Interest rates

Are “stable” ladder bond ETFs a good bet as interest rates rise?

Ladder bond ETFs typically mature or are redeemed at the end of a given year. Owning a series of them over a short or long term payout period allows the rest of a client’s wallet to stay invested for the long term.William_Potter/iStockPhoto/Getty Images

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Soaring interest rates in a spiraling bond price environment creates an opportune time for investors to rebalance their portfolios with effective fixed income strategies during volatile times.

As a result, laddered bond exchange-traded funds (ETFs) have recently seen an increase in fund flows as the Bank of Canada and other central banks have taken benchmark rates to multi-decade highs.

After seeing large outflows for much of the first half of this year, Canadian laddered bond ETFs turned the tide in the third quarter, taking in $46 million, according to National Bank Financial, which is tracking closely. market fund flows. The Invesco 1-3 Year Laddered Floating Rate Note Index ETF PFL-T proved popular with investors after the fund cut its management fee to zero in July, with effect for at least a year.

In the United States, the trend is more apparent. More than US$3 billion has been invested in BlackRock’s iShares family of laddered bond ETFs since June, about half of that in high-quality bond funds.

“They’re getting a lot of interest right now,” says Luke Shange, vice president of corporate communications at BlackRock Inc., in New York.

Their appeal stems from a few reasons other than generating stable, low-risk income. One of the factors is the much greater liquidity available to the units compared to buying bonds directly. Less duration risk is another, while the low fees inherent in ETFs are always attractive.

“These are for your stable investor Eddie,” says William Bluteau, wealth management partner at Bluteau Caseley Wealth Management Group with National Bank Financial Wealth Management in Halifax.

“You don’t really know where interest rates are going – you don’t want to call on that – but you need exposure and income.”

Ladder bond ETFs have the advantage of being simple and transparent. They are usually intended to mature or be repaid at the end of a given year and owning a series of them over a short or long term payment period allows the rest of a customer to stay invested for the long term.

Advisors and investors can research a series of specific bonds to create their own scale, but ETFs simplify the process at a lower cost. Management fees for RBC iShares laddered bond ETFs start at 0.15%, for example, while Invesco’s BulletShares funds have annual fees as low as 0.1%.

Flows from the collection of tax losses

Some of the recent inflows into these funds have come from investors wiping the slate of underperforming stocks and choosing to sell them to reduce their overall tax bill, Bluteau said.

“It’s probably a lot of rebalancing. It’s probably one of the worst markets we’ve seen in decades,” he says. “If an investor’s money is held in a taxable account, they’re going to reap that tax loss and put that proceeds into a new idea.”

Investors are cutting losses on beat assets such as longer-dated bonds and shifting to shorter-dated fixed-income securities – a trend that has accelerated as the inverted yield curve s is accentuated.

“Instead of going back into eight- or 10-year bonds, they’re saying, ‘Hey, I’m going to sell and crystallize this loss. I’m going to go shorter in a one- to five-year laddered ETF,” says Bluteau.

With the inverted yield curve, investors are currently not well compensated for the duration of longer-term ETFs. Even relatively shorter duration stocks are feeling the pressure. For example, RBC’s iShares 1-5 Year Laddered Corporate Bond ETF RBO-T has a yield to maturity of 4.8%, which isn’t much more than BMO’s 4.09% yield. Ultra Short-Term Bond ETF ZST-T

Presumably, as the yield curve eventually returns to a more traditional slope, the bond ladder approach will be more profitable, Bluteau says.

How to play near peak rates

According to Per Homer, wealth management advisor at Assante Financial Management Ltd., some demand for laddered bond ETFs is also based on bets that the current rate-tightening cycle is about to run its course and some investors are positioning themselves to a rally in the bond market. , in Mississauga.

As the bond market recovers, downed bond ETFs will erase short-term declines and see their unit prices rise, he says. “It’s kind of like a bowling ball on a trampoline – at some point that trampoline is going to bounce and that ball is going to go with it.”

The TD Select TCSB-T Short-Term Corporate Bond Ladder ETF, for example, has fallen more than 5% this year, and it’s far from alone among bond ETFs to post declines.

“At some point you’re going to see the Bank of Canada reverse course on rates and lower them,” Homer says. “When they do that, you’re going to get those capital gains. And because you have the liquidity of an ETF, you will be able to profit from it very easily, unlike if a client held a random corporate bond.

Still, Homer cautions against turning to laddered bond ETFs to generate outsized returns, a sentiment echoed by National Bank’s Bluteau.

Laddered or not, using bond ETFs for above-average gains “is more of an asset allocation decision based on interest rates right now,” says Bluteau. The investment objective must remain to use them for a stable and reliable income over a period of several years.

“A traditional bond ladder is about maturity and cash flow,” he explains.

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