Short-term bond ETFs offer a return for cautious investors

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While acknowledging that bond ETFs do not have the primary guarantees of GICs or other cash deposits, Mathews said short-term bonds can help diversify a fixed-income portfolio while limiting the risk of loss. duration.

By definition, funds in the Canadian short-term fixed income category invest primarily in high-quality securities with an average maturity of less than 3.5 years.

Bond prices move in the opposite direction of interest rates. If interest rates skyrocketed by a percentage point, for example, that would imply an 8% capital loss for a broad-market Canadian bond ETF with an average maturity of eight years. The more dated the bond portfolio, the greater the losses.

Conversely, shorter-term bonds are less risky. “Where returns can be found in the short end of the curve today,” said Mathews, “can outweigh much of the risk an investor can take in terms of the rising rate environment. . “

For advisors, a short-term Canadian bond ETF can be a liquidity tool or a tactical one, said Jonathan Needham, vice president, ETF Distribution, at TD Asset Management Inc.

They are potentially an immediate source of liquidity or they can be used to express the point of view of advisers who wish to decide where their clients should be along the yield curve. If outsourcing this asset mix decision, Needham added, a more appropriate choice would be a broader strategy like that of the TD Income Builder ETF.

The category of short-term fixed income ETFs, with assets totaling approximately $ 17 billion, is dominated by index strategies. Led by the $ 3.3 billion iShares Core Canadian Short Term Bond Index ETF, the five largest funds, each with over $ 1 billion in assets, have management expense ratios (MERs) of up to 11 basis points. This is a significant advantage in this low yield category.

Another characteristic of historically best performing ETFs is the emphasis on corporate bonds. BMO Short-Term Corporate Bond Index ETF, Desjardins 1-5 Year Laddered Canadian Corporate Bond Index ETF, Invesco 1-5 Year Laddered Corporate Bond Index ETF, iShares Core Canadian Short Term Corporate Bonds ETF and Vanguard Canadian Short-Term Corporate Bond Index Index ETFs all have five-star Morningstar Ratings for risk-adjusted returns.

The iShares Enterprise ETF illustrates the return advantage, with a 12-month return of 2.88% higher by more than half a percentage point than its more widely positioned iShares counterpart, the iShares Core Canadian Short Term Bond Index ETF.

Active managers, although at a higher cost, may attempt to add value through company selection as well as duration management. “There are different factors as to why an investor might choose low cost index exposure versus active higher cost exposure,” said Mathews.

The actively managed Mackenzie Canadian Short-Term Fixed Income ETF recently posted a 12-month return of 2.2%, similar to its passive counterpart, while holding more corporate issues and taking significantly less duration risk. “This is the kind of behavior that differentiates an eight basis point product from a 35 basis point product,” said Mathews, referring to the management fees of the two Mackenzie ETFs.

At TDAM, the only product in the category is the TD Select Short-Term Corporate Bond Actively Managed ETF, with an MER of 0.28%. At the end of October, the three-year history required to qualify for a Morningstar Rating was just short of the past three years. The ETF outperformed its passive benchmark, overcoming the hurdle of its higher fees.

Elsewhere in the category are a few ETFs – the BMO Ultra Short Term Bond ETF and the Horizons Active Ultra Short Term Investment Grade Bond ETF – that have short terms, even within their term. peer group.

The BMO ETF, for example, has a term of only about six months. Less risk has also meant lower returns. For the three years ended September 30, the ETF has an annualized return well below the average of 1.7%.

Several ETFs that specialize in floating rate securities take the least duration risk in the Canadian short-term securities category: CIBC Active Floating Rate Bond ETF, Investment Grade Active Floating Rate ETF , Invesco 1-3 Year Laddered Floating Rate Note Index ETF and iShares Floating Rate Index ETF.

The generally high credit quality of these ETFs sets them apart from funds in the variable rate loan category, which offer a higher yield but have significantly lower holdings than investment grade.

The yields of short-term bond ETFs that hold floating rate securities are lower than those of others in the category, as is their duration risk. In fact, since interest payments on floating rate securities rise when market rates rise, these ETFs can perform well in a rising rate environment.

With a weighted average duration of only 0.15 years, the sensitivity of the Invesco ETF (TSE: PFL) to rising rates is “fairly minimal,” said Pat Chiefalo, Canadian head of ETFs and indexed strategies at Invesco Ltd, based in Atlanta. PFL is well positioned to potentially offer higher yields than savings accounts, while benefiting from the prospect of a rising rate environment due to its low duration profile. “


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