I understand that when interest rates go down, the value of fixed-income vehicles should go up. Well, interest rates have been going down, but the bond exchange-traded fund that I bought, the Harvest Premium Yield Treasury ETF (HPYT), has fallen in price. Can you explain?
All interest rates are not the same. There are short-term rates, long-term rates, deposit rates, consumer borrowing rates, corporate borrowing rates, fixed mortgage rates, variable rates and – avoid this one if possible – the rate loan sharks charge to lend you money.
Not all of these rates move in lock-step with each other. Sometimes, they go in opposite directions, which is what appears to be happening in your case.
The U.S. Federal Reserve and the Bank of Canada have been cutting their policy interest rates, which are the overnight rates at which commercial banks borrow and lend their excess reserves to each other. When central banks cut their target for this rate, other short-term rates – such as variable mortgage rates, deposit savings rates and short-term bond yields – typically follow.
But here’s the thing: The Harvest Premium Yield Treasury ETF does not invest in short-term bonds. Rather, it invests in ETFs that hold longer-dated U.S. government bonds. HPYT’s largest holding is the iShares 20+ Year Treasury Bond ETF (TLT), which accounted for 68.9 per cent of HPYT’s assets as of Sept. 30.
Even as short-term interest rates have dropped, the yields on longer-term bonds have gone up recently. They ticked up again this week, reflecting worries that president-elect Donald Trump’s economic policies could reignite inflation. As I am writing this on Friday, the 30-year U.S. Treasury is yielding about 4.46 per cent, up from about 3.94 per cent in mid-September. As long-term bond yields have risen, their prices have fallen, which has hurt the value of HPYT.
Other factors that could affect HPYT’s price include costs associated with currency hedging and the ETF’s use of covered-call options on as much as 100 per cent of the portfolio to generate additional income.
What are you planning to do with your shares of BCE Inc. (BCE) in light of this week’s news about the company?
On Monday, BCE announced that it is acquiring Ziply Fiber, a fibre internet provider in the U.S. Pacific Northwest, for about $5-billion in cash and the assumption of about $2-billion of debt. BCE said it plans to maintain its annualized dividend at the current level of $3.99 for the year ending Dec. 31, 2025, and “intends to pause dividend growth until BCE’s dividend payout and net debt leverage ratios are tracking towards our target policy ranges, subject to review annually by the BCE Board of Directors.”
Translation: Don’t expect BCE’s dividend to rise any time soon. The company’s disappointing third-quarter results, which reflected intense price competition in the wireless space, further underscored the challenges it is facing.
Given that the company no longer meets the principal criterion for inclusion in my model Yield Hog Dividend Growth Portfolio, I have “sold” the portfolio’s 115 BCE shares for proceeds of $4,478.10. In a future column, I’ll discuss how I am reinvesting the cash.
I’ve owned SPDR S&P 500 ETF Trust (SPY) for nearly 20 years, and it has done very well. Recently I have been buying the Vanguard S&P 500 ETF (VOO) because I was more familiar with Vanguard. I realize these two exchange-traded funds are basically the same and their performance is virtually identical. Recently, however, I received correspondence from Vanguard that VOO may become “non-diversified” and that “the fund’s performance may be hurt disproportionately by the poor performance of relatively few stocks, or even a single stock, and the fund’s shares may experience significant fluctuations in value.” I am not familiar with diversified and non-diversified ETFs. Do you have any comment on why Vanguard has done this?
Vanguard is simply acknowledging that the S&P 500 Index that VOO tracks has become highly concentrated in a handful of large companies and that the lack of diversification could affect the fund’s performance.
In the note Vanguard sent to VOO unitholders, the company specifically flagged the information technology sector as having a “significant portion of the fund’s assets.” According to the latest portfolio update from Vanguard, the technology sector accounted for 31.7 per cent of the fund’s assets, with Apple Inc. (AAPL), Microsoft Corp. (MSFT) and Nvidia Corp. (NVDA) each making up more than 5 per cent.
“Companies in the information technology sector could be affected by, among other things, overall economic conditions, short product cycles, rapid obsolescence of products, competition and government regulation. Sector risk is expected to be high for the fund,” Vanguard said.
Under the U.S. Investment Company Act of 1940, a fund qualifies as diversified if it has no more than 25 per cent of its total assets invested in companies that each account for more than 5 per cent of the fund. However, Vanguard said it recently amended VOO’s prospectus such that “the fund will continue to track its target index even if the fund becomes nondiversified as a result of an index rebalance or market movement.”
In other words, despite the heavy concentration of tech stocks, it’s business as usual for VOO.
The lack of diversification is not unique to VOO. Any ETF that tracks the S&P 500 has become less diversified after the massive run in tech stocks.
Bottom line: The tech sector has contributed to big gains for the index in recent years, but that momentum could go into reverse if technology stocks stumble. This isn’t necessarily a reason to sell or trim your VOO or SPY holdings, unless you feel that they have become such a big portion of your portfolio that cutting back will help control your risk.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.