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