Skip navigation

News from The Globe and Mail

These bond ETFs are providing a leaky defence for investors

So much for the go-to strategy for playing defence with your bonds in a rising-rate world.

Short-term bonds are supposed to be preferable to longerterm bonds when interest rates are rising.

The price of bonds maturing in one through five years can certainly fall as rates edge higher, but longer-term bonds should do worse.

Oddly, this hasn't happened amid the interest-rate increases since last summer.

If you look at bond exchangetraded fund returns to Jan. 31, you'll find that short-term funds have done worse than more diversified bond ETFs covering the entire bond market, including bonds maturing in five to 30 years.

Some quick examples: BMO Aggregate Bond Index ETF (ZAG) was up 1.6 per cent for the year to Jan. 31 on a total return basis, including interest plus share price changes.

BMO Short Federal Bond Index ETF (ZFS) was down 1.2 per cent.

BMO Short Provincial Bond Index ETF (ZPS) was down 0.6 per cent.

BMO Short Corporate Bond Index ETF (ZCS) was up 0.4 per cent.

Bond sensitivity to rising rates is measured through duration as measured in years - the higher the duration, the more risk there is if rates rise.

If rates rise by one percentage point, the price of an ETF with a duration of five would fall five percentage points (and vice versa, if rates fall).

ZAG has a duration of 7.4 years, which reflects a portfolio that is 46 per cent weighted to bonds maturing in one to five years, 22 per cent weighted to bonds maturing in five to 10 years and 32 per cent weighted to bonds maturing in 10 to 30 years.

ZFS and ZPS have durations of 2.6 and 2.9, respectively. While that suggests substantially less sensitivity to rising rates, both have underperformed ZAG significantly in the past year.

ETF industry people have theorized that this anomaly is the result of an usual twist in how the bond market has reacted to rate increases by the Bank of Canada.

Short-term bond yields have risen much more dramatically than longer-term yields.

The bond market seems unconvinced that we're moving into an economic cycle in which interest rates will consistently move higher. That's why longer-term rates, projecting what's off in the future, aren't moving much.

The net result is that shortterm bond ETFs are suffering, while funds with longer-term bonds are holding up well.

How long this inversion of normal bond-market behaviour lasts depends on whether the rising rate trend of the past six months gains momentum or fizzles.

The lesson for investors who want to play defence with bonds is that a short-term bond ETF isn't an ideal solution on its own.

It makes sense to think about partnering it with a more diversified bond ETF such as ZAG.

© The Globe and Mail

Search the News
Search using one or more of the following options:
    Symbol  Lookup
* Can only be used when searching The Globe and Mail and the newswires. Search Tips

Only GlobeinvestorGOLD combines the strength of powerful investing tools with the insight of The Globe and Mail.

Discover a wealth of investment information and and exclusive features.

Free E-Mail Newsletters

  • Morning news headlines
  • Morning business headlines
  • Financial highlights
  • Tech alert
  • Leisure

Sign-up for our free newsletters

Back to top