Under the Hood: Claymore Corporate Bond

This post is the first in a planned series called Under the Hood, where I’ll take a detailed look at a specific ETF or index fund.

The fund: Claymore 1–5 Year Laddered Corporate Bond ETF (CBO)

The index: CBO tracks the DEX 1-5 Year Corporate Bond Index, which appears to have been custom-made for this fund. The index lays out a set of rules for building a laddered portfolio of short-term, investment-grade corporate bonds. It includes 25 bonds divided into five equal “buckets”: five of the bonds have a term to maturity of 1–2 years, five others have terms of 2–3 years, and so on up to 5–6 years.

The cost: The MER is 0.28% as of June 2009, including a management fee of 0.25%.

The details: Claymore launched this ETF just over a year ago and it has been very popular, with an average daily trading volume of about 115,000 shares. It’s a well-designed index: the laddering technique is an excellent way to achieve a balance between good yield and a minimum of interest-rate risk. (In most cases, bonds with longer terms have higher yields, but their market value will fall more sharply when interest rates go up.)

CBO currently pays a quarterly distribution of $0.24, which works out to a yield of about 4.6%. However, the average yield to maturity is about half that. Without getting too deeply into bond math, what this means is that all of the bonds were bought at a premium (a price higher than their face value). Eventually the fund will probably suffer a series of small capital losses as these bonds are sold, so the total annual return on the ETF may be lower than that 4.6% yield suggests. That’s not a knock against CBO specifically: with interest rates at rock bottom and likely to rise this year, just about every bond fund is in this boat.

I was confused when I looked at the individual bonds in this fund. Because this is a short-term fund, I was expecting to find only bonds with maturities between 2010 and 2015. In fact, one matures in 2020, and two are dated 2049. I contacted Claymore to ask why, and they explained that these bonds are callable within five years, which means that the issuer can redeem them before the maturity date. In the past, these bonds have always been called by the banks after five years, so for all intents and purposes, they behave like short-term bonds.

The alternatives: CBO’s closet competitor in the marketplace is BMO’s Short Corporate Bond (ZCS). BMO’s fund is more diversified (it holds 66 bonds rather than just 25), but it’s also more expensive (0.35% MER) and it doesn’t use the laddering strategy.

iShares Canadian Corporate Bond (XCB) and iShares Canadian Short-Term Bond (XSB) are similar, but with important differences. XCB holds mid- and long term corporate bonds as well those with less than five years to maturity; XSB is about 70% government bonds and only 30% corporates.

The bottom line: Claymore’s 1–5 Year Laddered Corporate Bond ETF is an excellent choice for the corporate bond portion of a Couch Potato portfolio. I feel that its low cost and laddered structure give it an edge over its competition. It’s also eligible for Claymore’s dividend reinvestment plan (DRIP), which is a nice feature in a bond fund that pays a substantial yield.

Disclosure: I own CBO in my own portfolio.

30 Responses to Under the Hood: Claymore Corporate Bond

  1. Maxwell V Hayward March 12, 2010 at 7:12 am #

    I really like the idea of “looking under the hood” of some ETFs. I would love to see you do an in depth analysis of some of the wrap ETFs by Claymore (CBN/CND) and iShares.

    Thanks, Maxwell

  2. Canadian Couch Potato March 12, 2010 at 8:48 am #

    Great idea, Maxwell. I’ll definitely consider these for a future post.

  3. Ben March 12, 2010 at 9:21 am #

    So is the corporate laddered bond better in a couch potato portfolio than other options like XSB, XRB or XBB? If a Canadian had a five ETF portfolio and was only going to have one bond fund what would you suggest? How would this differ from say an 11 ETF portfolio? Your model portfolio and others seem to either split between corporate/government or short/real-return. Thanks.

  4. Canadian Couch Potato March 12, 2010 at 9:30 am #

    Great questions, Ben. If you have a portfolio with only one bond ETF, then you’re probably better off with either XBB or XSB, because you don’t want to ignore government bonds. But if you have a larger portfolio, you may want to split your bond holdings into government, corporate and real-return. If you go that route, then CBO is a good choice for the corporate part.

  5. Jason March 12, 2010 at 10:41 am #

    Thanks for the article. I am looking forward to more of your postings in this new series!

  6. Hungry Gal March 15, 2010 at 10:57 am #

    Dan – I like the “under the hood feature.” Looking forward to future installments.

    “Eventually the fund will probably suffer a series of small capital losses as these bonds are sold, so the total annual return on the ETF may be lower than that 4.6% yield suggests. That’s not a knock against CBO specifically: with interest rates at rock bottom and likely to rise this year, just about every bond fund is in this boat”
    If we expect BofC to raise rates this year, should we hold off making investments into bond etfs until some capital losses are realized to minimize the “pain”?

  7. Canadian Couch Potato March 15, 2010 at 11:30 am #

    Well, that’s really a market-timing call. Everyone is expecting interest rates to rise, but no one knows exactly when, or by how much. If you’re planning to get into a bond fund for the long term, perhaps the best strategy is to start easing in a little at a time.

  8. AmeliaH March 26, 2010 at 3:21 pm #

    Use Claymores DRIP system to reinvest dividends for compounding returns automatically every quarter. CBO is 90% of my TFSA. The other 10% is trading of the double leveraged ETFs HXD and HXU using automated technical indicator rule triggers.

  9. MGan January 18, 2011 at 12:10 pm #

    Hi Dan,

    Thanks for the site.

    One of my issues with these ETFs is your own point about the distribution being higher than the YTM. If I understand it correctly, my distribution will be fully taxed but then I will eventually stuck with some capital losses. By my rough numbers on ZCS since the YTM is about 200 basis point lower than the distribution, I’ll be seeing capital losses of about 200 basis points per year, and full tax on the 4.8% distribution).

    My problem , I already have substantial personal capital losses which I have not been able to offset, so the last thing I want is more capital losses and fully taxed interest income — (i.e I’m essentially being taxed on an implicit return of capital)

    Am I reading this correctly and is there any way around it or other ETFs with less inherent capital losses to come.

    Many thanks

  10. Canadian Couch Potato January 18, 2011 at 2:28 pm #

    @MGan: I don’t think there’s any way to get around the fact that bonds purchased at a premium will suffer capital losses unless interest rates fall between now and maturity (or sale). For what it’s worth, I have owned CBO for a couple of years now and the price dip has been only 0.7%, so it’s not dramatic.

  11. MGan January 18, 2011 at 5:38 pm #

    Hi Dan,

    I hear you – I’ve had medium-sized position in the likes of XCB for about 2 years and have had no capital loss (actually the opposite) but at the same time it’s probably the result of rates easing rather than rising in the last couple of years.

    Its frustrating fir me b/c I have a lot of capital in short term deposits. Won’t lock my money up in long-term GICs. Don’t mind some long-term risk (with liquidity like ETFs) but I hate the idea of feeling I’m losing on the taxation side all things being equal.

    thanks

  12. Dale November 29, 2011 at 6:06 pm #

    Hey Dan, thanks for insight on cbo. If corp bond yields do rise, cbo’s income should rise slowly with it? And at the same time the unit price should fall?

    Also, is cbo now buying bonds with lower yield than the bonds that are replacing?

  13. Dale November 29, 2011 at 6:09 pm #

    Sorry to bug. Is there a bond fund or other that will offset any of the small capital losses that cbo might experience. That is, is there something with income that might move inversely to cbo? thanks again…

  14. Canadian Couch Potato November 29, 2011 at 6:14 pm #

    @Dale: Thanks for the comments. Yes, if interest rates begin to creep up, all bond funds (not just CBO) will gradually see their yields rise slowly as maturing bonds are replaced with new issues that have higher coupons. These higher coupons will offset some of the capital losses the fund will incur from having bought bonds at a premium. The fund’s duration is the best estimate of how long it will take for these two trends (rising yields and falling prices) to offset one another. See this post for more info:
    http://canadiancouchpotato.com/2011/07/07/holding-your-bond-fund-for-the-duration/

  15. Dale December 1, 2011 at 6:43 am #

    Thanks . I was familiar with that formula, it’s very useful. What’s odd now though, is that the ishares long term bond etf’s are paying out less than cbo which is 1-5 years.

    Why is that?

    For higher income i will have to go with higher risk bond eft’s.

  16. Canadian Couch Potato December 1, 2011 at 8:07 am #

    @Dale: I think you may be looking at the funds’ average coupon rather than the yield to maturity. The coupon is mostly irrelevant. The YTM on short-term bonds is around 1.6%. On long-term bonds it’s around 3.6%.
    http://canadiancouchpotato.com/2010/11/22/bonds-gics-and-the-yield-illusion/

  17. Dale December 1, 2011 at 11:11 am #

    Thanks Dan. I was just going by payout ratio. So what you are saying is, that if rates do not rise, cbo will soon or eventually be paying out 1.6%?

    But the corp bonds that cbo holds have coupon rates of 4.5-6.5%? Don’t they hold then to maturity?

    Thanks again…

  18. Canadian Couch Potato December 1, 2011 at 11:19 am #

    @Dale: The bonds in CBO’s portfolio are sold, I believe, when they have one year left to maturity in order to adhere to the fund’s strategy. They were purchased at a premium, so even if they were held to maturity, the fund would still suffer a loss when they matured at face value. So the idea is that you might buy a $100 bond for $102.50, receive 4% interest on the face value ($4), and let the bond mature at $100. You gain $4 but lose $2.50, for a return of $1.50, or 1.5%.

  19. Dale December 1, 2011 at 11:56 am #

    Thanks. I will check with Claymore on that. They are usually good at answering questions. I am now confused as to how 6% bonds are worth 1.5% income. Yet the etf pays out 4.6%.
    I thought I was buying a grouping of corporate bonds that pay a rate of 4.5% – 6.5%.

    Signed, confused.

  20. Floyd December 22, 2011 at 2:28 pm #

    Monthly distribution dropped from .0785 to .0760. Any concerns?

  21. Karim March 8, 2012 at 8:45 am #

    Hi Dan,

    How do you know what the yield is on CBO. Looking at the website I see the followings:

    Index yield to maturity: 2.1%
    Index level total return: 131.6 (which I have no clude what it means)
    Index cash yield: 5.1%
    Indiccitaed distribution yield: 4.5%

    I don’t see the weighted avwrage term and coupon as we see on the Ishares ETF.
    Thanks
    Karim

  22. Canadian Couch Potato March 8, 2012 at 9:36 am #

    @Karim: One of my frustrations with Claymore is that they publish index characteristics rather than fund characteristics. In theory, these should be very similar, but in practice they may not be.

    The “indicated distribution yield” should be roughly equivalent to the “weighted average coupon.” Because this is a 1-5 year ladder, the average term to maturity will be right around 3 years (the midpoint between 1 and 5). The most important number is the duration, which is 2.7, almost identical to that of XSB.

  23. Tom Jewett April 21, 2012 at 12:06 pm #

    Maybe this question has been addressed and I missed it. But what effect will the repurchasing of matured bonds have on the index MV and YTM?

  24. Dale April 22, 2012 at 7:36 am #

    I hold a significant position in cbo. I’ll admit it’s my largest holding. And, my main goal is income and some equity growth, but mostly all designed for lower volatility. While a small equity position on its own seems to provide a contrarian counterbalance to bonds, I wonder if holding the LifeCos would be a nice hedge for cbo and rising interest rates. LifeCo’s should do better once interest rates increase, and the LifeCos are paying very nice divvy’s. There are only a few major players in Canada, so one could simply buy the four or five top players and avoid the etf route, and fees. To get exposure, is xfn the best offering, with the banks coming along for the ride?

    Any thoughts would be appreciated. Thanks…

  25. Dale April 22, 2012 at 7:50 am #

    I just sold my sailboat, and I think I will have the ‘courage’ to combine the proceeds with some other cash (outside of our one year emergency cash fund) – and then use cbo as the anchor along with zwb, zwu and xtr. It is a Frankenstein barbell creation for sure. The portfolio will have a yield of 5.5% compared to 1.6% in ING Direct ‘high interest’ savings.

    Yes this portfolio will make Dan do a spit take with his morning coffee. Sorry.

    I know the bonds, like interest, will not get preferential tax treatment . Wondering if you know how covered call products are treated in a taxable account?

  26. Canadian Couch Potato April 22, 2012 at 8:58 am #

    @Dale: I’m not here to judge your portfolio. 🙂 This thread on Financial Webring includes some links to resources about the taxation of covered calls:
    http://www.financialwebring.org/forum/viewtopic.php?f=32&t=112868

    Some more background on covered call ETFs:
    https://secure.globeadvisor.com/servlet/ArticleNews/story/gam/20120118/GIYIELDHOG0118ATL
    http://business.financialpost.com/2012/02/10/covered-call-etfs-good-for-income-not-return/

  27. Maybelline January 4, 2013 at 12:03 am #

    Hello there, now that it’s a new calendar year, I’m looking at contributing into my registered accounts and am looking at one bond ETF. I have the same question as Ben above, and although you answered it, can you pls explain why XSB would be a better choice than CBO, or why not to ignore government bonds? Is it for reasons of financial sector risk?

    Thanks

  28. Canadian Couch Potato January 4, 2013 at 8:53 am #

    @Maybelline: As with any investment decision, it simply comes down to understanding the risk/reward tradeoff. Corporate bonds have higher yields than government bonds, but correspondingly more risk. In the event of a market crash like we had in 2008-09, government bonds are likely to rise in value, while corporate bonds will suffer. So one fund is not better than the other: they just have different risk profiles.

  29. Maybelline January 5, 2013 at 5:21 am #

    Thank you for your quick responses and really informative posts. Any questions that I may have on previous posted topics have been pretty much been raised by other posters to which you have followed up w/valuable information. Thank you for such an amazing blog. 🙂

  30. Grape June 11, 2015 at 8:07 pm #

    If somebody bought a share for $20.40 in December 2011, and sold it today, they might have received $19.54 plus about $2.98 in monthly returns (sorry, I didn’t add them all up, just an approximation; the return in Dec 2011 was .076, today it’s .065) for a profit of $2.14, which is 10.5%, or 3% per year over the three and a half years. Is that about what everyone expected? Of course, the numbers all look worthwhile if you multiply by 1,000.

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