– It’s true that bond prices have been declining over the past year. In
fact, the iShares Core Canadian Universe Bond Index ETF you mention, which
represents a broad spectrum of investment-grade Canadian corporate and
government bonds, has dropped -3.0% in the past 12 months to July 31. And
this is due to the general trend of rising interest rates globally.
With relatively good economic growth in the developed nations, and
inflation showing some signs of inching up along with wages, central banks
are becoming more hawkish in their outlook. That means they are more
willing to raise their policy interest rates and generally remove monetary
accommodation to begin returning their balance sheets to normal, after
nearly a decade of so-called “quantitative easing” (whereby central banks
would purchase vast amounts of Treasury bonds, thus creating and sustaining
All this, of course, has a direct impact on bond prices and yields.
Where interest rate risk comes into play is in the pricing of bonds. Once
issued, bonds are traded in an informal (albeit very large) market. And
because of the inverse relationship of a bond’s price to interest rates, a
bond’s price will fall if general interest rates rise. Conversely, bond
prices rise when rates fall. (It’s a complicated mathematical relationship
that essentially keeps a bond’s yield competitive in the marketplace.)
Those high-quality government bonds will always pay the stated coupon rate,
which is based on the face, or par, value of the bond. What you actually
receive is the “yield” of the bond based on the price you pay. So if you
paid the face value (usually stated as “$100”) on a bond that carries a 2%
coupon rate, your yield will be 2%, or $2 per $100 of face value. But if
you paid something other than face value, your “yield” will be either
higher or lower than the coupon rate.
When analysts talk about interest rate risk, they’re not referring to
whether or not the bond will pay its interest. They’re referring to the
bond’s price. If rates rise, the price of your bond may fall below your
purchase price, resulting in a capital loss if you sell your bond before
The bigger bond ETFs track some fixed bond index. For example, the iShares
Core Canadian Universe Bond Index ETF passively tracks the FTSE TMX Canada
Universe Bond Index. In such indices there is no leeway for offsetting rate
or credit risk, and so the ETF will simply track the performance of the
However, in actively managed bond portfolios, such as those you’ll find in
fixed-income mutual funds, managers will monitor holdings continually, and
adjust them as necessary in an effort to mitigate various types of risk.
They do this in a variety of ways, including tilting bond holdings to
longer or shorter maturities, or investing in bonds with different risk
ratings, in different regions or countries, or attempting to anticipate
interest rate moves – all depending on the mandate of the fund as set out
in its prospectus. Some funds can be quite successful at this, as seen in
Fundata Canada’s list of Canadian fixed Income funds receiving a
monthly FundGrade A Grade. For example, at the top of the A Grade list for 12-month performance
through July is Arrow Capital’s
Exemplar Investment Grade Fund Series FL, with a 6.8% return.
Bond ETFs with an active management component are also being introduced to
the market, for example,
Purpose Tactical Investment Grade Bond ETF (TSX: BND) or the
First Asset Long Duration Fixed Income ETF (TSX: FLB). The funds I’ve mentioned are simply examples of what’s available, and are
definitely not recommendations to buy. Bond ETFs come in many
configurations, including those that track short- and long-term indices as
well as indexes of government bonds, corporate bonds, all bonds, laddered
maturities, and so on. It can get complicated.
In general, investing in fixed-income assets can be just as complex as
investing in equities, sometimes even more so. If you’re looking for the
best type of fixed-income investment to include in your portfolio, or
whether or not to switch from passive to active management styles, I’d
suggest consulting a qualified financial advisor. – Robyn
Robyn Thompson, CFP, CIM, FCSI, is the founder of
Castlemark Wealth Management, a boutique financial advisory firm specializing in wealth management
for high net worth individuals and families. Contact her directly by
phone at 416-828-7159, or by email at
for a confidential planning consultation.
Notes and Disclaimer
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The foregoing is for general information purposes only and is the opinion
of the writer. Securities mentioned are illustrative only and carry risk of
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