Bonds are an integral part of every Canadian’s portfolio; and are particularly attractive to those investors at or near retirement as investors look to replace their regular and stable salary with a certain stream of interest income.
But with interest rates hovering at all-time lows, the pressure to make every cent count has never been greater. Creating such exposure smartly can make all the difference in the returns.
Unlike equities which trade on an open stock market exchange with fully transparent bid and ask prices, bonds in Canada have to be purchased through a 'dealer network' which effectively removes all the efficiency and transparency of a fully functional liquid market. Unfortunately purchasing bonds in Canada is not as easy or as cost effective as purchasing stocks.
This is where it gets unpleasant for the retail investor. Compared to gigantic financial institutions who invest billions of dollars with pooled assets, it is extremely challenging for the retail investor to purchase a bond with similar efficacy as these large behemoth financial institutions. The only thing that might be worse than purchasing bonds through Canada’s dealer network is purchasing a bond mutual fund. The average expense ratio on a Canadian bond mutual fund is a whopping 1.75%. In today’s low interest rate environment, it’s just sheer insanity to own any bond mutual fund.
So how can the retail investor get the fixed income exposure with a handsome seniority and a tight bid ask spread? The average investor should consider various Exchange Traded Funds (ETF) to create fixed income exposure within their portfolios. ETF’s are managed by big financial institutions, and trade on any number of stock exchanges just like your favorite stock. The benefits to the average investor are numerous. A bond ETF, is basically a bunch of different bonds bundled up in a portfolio and traded in the stock market. Unlike the individual bonds themselves, there is substantially more liquidity in bond ETFs. Investors can easily exit their position at any time without the cost of large transaction fees. This advantage alone is all retail investors need to convince themselves that bond ETFs are the most efficient way to gain exposure to the fixed income market.
Additionally, many bond ETFs have huge amounts of assets under management and superior purchasing power. For example, one of the best known ETF providers is iShares. Total bond assets under management for iShares is in excess of two trillion dollars. That order of magnitude gives iShares huge leverage in negotiating with the best bond issuers.
Other key ETF bond providers within Canada include Vanguard, Powershares and Horizons Exchange Traded Funds. All of these are reputable companies that offer compelling value propositions. Vanguard in particular charges a measly 10 basis points on several of its Canadian bond portfolios. There is a reason why you want to construct a portfolio with both bonds and equities. Bonds carry the “promise”of fixed income with regular stable cash flows. Your goal as the investor is to maximize these cash flows in two ways.
One is to get the most for your money on your purchase by leveraging better buyers. Second is to minimize the fees you pay by going with the most efficient and competitive bond ETFs out there.