By Gordon Pape, Editor and Publisher
Ten days ago, The Dow Jones Industrial Average suffered its sixth-worst day in terms of point decline, dropping 767 points.
But that wasn’t the biggest financial story last week. Investors were even more concerned about the melt-up in bond prices as yields sagged to their lowest level in years.
By the end of trading on Thursday, yields on 10-year Canada bonds were down to 1.22% while 10-year U.S. Treasuries were yielding 1.72%.
A year ago at this time, Canada 10-year issues were yielding 2.10% while U.S. bonds were at 2.96%.
The dramatic decline in yields has been a surprise windfall for bond investors (prices rise as yields drop).
A year ago, the U.S., Federal Reserve Board was in the midst of raising its rates four times in an effort to get back to more normal conditions. No one suspected at that point that the Fed would do an about turn this year which would revive the bull market in bonds that most people thought was dead.
But a combination of slowing global growth, escalating trade wars, and strongarm pressure to cut rates from President Trump has changed the whole outlook.
And it’s not just the U.S. that’s turned dovish. New Zealand, India, and Thailand all announced rate cuts on Wednesday. The European Central Bank is expected to cut its rate in September and its deposit rate is already negative, at -0.4%. According to Deutsche Bank, about $15 trillion worth of sovereign bonds now have negative yields, meaning you have to pay governments or central banks to hold your money.
The Bank of England held the line at its August meeting, although it cut its growth forecast for next year and put the odds of a U.K. recession at one in three even if the country is able to negotiate a Brexit deal with Europe. A no-deal Brexit on Oct. 31 would almost certainly result in a massive rate cut.
I’ve been advising readers for a long time to ensure you have some bond holdings to cushion your portfolio against a potential stock market decline. Until recently, those investments were not generating great returns but now all that has changed. Bonds not only act as an insurance policy but they are also contributing to your bottom line.
For most people, the easiest way to add bonds to a portfolio is to buy ETFs that invest in them. Here are three I recommend.
iShares Core Canadian Universe Bond Index ETF (TSX: XBB). This fund is a proxy for the entire Canadian bond sector, government and corporate. It was first recommended in the IWB in March 2007 at $29.44 and closed on Friday at $32.40.
Virtually all the bonds in the portfolio are investment grade (BBB) or higher. About 70% is in federal and provincial bonds, 2% in municipals, and the rest in corporates. Over 23% of the holdings are in long-term bonds, which are the most sensitive to rate changes. When rates decline, the price of long-term issues soars.
The fund earned only 1.28% in 2018 but it has been hot this year with a gain of 8.32% to Aug. 8. Distributions are paid monthly and are currently $0.074 per unit ($0.888 annually). The MER is only 0.1%.
iShares Core U.S. Aggregate Bond ETF (NYSE: AGG). This is the U.S. equivalent of XBB. It tracks the performance of the entire U.S. investment-grade bond sector. It was first recommended in this newsletter in January 2015 at US$111.97. The closing price on Friday was US$112.64.
The credit quality of this fund is excellent, with almost 72% of the portfolio invested in AAA bonds. However, it has more exposure to short-term bonds (five years or less) than XBB and less to long-term issues (20+ years). That explains why the year-to-date gain is slightly less at 7.83%.
This fund actually lost a fraction in 2018 (-0.05%) but has more than made up for it this year. Distributions are paid monthly and are currently about US$0.26 per unit ($3.12 per year) for a yield of 2.8%. The MER is a miniscule 0.05%.
iShares Global Government Bond Index ETF (CAD-Hedged) (TSX: XGGB). This fund seeks to track the FTSE World Government Bond Index, hedged back to Canadian dollars. It’s a new fund, launched in September 2017 so we don’t have much performance history. It only gained 1.82% in 2018 but this year it’s ahead 7.37% year-to-date.
Just under 40% of the portfolio is invested in U.S. bonds. Other major countries represented are Japan (19.35%), France (8.27%), Italy (7.32%), Germany (5.29%), and Great Britain (5.08%). Just over half the portfolio is AAA rated and only a fraction is below BBB.
Distributions are paid monthly and are currently $0.029 per unit ($0.348 per year) to yield 1.6%. The MER is on the high side for a bond fund at 0.4%. The closing price on Aug. 9 was $21.34. We will add this ETF to the IWB Recommended List.
This article was originally published on August 12, 2019, in the Internet Wealth Builder newsletter.