Ask the Spud: RBC’s Target Maturity ETFs

Q: I just read about the launch of RBC’s family of target-maturity corporate bond ETFs. They seem like they would be an attractive option for the fixed-income portion of my RRSP. How do these products compare with more conventional bond ETFs? How do I compare their yields? And can I use them in a laddered fashion? — Karl T.

RBC became Canada’s sixth ETF provider when it launched a family of eight corporate bond funds last week. Unlike traditional fixed-income ETFs, which continually buy new bonds to replace those that mature, these new products have a “target maturity.” That means all the bonds in the fund will come due in the same year, and once they’re redeemed, the fund will be liquidated and all the money returned to investors.

ETFs like these are not exactly new in Canada: BMO launched four similar funds in January, with target dates of 2013, 2015, 2020 and 2025. However, RBC’s offerings fill in the gaps, covering every year from 2013 through 2020. Each ETF will mature on or about November 30 of the target year.

Extreme couponing

Whenever you buy an individual bond or a bond ETF, you’ll be quoted both its coupon and its yield to maturity (YTM). It’s crucial that you understand the difference between these two figures, or you’ll fall victim to the yield illusion that plagues so many investors.

The coupon tells you how much you’ll receive in interest payments each year, but that’s not the whole story. The YTM is a much more important number. When the coupon is higher than the YTM, it means the bonds were purchased at a premium, and they will suffer small capital losses when they mature. These losses will cause the fund’s price to fall, offsetting some of the interest payments and lowering your total return.

That’s where the YTM comes in: it factors in both the coupon payments and the expected capital loss and tells you what your total return will be if you hold the bond (or the ETF) until its maturity date. Have a look at the dramatic differences between the coupon and the yield to maturity in the new RBC funds:

Fund (Ticker) Coupon YTM Duration
RBC Target 2013 (RQA) 4.84% 1.85% 1.73
RBC Target 2014 (RQB) 4.78% 2.32% 2.70
RBC Target 2015 (RQC) 4.16% 2.60% 3.55
RBC Target 2016 (RQD) 4.56% 2.83% 4.22
RBC Target 2017 (RQE) 4.64% 3.01% 5.13
RBC Target 2018 (RQF) 6.39% 3.21% 5.67
RBC Target 2019 (RQG) 5.40% 3.43% 6.59
RBC Target 2020 (RQH) 5.12% 3.54% 7.27

.

The RBC Target 2018 fund’s distributions will be a whopping 6.39% a year, but these will be offset by capital losses, so your total annual return will be less than half that: just 3.21%. Don’t be misled by those tempting coupons. You’re not going to earn 5% or 6% annually with any of these ETFs.

Target maturity v. traditional

How do these yields stack up against those of traditional bond funds? Actually, there’s no meaningful difference in risk or return if you make a fair comparison. To do that, you need to look at corporate bond funds with a similar duration, which is a measure of sensitivity to interest rate risk. (The longer the duration, the more the fund’s price will drop if interest rates rise.) I’ve included the duration of the RBC funds in the table above.

Now let’s compare these with other corporate bond ETFs. You can visit the website for Claymore’s 1–5 Year Laddered Corporate Bond ETF (CBO) and learn that it has a duration of 3.07, which makes it comparable to the RBC Target 2014 ETF. You’ll also see that the yield to maturity of CBO is almost identical at 2.29%. Meanwhile, the iShares DEX All Corporate Bond Index Fund (XCB) has a duration of 5.78, which is very close to that of the RBC Target 2018 ETF. Again, the yield to maturity of XCB is virtually the same as the comparable RBC fund: in this case, 3.25% versus 3.21%.

The only difference here is that CBO and XCB will always have approximately the same duration. The durations of the RBC funds, however, will get shorter every year as the fund approaches the target maturity date.

How to put these ETFs to work

So how might a target maturity bond ETF fit into your portfolio? You might use them to fund a future obligation on a specific date: if you know that you will need your money in 2015 for a down payment, you could buy the RBC Target 2015 ETF instead of putting it in a savings account or buying a four-year bond or GIC. You’ll receive interest payments for the next four years, and then have your money returned to you at the end of that period.

Target maturity ETFs do have some advantages over individual bonds. The first is diversification: each RBC fund holds 20 to 50 issues. Another advantage is that you can invest small amounts, which is difficult to do with individual corporate bonds. You can also add new money to your investment whenever you want—although you’ll incur a trading commission each time.

The RBC funds carry a management fee of 0.30%, which you would not pay if you bought individual bonds. However, the retail spread on individual bonds can be very high (and hidden), especially if you’re buying from a discount brokerage. In many cases, the ETF will be a better deal in the end.

RBC’s new ETF website suggests that you can also use these products to build a bond ladder. Presumably they will launch a new ETF every year beginning in 2013, to replace the one that gets liquidated, allowing investors to maintain an eight-year bond ladder indefinitely.

However, for long-term investors who do not have a specific time horizon, a traditional bond ETF is almost surely a better choice. First, the fixed income side of a portfolio should include government bonds as well as corporates. And second, if you do hold corporate bonds, a single fund such as CBO or XCB will be more manageable and less expensive in the long run than building a ladder with these ETFs.

Got a question about index investing? Send it to mail@canadiancouchpotato.com and it may be answered in a future installment of “Ask the Spud.” Answers are provided as information only and do not constitute investment advice.

15 Responses to Ask the Spud: RBC’s Target Maturity ETFs

  1. Canadian Couch Potato September 23, 2011 at 8:28 pm #

    Here’s an update from RBC: “We do intend to launch a 2021, 2022 , etc., so there will be 10 funds trading at a point in time.”

  2. The Dividend Ninja September 25, 2011 at 6:58 pm #

    Dan, excellent post! It would be nice if one of these companies would launch some Target Matuirty ETFs with primarliy government and provincial bonds. They all seem to be corporate bond focussed… why?

    Cheers
    The Dividend Ninja

  3. Canadian Couch Potato September 25, 2011 at 8:49 pm #

    @Ninja: Good question. My guess is that government bonds are more liquid and easier to acquire individually, so there’s less of a need for a target maturity product like this. Investors who want to reach for a little more yield may look to corporates, but find the over-the-counter market a little harder to navigate.

  4. Be'en September 26, 2011 at 4:17 am #

    Aren’t you better off buying a 5-year GIC paying 3.5% interest than the ETF RQH yielding 3.54%?

  5. Canadian Couch Potato September 26, 2011 at 1:58 pm #

    @Be’en: You’re right, the YTMs are comparable, and if you hold for the full five years your returns are likely to be very similar. A couple of differences: GICs are not liquid, and if you need to sell before the five years are up, you will lose something. The ETF you can sell any time. Also, you can’t add money to a GIC, whereas you can add new money to the ETF position.

  6. Be'en September 26, 2011 at 7:26 pm #

    Thanks Dan..

  7. The Wealthy Canadian October 1, 2011 at 2:28 pm #

    Nice review Dan!

    Great job clarifying the often-overlooked YTM in comparison to yield.

    As Ninja pointed out, it’s too bad RBC never released a few government bond funds; it’s a bit of a bummer that they didn’t.

    A point of clarification: finding a 5-year GIC at 3.5% right now is literally impossible; at least from where I’ve been searching. I have a sizable percentage of my net worth allocated to guaranteed investment vehicles, and the best I can find as of now is below the 3% range (2.75% in fact). If anybody can find one at that rate, I would seriously like to know about it! :)

    In taking this into consideration, it may be advantageous to park some funds into a corporate bond despite the additional risk in comparison to other fixed income instruments.

    Take RBC Target 2018. After checking the holdings having an A+ rating (which look reasonably good) , and subtracting the management fee of 0.30%, we end up with a true yield of 2.93%. [The site lists MER as n/a and I couldn't verify the TER].

    Do these calculations sound accurate CCP?

    Nice post.
    TWC

  8. Canadian Couch Potato October 1, 2011 at 3:01 pm #

    @Wealthy: Thanks for the comment. The best GIC rates in the country are always available from the Manitoba credit unions. They are not CDIC insured, but they’re provincially insured. Personally I would consider that safer than corporate bonds. Some are offering up to 3.5% on five-year terms:
    http://www.outlookfinancial.com/products/gic
    http://www.achieva.mb.ca/ProductsRates/GICs.aspx
    http://www.assiniboine.mb.ca/Home/Today-s-Rates/GIC.aspx

    Yes, you do need to subtract the MER from the yield to predict your future returns. The TER is always backward-looking, so you won’t know that until the fund has been up and running, but I don’t think there should be significant turnover in these funds. It wouldn’t make much sense.

    All the best.

  9. The Wealthy Canadian October 2, 2011 at 10:02 am #

    Hi CCP,

    Thanks for the information! I was referring mainly to CDIC insured; I do have some guaranteed investment terms that are insured by Assuris, and I have heard of the Manitoba credit unions.

    I suppose I had a brief moment of excitement because it would certainly be nice to see CDIC GIC’s at that rate.

    With regards to the Manitoba credit unions, 3.5% is certainly something to consider when the need arises to park funds into safety. I totally agree in that this would be much safer than say, any of the corporate bonds.

    Thanks for the prompt reply. I’ve been writing a series about Index Investing on my blog, and the resources you offer investors through your site and articles in print are invaluable resources indeed. Keep up the great work!

    Cheers,
    TWC

  10. Pickering October 6, 2011 at 8:50 am #

    Just found this page – what a treat.
    Been reading Hank Cunningham for the past two years and can not seem to find the bonds to establish a ladder that makes sense to me.
    When I look at the literature for the targeted 2015 issue – see that the Current NAV is $ 19.92 and that the NAV at Maturity is $ 18.62
    Am I right in concluding that I will receive $ 18.62 per share on maturity or will they make this calculation in advance and have the distributions reflect this capital loss and payout at the issue price of $ 20
    Can not seem to find any info on distributions other than they will be Quarterly
    Got this page now displayed prominently on my Favourites Bar

  11. Canadian Couch Potato October 6, 2011 at 9:06 am #

    @Pickering: Glad you found this helpful. These are products are so new that I’m hesitant to say anything about exactly how they will pay out at maturity. I’d suggest contacting RBC directly to ask them. If you can’t get a straight answer, just email me and I will ask my contacts there.

    In the meantime, have a look at this page on the RBC site, and click on the “What Happens at Maturity” tab. It says, “unlike an investment in an individual bond where investors typically receive the bond’s par (or face) value at maturity, the RBC Target Maturity Corporate Bond ETFs will distribute the fund’s net asset value (NAV) at maturity. The funds do not seek to return any predetermined amount at maturity, and the amount an investor receives may be worth more or less than their original investment.”

    Cheers!

  12. F. Johnson July 9, 2012 at 11:49 am #

    Dear CCP,

    I have been agonizing over my fixed income portfolio, and one of the main questions I’ve asked myself is whether it would be better to go into GICs rather than take interest-rate risk in a bond fund or bond ETF. One question that factors heavily in this internal debate is how safe the Manitoba credit unions are. On that point, I think it’s important to note that Manitoba credit unions are not insured by the province of Manitoba. They are insured by the Deposit Guarantee Corporation of Manitoba: “There is no legislated requirement for the Manitoba government to provide financial support to the Deposit Guarantee Corporation of Manitoba.” http://depositguarantee.mb.ca/faq/

    The DBCM collects a quarterly assessment from Manitoba credit unions that is used to maintain a fund to be used to insure deposits with these institutions. I haven’t been able to find any information on what percentage of total assets that fund represents.

    My question to you is whether, in light of the above, do you still feel that Manitoba credit unions are safer than corporate bonds?

  13. Canadian Couch Potato July 9, 2012 at 2:14 pm #

    @F. Johnson: All I can offer is an opinion–I can’t claim any expertise here. But I think it would be extremely surprising if a Manitoba credit union went bankrupt and its GIC holders were left in the lurch by the DBCM. Consider the panic and contagion that would cause. My guess (and it’s only a guess) is that the province or even the federal government would step in if they had to.

    Are they safer than corporate bonds? I would have to say yes to that. The government is not going to step in to pay bondholders if a corporation defaults.

    Perhaps the best solution is to diversify your fixed income holdings across various GIC providers and investment-grade corporate bonds.

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