Low bond yields are bad news for investing in 2020 and possibly 2021 as well.
You’ve probably heard many times from investment strategists about how low yields challenge whether it makes sense for balanced portfolios to have 40 percent or 50 percent of their weighting in bonds. With five-year Government of Canada bonds yielding just 0.35% at the end of October, it’s hard to argue.
Amidst this gloom on bonds, one reader noticed a disconnect in her wallet.
“I keep reading how miserable bond yields are, but my bond ETF is doing better than most of my portfolio,” she said by email. “I wonder why it doesn’t act like the bonds underlying the fund.”
While bond yields are indeed woefully low, 2020 has actually been a great year for the bond market. The benchmark FTSE Canada Universe Bond Index produced a total return of 8% for the year through September 30, which includes both interest and capital gains.
In fact, mainly capital gains. When interest rates plunge, as they did earlier this year, the price of bonds and bond funds moves in the opposite direction. This is why the FTSE Canada Universe Bond Index may experience a sharp rise above bond market norms this year, even with very thin bond yields.
A sample of broad-based bond ETF returns that are like the index by holding both government and corporate bonds:
- BMO Aggregate Bond Index ETF (ZAG) increased 7.85% for the first nine months of the year;
- IShares Core Canadian Universe Bond Index ETF (XBB) increased 7.88 percent;
- Vanguard Canadian Aggregate Bond Index ETF (GVA) rose 7.82 percent.
Don’t get used to such results. Barring an economic disaster, interest rates will not fall further. The most likely outcome is that rates will stay at current low levels until 2021 and then gradually start to rise. Flat rates suggest that you get the interest paid on the bonds and not much more. Rising rates suggest capital losses that overwhelm meager interest rates and leave investors with losses.
Now you see why there are so few celebrations over bond yields in 2020. We are unlikely to see them repeat themselves anytime soon and, if we do, it will only happen if the economy is. in serious difficulty.
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Low bond yields are bad news for investing in 2020 and possibly 2021 as well.
You’ve probably heard many times from investment strategists about how low yields challenge whether it makes sense for balanced portfolios to have 40 percent or 50 percent of their weighting in bonds. With five-year Government of Canada bonds yielding just 0.35% at the end of October, it’s hard to argue.
Amidst this gloom on bonds, one reader noticed a disconnect in her wallet.
“I keep reading how miserable bond yields are, but my bond ETF is doing better than most of my portfolio,” she said by email. “I wonder why it doesn’t act like the bonds underlying the fund.”
While bond yields are indeed woefully low, 2020 has actually been a great year for the bond market. The benchmark FTSE Canada Universe Bond Index produced a total return of 8% for the year through September 30, which includes both interest and capital gains.
In fact, mainly capital gains. When interest rates plunge, as they did earlier this year, the price of bonds and bond funds moves in the opposite direction. This is why the FTSE Canada Universe Bond Index may experience a sharp rise above bond market norms this year, even with very thin bond yields.
A sample of broad-based bond ETF returns that are like the index by holding both government and corporate bonds:
- BMO Aggregate Bond Index ETF (ZAG) increased 7.85% for the first nine months of the year;
- IShares Core Canadian Universe Bond Index ETF (XBB) increased 7.88 percent;
- Vanguard Canadian Aggregate Bond Index ETF (GVA) rose 7.82 percent.
Don’t get used to such results. Barring an economic disaster, interest rates will not fall further. The most likely outcome is that rates will stay at current low levels until 2021 and then gradually start to rise. Flat rates suggest that you get the interest paid on the bonds and not much more. Rising rates suggest capital losses that overwhelm meager interest rates and leave investors with losses.
Now you see why there are so few celebrations over bond yields in 2020. We are unlikely to see them repeat themselves anytime soon and, if we do, it will only happen if the economy is. in serious difficulty.
Be smart with your money. Get the latest investing information delivered straight to your inbox three times a week with the Globe Investor newsletter. register today.
