The bond market has begun to mend the damage caused by rising interest rates.
Rising rates crush bonds – that’s why the benchmark FTSE Canada Universe Bond Index lost an average annual 1.2 per cent over the three years to Aug. 31 on a total return basis of bond price changes and interest payments.
Falling interest rates have the opposite effect – that’s why the index was up about 3.7 per cent for the year to late September and likely has more upside ahead. The easiest way to tap into the bond market rally: Buy an aggregate bond exchange-traded fund.
Aggregate bond ETFs mirror the benchmark FTSE Canada Universe Bond Index or competitors with a similar structure that combines short-, medium- and long-term bonds, plus government and corporate bonds. You own the entire bond market with these ETFs, which means you don’t have to sweat the details on what segments of the bond market are working better than others at the moment.
Just now, corporate bonds are doing a little better than government bonds. For the year through late September, the FTSE Canada All Government Bond Index was up 3.2 per cent and the FTSE Canada All Corporate Bond Index was up 5.5 per cent. The strength of corporate bonds could falter if investors feel the risk of recession is rising. Another trend of the moment that could change course is short-term bonds performing better than longer-term bonds.
The aggregate bond fund covers you on all fronts – you have exposure to bonds issued by the federal government and its agencies, provincial governments, big banks and other big companies. The cost of owning one of these ETFs is a bargain – management expense ratios tend to be in the 0.1 per cent range.
Two mega-size aggregate bond ETFs using the FTSE Canada Universe Bond Index are the $10-billion BMO Aggregate Bond Index ETF (ZAG-T) and the $8-billion iShares Core Canadian Universe Bond Index ETF (XBB-T). Competition between ETF issuers has resulted in the use of potentially unfamiliar bond indexes. For example, the Bloomberg Global Aggregate Canadian Float Adjusted Bond Index is used for the Vanguard Aggregate Bond Index (VAB-T), while the Solactive Broad Canadian Bond Universe TR Index is used for the TD Aggregate Bond Index ETF (TDB-T).
As you can see in the latest edition of the Globe and Mail ETF Buyer’s Guide, returns for all of these indexes tend to be similar. The same applies for their average yield to maturity minus fees, which is the best forward-looking indicator of yield. Right, now the net yield to maturity for aggregate bond ETFs is about 3.5 per cent.
You can beat that yield with guaranteed investment certificates, which offer the security of never falling in price like bonds. What you miss with GICs is the kind of price gains we’re seeing now with bonds.