed using historical interest rates. (See Historical Bond Returns).
nominal-bonds-1871-2017.png
I'm not discussing inflation-adjusted returns, here, because there now exist real-return bonds which are fully indexed (both the face value and coupons) to the CPI.

So, where are the bulls and the bears?
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Re: bonds ETF or bond fund

Post by longinvest » 12 Sep 2017 09:44

Based on the historical returns provided by Libra Investments (1970 to 2014) and the total returns of VAB (2015 and 2016), here's a similar nominal growth chart for Canadian bonds (1970-2017):
Canada-bonds-1970-2017.png
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