What are we looking for?
Bond funds for the do-it-yourself investor.
The screen
Though bonds as of late have provided less than stellar returns to investors, they are nevertheless a vital part of any complete portfolio. Generally speaking, bonds continue to provide protection in down markets and are a core part of an income-producing strategy.
For the DIY investor, buying individual bonds can be a tough gambit largely because of the limited inventory available through discount brokerages. That said, many reputable fund companies do offer DIY versions of long-standing fixed-income mutual funds through discount brokerages, without the drag of trailing commissions baked into the management expense ratio.
To provide some ideas along this vein for those who can do without advice from an adviser, I used Morningstar Direct to screen for Canadian-domiciled bond fund providers that have a star rating of four or better. Recall that the star rating is a look back at a fund’s risk-adjusted return against category peers on an after-fee basis. Though the star rating is indeed historical in nature, we’ve found that it does have some staying power. Funds that receive the highest rating of five stars tend to outperform those that receive four stars, which outperform three star funds, etc., in subsequent periods after receiving the rating.
In other words, as a group, funds that have a track record of doing well seem to continue to do well, whereas funds that have performed poorly continue to perform poorly. Given that bonds are highly sensitive to interest rates, which will inevitably rise (causing bond prices to fall), I also put emphasis on the effective duration of each fund. Effective duration is essentially a measure of the portfolio’s sensitivity to interest rates (those with greater duration have a higher sensitivity to a change in interest rates).
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
What we found
The funds that met the requirements are listed in the accompanying table alongside their ratings, MERs, trailing returns and effective duration. Investors are urged to first consider the category to which the fund belongs given that the star rating is given relative to peers. The category name will provide a reasonable idea of the types of holdings within the portfolio in terms of type of bonds held and the geographic exposure. The table is sorted first on category, then on effective duration within that category group.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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