Archive | September, 2010

Choosing a Canadian Bond Index Fund

In my last post, I argued that virtually all long-term investors should have a significant allocation to bonds in their portfolio. That raises an obvious practical question: if you’re a Couch Potato investor, which bond index fund should you use?

Let’s begin by looking at the most widely followed fixed-income benchmark in Canada: the DEX Universe Bond Index. It consists of about 70% government issues (45% federal, 24% provincial and 1% municipal) and 30% corporate bonds. About half of the bonds in the index have maturities of five years or less, about a quarter mature within five to ten years, and another quarter extend past ten years. In short, this index has it all (with the notable exception of real-return bonds). If you’re looking for a single fund that covers the Canadian investment-grade bond market, look for one that tracks the DEX Universe.

Your bond fund choices

While there is a wide variety of fixed-income ETFs in Canada, only one follows this key benchmark, and that’s the aptly named iShares DEX Universe Bond Index Fund (XBB). Launched in 2000 (which makes it ancient by ETF standards), XBB has more than $1.6 billion in assets and an MER of just 0.33%.

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Why Every Portfolio Needs Bonds

Back on March 25, I wrote a post called The Bond Dilemma that described how nervous fixed-income investors were in early 2010. The Bank of Canada had strongly suggested that it would raise interest rates later in the year, and I was receiving a number of emails from people who said it was foolhardy to invest in bonds, which seemed almost guaranteed to lose money.

The year isn’t over yet, but once again the conventional market predictions seem to be wrong. We did get two small interest rate hikes this year, and yet bonds have been one of the best-performing asset classes so far in 2010. While stocks in developed markets are treading water, bond index funds are up over 5%. They’re the only reason balanced investors have had positive year-to-date returns, despite all the forecasts about how bonds were certain to get killed.

Bonds have a reputation for being boring, even a bit stodgy. Yet the performance of Canadian fixed income has been excellent for three decades. In the 1980s, steadily falling interest rates created a huge bull market for bonds. During the 1990s, when US stocks were shooting the lights out and getting all the attention,

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