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Mailbag: TD Canadian Bond Index Fund (TDB909)

Recently in the comments of The Bond Guide – Investment Guide to Corporate Bonds

Jordan wrote,

Thanks for the great information. I have one question. I have owned the TD Bond Index Fund (TDB909) for a number of years. During that time, the fund is always close to book value. I would have thought that, as interest rates have fallen over the past months (many months) that the market value of the fund would have increased. Nobody has been able to explain this to me and I am starting to wonder why I don’t sell them and purchase corporate bonds directly. I would appreciate any information.”

Jordan has a few concerns that deal with more than one question related to the TD Canadian Bond Index Fund (TDB909).

For readers not familiar with TD Bank’s index funds they are a series of low cost no-load mutual funds that track specific indices that can be purchased and sold through most investment advisors and there is an E-series of the funds available only through TD at a lower cost.

These funds include:

Canadian Equities (TSX)
TD Canadian Index – I: MER: 0.84%
TD Canadian Index – E: MER: 0.31%

US Equities (S&P500)
TD US Index – I: MER: 0.53%
TD US Index – E: MER: 0.33%

Canadian Bonds (TSX DEX Universe Bond)
TD Canadian Bond Index – I: MER: 0.79%
TD Canadian Bond Index – E: MER: 0.48%

International Equities (MSCI EAFE)
TD International Index – I: MER: 1.31%
TD International Index – E: MER: 0.48%

* Currency Hedged versions of both US and International funds are also available

The fund Jordan is referring to is TDB909 or the TD Canadian Bond Index-E fund which has an MER of 0.48% and is one of the most affordable methods of gaining access to a broad collection of high quality bonds for an investor seeking to invest in the fixed income allocation of their portfolio.

TDB909 is a very conservatively run bond fund focused on achieving monthly income for its holders and has traditionally paid out all distributions as interest with minimal capital gains. The fund is intended to target conservative investors looking to preserve their capital while achieving a modest return in the form of income. Investing in TDB909 and investing in individual corporate bonds are at two different spectrums of risk and investing in one or the other depends on risk tolerance.

When you look at the holdings of TDB909 you get a very clear picture of the fund and how it’s organized for investors. The fund has 50% of its assets in 1-5 year bonds, 18.5% in 5-10 year bonds and 30.4% in 10-20+ year bonds which means the fund is heavily weighted to longer term interest rates. We’ve seen a lot of movement in short-term interest rates, but not a substantial move in longer term rates and this is likely why you haven’t seen a massive price jump in the valuation of the mutual fund units. 50% in short-term bonds is substantial, but the fund is balanced enough to not move in one direction or another in any significant way to protect investors from interest rate risks.

When you examine the funds’ Top 25 holdings (36.4% of the portfolio) you quickly see that it’s dominated by government and Canadian Housing Trust bonds. Overall 46.7% of the fund is placed in Federal bonds, 27.3% in Provincial bonds and only 27.3% in investment grade corporate bonds. As James Hymas commented in The Bond Guide there is a trade-off on premium any investor takes for safety when investing in government bonds that can decrease the yield you receive for less risk and increased liquidity.

The performance of TDB909 over the past year has been pretty good considering the volatility in both interest rates and the markets since the credit crisis peaked. From August 2008 to May 2009 the fund was up approximately 3.9% (not including distributions) which matches its mandate of conservative management of fixed income assets. The fund has also handily outperformed the Canadian Fixed Income Peer Index over that same time period.

Bond funds trade close to book value because of the nature of how bonds are valued. For any specific company there is an intrinsic value based on assets and operations. A bond has a value based on credit quality and interest rates. Comparing the two different assets on their increases in book value isn’t an apple to apples comparison.

Corporate bonds certainly have the potential of achieving higher returns than very conservative government bonds, but there are proportionally higher risks an investor takes (company, credit, liquidity, interest, etc) that I spoke to in The Bond Guide that you are exposed to at a greater degree when you invest in individual corporate bonds.

Whether to sell your TBD909 holding and invest into individual corporate bonds for higher returns is a risk vs. reward question that I can’t answer for Jordan. His/her decision isn’t a simple one and understanding the risks taken with individual bonds should be seriously considered.

A corporate bond ETF (XCB) is one option for Jordan who is looking to gain passive exposure to corporate bonds without taking on all of the risk associated with choosing individual bonds.

Disclosure: I own units of TDB909 at the time of this post.

{ 15 comments… add one }
  • Patrick June 17, 2009, 12:30 pm

    Do you get monthly distributions with this fund? The prospectus just says it "may" distribute income monthly.

  • Nurseb911 June 17, 2009, 12:45 pm

    Patrick: Yes the fund distributes income monthly. I re-invest the income into new units (compounding the growth) but for many retirees who use the fund it provides some monthly income depending on how many units you hold. The word "may" used in the prospectus might just be a precautionary term in the event that they skipped income one month for any number of reasons.

  • Patrick June 18, 2009, 2:36 pm

    Sorry to keep asking these kinds of things, but I just couldn't tell from the prospectus… What's the distribution yield on this fund?

  • Nurseb911 June 18, 2009, 4:17 pm

    Patrick: the distribution will change each month dependent on the income after fees) that the fund generates from its bond holdings (income from bonds and capital gains)

    For the past three months here is the % paid out in units to my account:

    March: 0.36% (4.34% annualized)
    April: 0.36% (4.34% annualized)
    May: 0.35% (4.20% annualized)

  • BIGINTOBONDAGE June 19, 2009, 9:17 am

    this post over-exaggerates the risk of investment-grade corporate bonds to inflation and defaults in canada.
    'jordan' would likely be better served by selling the bond fund and opening a discount brokerage account, using the fixed income tools readily available and diversify (no more than 10% of your money in a single issue) among AA-BBB rated utilities, financials, reits, and retailors (molson, loblaws), and create a 7 year ladder. he can preserve the rest of the capital in 10 year real return bonds if he's that afraid of interest rates and inflation and wants a clear 10 year plan.
    the MER (about 0.1%) will be included in the original price and the yield will likely be 100 basis points(or 1%) higher than the TD bond fund.

  • Nurseb911 June 19, 2009, 11:58 am

    I don't think it either over or under-exaggerates risk. Jordan didn't disclose what amount of capital he/she had invested in the bond fund and buying individual $5,000 bonds might be cost or risk restrictive to that investor's approach. One would argue that if he/she had anything less than $50,000 invested in the bond fund that individual bond ownership (mixed between corporates and government bonds) would be ill-advised based on security risk.

    The plan you presented BIB is good for a more novice bond investor, but I think (and I can't speak for Jordan) that the question was posed be a new investor looking to learn more about individual bonds. There I still think diversifying into a corporate bond ETF with the bond fund would be a better option while he/she learns what's required to appropriately protect themselves from risk.

  • Patrick June 19, 2009, 12:09 pm

    Ok you bond guys… The distributions from this fund being around the "4% rule", what would you think of a retiree putting her entire savings into this fund and living off the distributions?

  • Nurseb911 June 19, 2009, 8:49 pm

    You should never have all your eggs in one basket and although this fund is highly rated against its peers and diversified into many issues there is risk. If an individual has the time, knowledge and size of a portfolio to invest into individual bonds than BIB's suggestion on a model portfolio is a valid consideration.

    The problem for a retiree is that a sizeable amount of capital could be eaten up by fees very easily. A $500,000 base of capital at 0.48% per year is still $2400 in fees and the taxable exposure in a non-registered account isn't that great. The bond fund is a good choise for a passive investment strategy, but I wouldn't recommend putting your entire portfolio into the hands of one investment manager.

  • BIGINTOBONDAGE June 19, 2009, 8:52 pm

    interesting points.
    however, the flexibilty and long-term planning related to the purchasing of individual bonds would allow the new investor to 'fill up' the individual rungs of a properly laddered portfolio slowly, over time. If you start with $5000 and can contribute the same amount each year in savings, you can purchase individual bonds safely.
    security risk, as you descibe it here, is essentially meaningless.
    TD waterhouse (and most large online financial institutions in canada) offers a call centre for anyone who has a discount brokerage account. they will happily discuss diversification, credit risk, inflation and interest rates. this will further help an individiual investor who takes the time to learn about bonds.

  • Patrick June 22, 2009, 11:12 am

    Thanks guys. This has been very informative.

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