In defense of bond funds


Date: 15-Feb-99 - 7:49 AM
Subject: In defense of bond funds
From: Bylo Selhi

Conventional wisdom has it that one should own a ladder of bonds rather than a bond fund. This argument has two parts:

  1. The one-time commissions paid to build a bond ladder are much lower than the annual MER paid to a bond fund.

  2. Because bond funds are volatile -- NAVs fluctuate up and down inversely with interest rates -- when one needs money one may be forced to "sell low". With a bond ladder one gets an assured income stream and if one holds each bond to maturity there is no loss of capital.

I'd like to challenge this reasoning:

  1. The problem with building a bond ladder is the hidden cost of commissions when you buy the bonds. These commissions are particularly high when you cannot afford to buy individual bonds in large denominations. Indeed, the standard denomination -- the equivalent of a "board lot" -- for strip bonds is I'm told $100K. When you buy smaller amounts you have to pay higher commissions partly because the broker has to divide the bond on behalf of you and your fellow smaller investors. So smaller investors are usually advised to use bond funds and then switch to a bond ladder when they have enough money to make that economical.

    How much is enough? Has anyone analysed the commission cost to build a 5-year, 5-rung bond ladder out of $50K ($10K per rung), $100K, $250K, $500K, etc.? (Here's an opportunity for bond ladder proponents to make their case.)

  2. Yes bond funds are volatile, but that volatility is much lower than stocks. If you intend to buy and hold until retirement -- when you will presumably need a steady income stream from your portfolio -- then what's the problem?

    • Remember that regardless of their NAVs at any particular moment, bond funds pay out an income stream that's based on the interest payments from the many bonds they own. If you follow all the "safe withdrawal rate" studies, you shouldn't draw more than 4% or 5% annually from your portfolio.

      When was the last time bond funds failed to generate those returns? (If interest rates drop significantly below present levels you could more than offset the lower income with capital gains.)

    • Realise also that the equity side of one's portfolio will generate income streams from dividends and capital gains distributions. This is additional income that you receive without being forced to sell any fund units when NAVs are "low." (For this reason retirees probably ought to change the payment of all fund distributions from "reinvest" to "cash.")

Now let's move up in portfolio size. If you're a so-called high-net-worth (HNW) investor with at least $1M you can engage an investment counsellor (IC) to manage your portfolio. ICs charge 1% to 1.5% annually on assets plus custodial costs (another 25bp or so.) Even if a HNW investor wanted to have an IC look after the equity side of their portfolio wouldn't they be better off investing the fixed side on their own into PH&N Bond (a closet SM Universe indexer with MER=0.56%) or CIBC's new bond index fund (which tracks the SM Universe bond index for an MER of 0.3% on investments over $150K)?

Why pay 1.25% or more when you can pay as little as 30bp? What added value would an IC provide? Indeed I'd argue that an IC can't begin to match the diversification of the SM Universe bond index.

Isn't it time to reconsider the conventional wisdom that bond funds aren't good for your (financial) health?

Date: 15-Feb-99 - 9:05 AM
Subject: Re: In defense of bond funds
From: orgrindr

Bylo ...Thanks for your valuable comments, past and present. We are 2 yrs away from converting my wife and my RSPs to RRIFs thinking bond funds in SDRRIFs with SWPs. My limited research has most bond funds showing negative returns for 1990 and 1994 So, is it possible for bond funds to not produce the recommended 4-5% withdrawal max?

Date: 15-Feb-99 - 9:31 AM
Subject: Re: In defense of bond funds
From: George$

Hi Bylo: A good post. I believe that bonds have been out of favour because of the extended and remarkable tear by equities [US in particular]. But like an overdue earthquake - methinks a serious correction has to follow at some point, but of course nobody knows when. Your beating of the bond drum may be prescient. It will be interesting to see when the "when" takes place.

Until three months ago I never seriously considered a bond or a bond fund. It was only equities. But last November, at age 58.5, I did diversify our RRSP into some CIBC Global Bond Index and CIBC Canadian Bond Index - at a mer of 0.30%.

I still don't understand why anybody under the age of 40 would consider bonds - unless they believe in market timing, which I don't. It seems to me that IF TIME is on your side the higher returns of equities is far more important than the associated higher volatility [risk] of equities. The "if" is the key. Time is the one great leverage factor the young investor has and so why throw it away in bonds?

I do totally agree that paying an investment counsellor [or a bond fund] an annual fee of 1% to 1.5% to manage a HNW portfolio in bonds is ridiculous. That is about 20% total returns on bonds today! A cynic might view this as an appropriate mechanism for the re-distribution of wealth - from the HNW to the non-HNW.

Date: 15-Feb-99 - 9:56 AM
Subject: Re: In defense of bond funds
From: I'm Howard

Good posting Bylo, and methinks I will reexamine my Altamira holdings to look at the Scotia platform.

E Trade in the US are attempting to open th eBond market to the retail investor, but I totally agree with you that a bond fund makes more sense.

ALL portfolio's must contain some Bonds, as even young peoplke may need emergency cash and bonds smooth out the curves.

Iam totally in Bonds in my RRSP as , like the lecture I gvae my 80 year old father yesterday, do not get greedy, if you have enough go to the most conservative investment.

If 4% cash flow is generated by your funds and that meets your needs, gom a 100% GIC's.

Anyway I am rambling, but once again Bylo, a nice posting. oh Yeah, I have PH&N and I am thinking of switching that to Altamira, why not, or even to Scotia???

Date: 15-Feb-99 - 10:08 AM
Subject: Re: In defense of bond funds
From: john_d

You are preaching to the converted here, Bylo.

Those who claim that owning bonds is "safer" than bond funds don't understand how bond funds work. Owning laddered bonds is no less riskier than a low-cost bond fund. Their market valuations fluctuate as much as any bond fund - probably more - in the secondary bond market. That people aren't aware of their current bond valuations and plan on hanging on to them to maturity doesn't make this any less so. The risk is there even if it is unseen. None of us plans on some unforseen circumstance requiring immediate cash but they do occur nonetheless.


Most domestic bond funds had a negative return in 1994 only. PH&N Bond returned +8.1 percent in 1990. Had you owned laddered bonds back in 1994 and were forced to liquidate some of them before their maturity you too would have lost money. Yes, if you weren't forced to liquidate you would not have lost anything, but the same reasoning applies equally to a bond fund.

I must wonder how low-mer companies like Bissett, Mawer, PH&N will respond to the encroachment of index funds into their arena? I would think that their type of a la carte customer would be attracted by the allure of even lower MERs. I know that I am.

Date: 15-Feb-99 - 10:10 AM
Subject: Re: In defense of bond funds
From: mikale

Bylo, seems like an apple to orange comparison.

1. The laddered portfolio has a shorter duration than an SCM Index bond fund. Given that the yield curve is predominately positively sloped, the bond fund should have higher current yield. This would work against the fund holder in the short term in a period of rapidly rising rates when there will be a mad rush to the exits from bonds to MMFs to preserve capital.

2. The SCM Index bond fund probably has a 60:20:20 mix of federals, provincials (+ municipals) and corporates creating a higher yield than a ladder solely in federals. It is nigh impossible for an investor even with $500K in total to diversify corporate debentures at reasonable dealer markup.

3. Assuming that the cash flow is to be consumed during retirement then there is no issue as to reinvestment risk which would favour the bond fund given the preponderance of upwardly sloping yields and the dealer markup on smaller reinvested amounts.

Date: 15-Feb-99 - 10:22 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi


Thanks for the kind words. You raise an important question.

According to my records (on Quicken) PH&N Bond had a NAV of $9.31 on 31Dec93. Over the course of 1994 it dropped some 11.2% to end the year at $8.21. According to PH&N's website, the actual loss in calendar 1994 was 4.1%. So the difference, +7.1%, must have been paid out in distributions. As long as you didn't panic in 1994 and sell, the NAV recovered in 1995 and of course the income stream continued.

BTW, it's not easy to determine the amount/share actually paid in distributions. PH&N's website only goes back to 1995. But based on 1995 to 1998 numbers I'd guesstimate it was around 70 a share. Using the YE94 NAV of $9.31 that's 7.5%. (The discrepancy is also due to the fluctuations in NAV throught 1994.)

George & jd,

Although I've been a loyal PH&N fan for years, I too am starting to look at CIBC's index fund. Hmmm...interesting(!) times.


In my experience sometimes GICs (and even CSBs, OSBs, etc.) rates beat Gov't of Canada strip bonds, especially when comparing net of commissions. Someone who has retired ought to keep some of their portfolio in bonds to guarantee income for 5 years or so in case bond funds are depressed for a protracted period (e.g. should inflation return with a vengeance.)

Date: 15-Feb-99 - 10:32 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi


1. OK, then let's compare to a longer ladder, say 5 rungs spread over 10 years.

2. Exactly. An index fund ought to provide higher returns through greater diversification, without significantly affecting the higher default risk of corporates (or even munis.)

3. Agreed.

So again, why is the conventional wisdom against low-MER bond funds?

Date: 15-Feb-99 - 11:08 AM
Subject: Re: In defense of bond funds
From: mikale

I wasn't aware of the conventional wisdom.:-) Is it a stock broker thing?

Intuitively, it makes more sense to use low cost funds during the accumulation phase (a longer time frame to ride out lower NAVs) and ladders during the distribution phase, particularly if the retiree has little room for "withdrawal rate error."

FWIW, many investors have been lulled into a false sense of security during the past 18 year secular decline in interest rates. The 30 year U.S. T-Bond "zero coupon" has outperformed the S&P500 by about 4% CAR over the last 20 years. Is that going to happen in the next 20?

BTW, I am wondering if you have the time or inclination to HTML create the Chart and formula published by the IDA to show the effect of dealer markup on strip bond yields and post it on your home page. Ya may have to commission gummy.:-) It is illuminating for the purpose of this thread and others to come.

Date: 15-Feb-99 - 11:24 AM
Subject: Re: In defense of bond funds
From: john_d

I too would consider CIBC, but as I have indicated before I am a bit uncomfortable with the CIBCs term "rebate" on accounts >$150k. It suggests to me something temporary like a special introductory offer, soon to be discontinued once their introductory period is over.

In addition, my entire RRSP account is with PH&N and I don't want to go through the paperwork hassle to save 0.3 percent or so on the MER.

I don't think the benefits outweigh the costs. And who knows? - Perhaps companies like PH&N and Bissett will respond in kind by reducing their MERs. I think index funds are their direct competition. People who use planners and buy AGF, CI, Fidelity et al aren't concerned about low MERs - obviously. I don't think index funds threaten to take much current business away from planners.

I read with amusement in the Star this morning that index funds are the fastest growing "hot" fund segment in the mf market. What is the annual growth rate of a fund starting with $0 and ending up with $1 in 12 months? Who says one needs statistics to lie efficiently?

Date: 15-Feb-99 - 11:47 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi


Well in the past when I've referred to low-MER bond funds like PH&N, some people have jumped on me with the "laddered bonds beat bond funds" mantra. They seem to miss the low-MER qualifier.

Bogle in Costs and Bond Funds makes a compelling case for low-cost bond funds by demonstrating that "the low-cost fund group not only delivers the highest returns, but it assumes the lowest risks, measured both by duration and price volatility."

Re the booklet I assume you're referring to Strip Bonds and Strip Bond Packages and this:

Commission per $100

Yield before commission

Term to maturity and yield after commission




















































You must have ESP cuz one of the reasons for starting this thread was to add some bonds vs. bond fund material for my website. That's why I just happen to have the table handy. Any proofcheckers out there? :-)

(For those who don't know about this free booklet), call your favourite (discount or full-service) broker and ask for a copy. No bond investor should be without it.)

Date: 15-Feb-99 - 11:52 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi

BTW, one of the reasons for posing the cost comparison challenge in my first post is to find out what brokers charge in practice for various sized bond portfolios.

The IDA table represents quite a broad range (6:1) in commissions. Can one in practice buy a 5-year strip for a commission of $0.25 per $100 (i.e. $25 on a $10K bond)?

Date: 15-Feb-99 - 12:01 PM
Subject: Re: In defense of bond funds
From: mikale

Excellent Bylo and this proofreader says publish!

As for the ESP stuff, forget it, although on certain occasions I suffer bouts of existential insomnia. :-)

Date: 15-Feb-99 - 12:13 PM
Subject: Re: In defense of bond funds
From: George$

John: Inertia I understand and practice myself.

But you also say: "I am a bit uncomfortable with the CIBCs term "rebate" on accounts >$150k. It suggests to me something temporary like a special introductory offer, soon to be discontinued once their introductory period is over."

I don't belive they can step bacwards and do so without risking a terrible black eye - and for that reason alone will not. Secondly, I do believe CIBC has the long term goal of trying to emulate Vanguard in Canada - to the extent that they can and still make some profit [which of course Vanguard does not].

The "rebate" scheme was an "instant" response by CIBC to Royal and Altamira and their lower fees and gave CIBC 3+1 months of time for implementation of the program. They needed that time.

Date: 15-Feb-99 - 1:08 PM
Subject: Re: In defense of bond funds
From: I'm Howard

Bylo, my question still remains, why not the Altamira bond fund over PH&N , given that Altamira has beaten PH&N over the last ten years???

The fund gives you an accurate value, daily, wheeras trying to sell an individual issue is a real pain.

If inflation returns with a vengance, maybe the bond fund manager is smart enough to sell and to buy to take advantage, something Marcus seems to have demonstrated time and again.

Date: 15-Feb-99 - 1:12 PM
Subject: Re: In defense of bond funds
From: Bylo Selhi

Re CIBC's ability to hold their 0.30% MER:

PH&N Bond has assets of $2.23B and an MER of 0.57%. This generates around $12.7M in fees annually.

CIBC Index Bond has assets of $134M and an MER of 0.30% or 0.90%. This generates somewhere between $400K and $1.2M in fees annually.

Bissett Bond has assets of $234M and an MER of 0.75%. This generates $1.8M in fees annually.

I can't imagine a bank doing anything profitably for less than a $1M let alone $400K. They probably have to pay the fund "manager" alone close to that. Cadsby1 must be praying that the fund's assets grow very quickly.

Now PH&N is in an interesting situation. If they do nothing they risk losing fund assets and thus fee revenue. OTOH if they lower their MER to match CIBC's 0.30% they stand to lose several times more in fee revenue than CIBC collects in total.

Perhaps with bond funds size really does matter.

1Last year at this time Cadsby was defending his decision to hire Pape as the official CIBC mutual fund shill. This year he's bucking to become Canada's version of John Bogle. What an about-face!

Date: 15-Feb-99 - 1:23 PM
Subject: Re: In defense of bond funds
From: rayw

Good thread, Bylo, and I agree with you that the "conventional wisdom," based on my reading of popular authors on personal finance (and my own discussions with a couple of brokers), are that ladders of bonds are the investment of choice for fixed income, at least in sizable accounts in most circumstances. I'm looking forward to a defense of that view on this thread.

I have no experience whatever in buying bonds directly. The funds maturing in RRSPs this season I split pretty much evenly between a two-year GIC at 4.95% and PH&N bond fund. Picking a bond fund (or a GIC) would seem to me like shooting fish in a barrel compared to shopping for bonds. In my own case, I'd be pretty much left to the mercy of my broker. And in an RRSP account, how does a guy shop around effectively, when the hassle of transfers out (and fees and foreign content) may be involved?

Like others here, I'm attracted to the CIBC bond index fund and MER rebate. The attraction here is not simply the 27 basis points spread in MER with the PH&N bond fund, but the leverage it offered by a bond fund purchase into the other CIBC index offerings at 0.3 percent.

Just a final point on the question of HNW investing, which Bylo raises. It's been a few weeks since I read Chevreau's The Wealth Boomer, which attempts to argue the merits of the options available to the HNW crowd. But it seems to me that, at least on the grounds of cost, he fails to make his case. The main argument left to Chevreau, I think, would have to turn on the tax sensitivity of segregrated equity accounts for investors who prefer active management. But he doesn't really develop the argument.

Date: 15-Feb-99 - 1:32 PM
Subject: Re: In defense of bond funds
From: Bylo Selhi


1. Altamira Bond's higher returns are due to its investment in very long term bonds. When interest rates drop (like recent years) this results in incredible capital gains. Should (when) interest rates rise this will result in equally incredible capital losses. In 1994 Altamira Bond lost 8.9%; PH&N lost 4.1%.

2. No one (no, not even Bob Marcus) has exhibited the ability to consistently call interest rates over the long term.

3. There have been a number of articles on bonds that concluded that beyond about 2 years, the added interest rate risk of longer term bonds is not fully compensated by their somewhat higher returns. Even PH&N Bond is pushing things with an average duration of about 5 years last time I looked.

4. According to Globefund, Altamira's 10-year CAR is 12.59% vs. PH&N's 11.22% vs. the index's 11.44%. The respective 3-year risk are 7.05, 4.48 and 4.67. Is the extra 1% worth nearly twice the volatility?

Date: 15-Feb-99 - 2:02 PM
Subject: Re: In defense of bond funds
From: George$

Bylo: I did not realize that a year ago CIBC had hired "Pape as the official CIBC mutual fund shill."

Boy, that changes my opinion somewhat. I think in the past you have pointed out that I can be too generous with my "give them the benefit of the doubt" philosophy. Thanks.

Date: 15-Feb-99 - 2:26 PM
Subject: Re: In defense of bond funds
From: Bylo Selhi

Perhaps "shill" is overstating it a tad. This isn't the article I recall reading. That one questioned the propriety of this arrangement and had a defensive sounding quote from Mr. Cadsby. Nevertheless: New CIBC funds plan offers advice, choices.

Also after the announcement Pape ran a piece in his mutual fund newsletter in defense of his impartiality, etc. despite receiving fees from CIBC to recommend certain funds over others. Personally I don't care any more -- I cancelled my subscription to his newsletter. But he does have a conflict of interest -- even if he doesn't want to acknowledge it.

Date: 15-Feb-99 - 2:35 PM
Subject: Re: In defense of bond funds
From: George$

"I cancelled my subscription to his newsletter". Bylo, meboy, how can you admit without shame to such a lapse in judgment as to subscribing in the first place? :+))

Date: 15-Feb-99 - 2:46 PM
Subject: Re: In defense of bond funds
From: chuck.m

RE: proofreading the bond yield table.

It appears the yield drops from the 15 year time period to the 25 year time period in most cases. This doesn't make sense to me. I would expect the commission to have less effect on the overall yield as time goes by.

Can someone explain, or has the cell data been juxtaposed in some instances?

Date: 15-Feb-99 - 3:47 PM
Subject: Re: In defense of bond funds
From: rayw

I was struck as well by the irony of CIBC's promoting, simultaneously, its Choices program (advised by Pape) and it's index funds. Pape has refused in the past to give an index fund better than a $$ rating on the grounds that "it can't possibly outperform the index." Like Bylo, I let my subscription to Pape's newsletter lapse -- but not because I perceived anything unethical in his conduct (his biases are pretty much declared and out in the open). I enjoy reading Pape, by and large, but his newsletters just cost too much -- and the self-promotion gets a little tiresome.

Date: 15-Feb-99 - 4:15 PM
Subject: Re: In defense of bond funds
From: myle

Last thursday I went to the CIBC conference at the Prince Hotel in Toronto to hear Ted Cadsby and Giselle Wilson (CEO of TAL fund Management) discuss a number of financial issues related to mutual and Index funds. Ted did say that he had given up trying to figure out the best funds to invest in. He quoted a CIBC study showing that for the USA and Europe Index funds beat Managed funds by a very large margin. In Canada Managed funds beat Index funds by just a little. As far as Canadian Bond Index funds are concerned , they beat Managed Bond funds on average by 1.5%. For Emerging markets Managed funds beat Index funds by a very large margin. Ted also mentioned that when they analized the 1999 recommendations of the so called leading Canadian Mutual fund experts (GordonPape, Ranga Chand, Duff Young etc.) there was only one fund they all agreed on: Bissett Equity.

Date: 15-Feb-99 - 6:11 PM
Subject: Re: In defense of bond funds
From: Bylo Selhi


In your 1:23pm post the first paragraph sounds like you think bond ladders are better than bond funds, but paragraphs 2 and 3 sound like you favour bond funds. Please clarify.

BTW, I'll be getting a copy of The Wealthy Boomer soon and will post my comments. As I understand it, this book covers low-MER index funds and also Jon's Rip van Winkle portfolio.


Alas, I'm human ;-)


Hmmm...very interesting. I double checked the IDA booklet and the numbers appear correct.

Date: 15-Feb-99 - 8:43 PM
Subject: Re: In defense of bond funds
From: rayw

Sorry for the ambiguity in my posting, Bylo. In my first paragraph, I merely meant to agree with you that the "conventional wisdom" in the personal finance industry seemed to be that, at least for larger accounts, bond ladders were preferable to bond funds. The prevailing, though by no means unanimous, view here at the Library would seem to be to the contrary.

Additionally, I expressed the hope that proponents of the "conventional wisdom" in this old debate, which includes some Library regulars (by my recollection), would put forward their arguments. In other words, I think the discussion is worth having.

For my own part, as I indicated in my posting, my bias is toward the position you've advanced in this discussion, along with jd and others. Once maturities get beyond five years, I'd just as soon go with professional management at the cheapest price and with low risk -- generally avoiding the heavy bets involved in purchasing long-term bond funds.

On the short end, where I have a better feel for what I'm doing (and the risks are limited), I'm not big on short-term bond or mortgage funds.

I look forward to hearing from OntFA and Warren in this discussion.

Date: 16-Feb-99 - 10:12 AM
Subject: Re: In defense of bond funds
From: I'm Howard

Bylo, I compared Altamira, PH&N, AND THE SCM Bond Index.

they were almost like one line until two years ago when Altamira moved above both.

PH&N is the bond Index, no differance, but I am unaware of how you buy this index.

As far as returns, when dealing with Bonds even 1% is agood return to ask for above the competitors, they do not exactly give you double digits.??

I have to believe that if this fund has a10 year track record, future are apretty good reflection of the past, unlike equities.

Date: 16-Feb-99 - 10:26 AM
Subject: Re: In defense of bond funds
From: _PK_

Hi Howard -

I think you actually validated Bylo's analysis in your last post. Essentially, Altamira's bond fund made a bet to lengthen duration a couple of years ago. They won. Personally, I don't put alot of stock into somebody who successfully guesses a coin flip.

BTW, I agree with you that PHN's bond fund is essentially the SCM index. They specifically say in their prospectus that they want to maintain the fund's duration and composition within fairly narrow parameters of the index. Also, from what I understand, CIBC's bond index is a low MER play on the SCM index.

Date: 16-Feb-99 - 11:50 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi


Howard's asked the same question in the past. He's gotten basically the same answer each time. Methinks he's looking for us to validate his choice of Altamira Bond. It ain't gonna come from me.

BTW, CIBC Can Index bond fund's mandate (according to the prospectus) is to track the SCM Universe. It hasn't been around long enough to judge their success in achieving that goal.

Date: 16-Feb-99 - 1:45 PM
Subject: Re: In defense of bond funds
From: doubleu

Myle. Re: CIBC's analysis of fund choices among all the so-called experts. I just checked the December 17th edition of the Globe's Mutual Fund Report where they rated the various '99 books. According to the Globe, there were 6 funds which found favour among all the experts: PHN Dividend, Royal Dividend, Templeton International Stock, Fidelity International Portfolio, Bisset Retirement and Global Strategy Income Plus. Bisset Cdn Equity was rated top by 5 out of 6 authors. Does Cadsby have a poor research department or skewing his comments to fit his message?

Date: 16-Feb-99 - 3:31 PM
Subject: Re: In defense of bond funds
From: I'm Howard

Bylo, my point is and was, over ten years the curves for all three are basically the same line, except that obviousdly Altamira made the right decision two years ago and rewarded their investors.

are they to be faulted, or was the management at PH&N in error for their decisions.

i own both, but as far as validation for my decisions, that happens every December when I compare the NAVPS vs January.

I look to no one else for validation, but i do seek intellligent input other than, he was lucky, it was a coin toss.

Worst case scenario, Altamira returns to the mean, along with PH&N?

Date: 17-Feb-99 - 12:11 AM
Subject: Re: In defense of bond funds
From: myle

Doubleu, it is probably a combination of both.

Date: 17-Feb-99 - 2:16 PM
Subject: Re: In defense of bond funds
From: Bill C

The latest info that I have from PalTrak shows that the average maturity for :

Altamira Bond = 18.4 years PH&N Bond = 10.4 years

While Altamira has done well over the years with interest rates trending downward, you need to consider whether of not you expect that trend to continue. If not, then maybe you might want to reconsider your decision.

Bill C

Date: 17-Feb-99 - 2:21 PM
Subject: Re: In defense of bond funds
From: Alberta-Jon

Hi Bylo,

I'm really surprised that no one has taken you up on your challenge. Many times, here, I have read people singing the praises of laddered bonds, clipped or otherwise. I know I have read Chevereau's book on the Wealthy Boomer and he seems to argue in favour of laddered bonds. I know many other "experts" also think this is a better way to meet the needs of your safe income section of your portfolio.

It seems to make sense: if you want safe, assured income: buy laddered bonds. You know exactly what you are going to get in any given year. Not so with bond funds or so it seems. What's the point of having your bond funds (the portion of your portfolio that is supposed to be safe)going up and down, almost as much as equities? Often times it seems that bond funds fail to give what they promise: safe, know in advance income.

Having said that I will stay with bond funds, either CIBC Index or PH&N. But more because I'm not sure about the rules and culture of buying and selling bonds. But I sure would like to more actively explore this option. So:

Come on folks at least make it a debate. Surely not everyone that drops by here is against buying bonds.

Maybe, Bylo it is the high respect we have for you that no one dares take you on :)

Date: 17-Feb-99 - 2:42 PM
Subject: Re: In defense of bond funds
From: doubleu

I'd suggest that for the 'average' DIY (if there is such a thing) the issue is just as A-J suggests: lack of familiarity with the process, plus the simplicity of buying and tracking bond fund performance.

Date: 17-Feb-99 - 9:19 PM
Subject: Re: In defense of bond funds
From: Warren-1   Old Alias:

Bylo, good thread - as you know, I am a supporter of bond funds with LOW MERs - but, the arguements ("conventional wisdom" IOW) in favor of laddered strips have some merit if you look at the MERs on many of the load bond funds out there - I believe PALTrak reports median MER for a Cdn Bond fund in around 1.67% - if you believe that the "face yield" on a bond portfolio might be say 5.25% today, then the cost to sell and manage the fund is chewing up about 32% of the return before we even get started. Whew!

OTOH, if the bond (strip) retailer is discounting the annual yield by 80 to 150 bps, is this not almost more expensive on a year-to-year basis than PH&N's mere 57 bps MER - if you average the costs and discounts together for a few maturity terms, and then factor in the "soft cost" (hassle factor) of having to renew the strips every year, I would guess that the costs come close. As for the bond index funds - this is making the choice a lot more interesting, I'll admit.

Your points about IC's are well made, but a good advisor or strong DIYer will realize that the bond funds should be "broken out" and managed under a separate cost structure, or even with a separate manager (using a specific multi-manager approach, where a strong bond manager is used for that section of the assets) and the fees for such management are set accordingly - they can be as low as 50 bps on this class of assets. This is a variation of the old argument on balanced funds where the MER might be in the range of 2.1% for the whole portfolio, and with approx 50% of that portfolio being in bonds, you end up paying this high MER on the bonds too - the Wealthy Boomer cites a balanced Cdn fund as one mainstay of the portfolio for Rip Van Winkle - me, I'd rather add one extra fund and gently manage the mix over the years, and save 150 bps on the bond MER - at the current (and likely lower in the future) rates, this will make quite a difference.

One advantage of a managed bond portfolio is that the choices could be selected to provide a bit more yield by sprinkling in a few more corporates (quality ones of course), and of course average term and duration could be moved a bit either way ..... right now, for the "bond funder" your duration and term is fixed roughly to the index, except as in the case of Altamira (as was noted above) which made a move to lengthen term and as a result benefitted more than others by the long decline in yields.


Date: 17-Feb-99 - 10:49 PM
Subject: Re: In defense of bond funds
From: john_d


True, there is certainly much volatility in the price of housing. But, an individual who rents faces uncertainty about what the rent will be. Owning a home reduces the uncertainty over housing costs, although uncertainty about maintenance costs and taxes remain.

Have I overlooked the opportunity cost of homeownership? No. Have you forgotten the rent that a tenant has to pay - that the homeowner doesn't?

The main benefit to owning a house is that unlike financial assets, the rate of return from owning housing is nontaxable, and the increased value of a house is not liable for capital gains tax either. For example, say that you have $300k at your disposal. If you invest it in a financial asset and rent your housing, you are liable for taxes on the financial asset's rate of return. On the other hand, if instead you use the $300k to buy equity in a house, you will save the rental cost and no longer be liable for tax.

But the unattractive attribute of owning is that housing is fairly illiquid. Murphy's Law dictates when you need to sell there are never any buyers interersted - it often takes a considerable length of time to find someone who really likes your house. And like you mentioned then there are the real estate agent's commission.

Speaking of housing opportunity costs ... there is this house up the street from me that was built back in 1990 - it replaced a smallish bungalow. Once construction was completed the owner put it on the market asking for $1.1m. Now our street may be somewhat upscale, but it isn't that upscale so he didn't get any offers. The house today is still unsold - the owner took it off the market in 1991 - and to this day it has never had any occupants. It has been sitting empty for going on 9 years now. The property taxes on this home are $12k pa (girlfriend works in a real estate office). A similar house next door was constructed at around the same time but it sold in 1990 for $800k, which is probably what the current market value of this mystery house is worth today.

This owner has been letting this $800k asset sit idle for almost 9 years racking up tax bills, maintenance and utility charges - and he isn't even living in it!

Date: 18-Feb-99 - 7:46 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi


"I'm really surprised that no one has taken you up on your challenge..."

So am I frankly. I welcome healthy debate. That's why I started this thread. Let's have the bond ladder proponents publish some realistic numbers on how the average retail customer would fare in creating "a 5-year, 5-rung bond ladder out of $50K ($10K per rung), $100K, $250K, $500K, etc." versus a low-MER bond fund.

Perhaps the comparison should even be broadened to include (a) conventional federal/provincial bonds or strips versus (b) federal/provincial savings bonds or GICs versus (c) bond funds. I've noticed that at times, trust company or credit union GICs -- even premium CSBs and OSBs -- can be competitive with regular bonds.

Years ago most of the fixed part of my portfolio was in laddered bonds or 10.25% CSBs. Then I discovered how bonds are "marked up" to provide for the dealer's commission. The next time I wanted to buy a bond I got a few quotes and worked out the net yields. Suddenly bonds didn't look like such a good deal.

A couple of years ago a CDIC-insured trust company 5-year GIC paid 25bp more than a 5-year Gov't of Canada strip -- at least at the price I was offered. (Similarly last June's Ontario Savings Bonds step-up series paid an average 5.4% over 5 years with full cashability every 6 months. At that time 5-year Ontario strips paid significantly less and "cashability" was subject to the market.) "Often times it seems that bond funds fail to give what they promise: safe, know in advance income."

I guess it depends on whether you're counting on the income stream or the capital. Remember that the income stream continues even as the NAVs fluctuate. Unless we enter another secular inflationary period the NAVs will recover as they did in 1995. As I said on 15-Feb-99 - 10:22 AM: "Someone who has retired [i.e. who depends on their savings to provide income] ought to keep some of their portfolio in bonds to guarantee income for 5 years or so in case bond funds are depressed for a protracted period (e.g. should inflation return with a vengeance.)"

I'm getting a copy of Chevreau's book real soon and look forward to reading about the case Jon makes in favour of bonds.

"Maybe, Bylo it is the high respect we have for you that no one dares take you on :) "

It hasn't stopped anyone before! ;-) But thanks for the nice words. Besides if a bond proponent "takes me on", I'm certain that regardless of who prevails, we'll all learn and so we'll all win.


Good points and more to ponder.

BTW, in defense of balanced funds and RvW [digression] you can have your cake and eat it to with PH&N Balanced. The MER is just about the same as the blended MERs of the funds in which it invests. Last time I worked it out the cost was maybe 6bp. Bissett charges a bit more, ~40bp, to perform the balancing act.

Back to bonds, this morning's G&M monthly MF section has a piece on this very topic: Buy bonds directly or go for a bond fund?

Peter Brewster's comments will interest A-J, however Brewster keeps using the average 1.5% bond fund MER to make his case for laddered bonds. As Warren says 1% or 2% MER premium on a bond eats up a good chunk of the returns. So then Brewster concedes that if you stick to low MER funds it's not so obvious a decision. But he says nothing about CIBC's 0.30% MER offering. Hmmm...

Eric Kirzner says "With a fairly large RRSP, probably about $100,000, I'd prefer bonds, but you do need that kind of size to get diversification and a range of maturities." Again I ask the bond fund proponents, how much does it really cost (annually) to build a 5-year ladder out of a $100K?

Date: 18-Feb-99 - 8:52 AM
Subject: Re: In defense of bond funds
From: _PK_

Hello Howard -

FWIW, here are two arguments against Altamira's bond fund.

1) The Expected Return Argument:

The expected return for a bond or bond fund is its yield. Any other return (both positive or negative) has to come from interest rate movements (which are highly speculative) or, to a small extent, bond switching strategies. As a guess, given Altamira's longer duration relative to PHN and the essentially flat yield curve, the yield for Altamira is about 6% while PHN's yield is maybe 20-25 basis points lower (call it 5.8%). Factoring in the MER, the expected return for Altamira's bond fund would be 4.53% [ie. 1.06 - (.0138 x 1.06)] while PHN has an expected return of 5.20% [(ie. 1.058 - (.0057 x 1.058)]. Given Altamira's higher volatility, you are buying a lower expected return with higher risk -- not a good buy in my books.

2) The Portfolio Construction Argument -

Most people include fixed income in their portfolios for risk mitigation purposes. If you are going for return, there are better choices. Longer duration bonds do not have near as favourable risk mitigation characteristics as do short bonds (or T-bills). To illustrate, probably the most likely reason for a serious downward movement in stocks would be interest rate increases. Long duration bonds will decline in value much more than short duration bonds when interest rates rise. In fact, T-bills actually benefit from interest rate increases due to enhanced yield. So, at the exact moment when you want your fixed allocation to buffer equity declines, long duration bonds are also declining in value. Short duration bonds have better portfolio construction characteristics. BTW, this is a point I should heed to a greater extent myself.

Obviously, it is up to you to judge the merits of these points. However, you did ask for reasoned debate (not merely that Altamira made a bet and won -- which I do believe, BTW).

Date: 18-Feb-99 - 4:15 PM
Subject: Re: In defense of bond funds
From: OntFA

Well here goes my entry (nothing exciting here)...I will sometimes recommend a direct bond investment, but it will typically be a mid-term issue and just one purchase. Generally, when I do this, it's not in the form of laddering, it's a single issue purchase. This environment doesn't provide the incentive for retail clients to spend more on laddering or "barbelling" as far as I'm concerned. That said, I usually make sure a client has $50k to devote to this one bond purchase. I would tend to agree with Kirzner on the minimum $100k for laddering and I might even suggest $150k to $200k. In many cases, good low cost funds are the best choice. I like PH&N (57 bps), Lotus (75 bps), McLean Budden (100 bps), and CIBC (30 to 50 bps). No load funds in my recommended list for gov't bond funds. For added yield and diversification, I will certainly go to some high yield or global stuff. And I stick strictly to funds for that - regardless of size of purchase.

Date: 19-Feb-99 - 10:53 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi

Here's a brand new article by Frank Armstrong that, while not strictly about bonds vs. bond funds, discusses some related issues of interest to retirees: Having it Both Ways: Allocating Assets for Income and Growth in Retirement.

To get started, put enough cash in money-market funds to meet your income requirements for the next year... should keep five to seven years' worth of cash set aside in short-term bonds. Those short-term bonds can be a life raft during a storm in the equity markets....

Date: 19-Feb-99 - 8:21 PM
Subject: Re: In defense of bond funds
From: benkel

Bylo,one way to purchase bonds in a cost-effective way is to purchase new issues in the primary market.In this market,the retail investor is paying the same price offered to large institutional investors.

Currently,TDGL is offering the following new bond issues:

1)Prov. of Alberta 3 Year Euro-5.5% March 15,2002 --$US-based

2)Prov. of Manitoba 7 Year Euro-5.25% March 3,2006 --$CDN-based

3)GMAC 5 Year Euro-5.50% June 4,2004--$CDN-based

4)Canadian Tire 5 Year-2.25% June 1,2004--$CDN-based

These new issues could be used to begin to build a cost-efficient short/mid-term laddered bond portfolio.

Admittedly,if you don't hold the issues to maturity,you would risk high trading fees if and when you want to sell.

However,if,as stated in Frank Armstrong's article which you cite above,you have enough cash in a MMF to meet cash rquirements for a year,and you have a bond maturing at least every two years,this shouldn't be a big problem.

Internet Link:  TDGL-New Issues

Date: 19-Feb-99 - 8:27 PM
Subject: Re: In defense of bond funds
From: benkel

The Canadian Tire bond which I refer to above is actually a 5.25% bond,priced to yield 5.378%.

Date: 20-Feb-99 - 6:22 PM
Subject: Re: In defense of bond funds
From: George$

Just want to participate a bit.

Some points from the Vanguard link below: -

"But bond funds offer important pluses, he added:

They offer more diversification than most investors can get by buying individual bonds. This diversification applies to the issuers as well as different sectors and maturities.

They are managed by professionals with access to extensive research, market information, and skilled securities traders.

They can transact in the market at a lower cost because bond funds pool the money of many investors.

They distribute monthly dividend payments, while individual bonds make semiannual coupon payments. An investor looking to live off the income stream may prefer the regularity of a monthly dividend payment.

They allow investors to reinvest their dividends to buy more shares in amounts far smaller than the cost of an individual bond.

They offer liquidity. If you put $10,000 into a fund you can exercise checkwriting privileges and take $500 out. With individual bonds, you cannot easily redeem part of your investment."

[end quote]

Internet Link:  Vanguard's Index Bond Chief

Date: 03-Mar-99 - 8:16 PM
Subject: Re: In defense of bond funds
From: benkel

The link below is a very good discussion on buying new issue US bonds.It is written by Fidelity,but these new issues would also be available through Waterhouse Securities and Jack White.

Internet Link:  Understanding The New Issue Debt Marketplace

Date: 04-Mar-99 - 11:56 AM
Subject: Re: In defense of bond funds
From: I'm Howard

I called Altamira and was told that at the beginning of the year that Marcus had reduced his time frame and was in the 10 year time frame for defensive purposes.

he feels that theer will be buying opportunities and he is very optimistic for the fund's performance this year.

i suggested 10% but they would not guess.

Sounds like they are doing their job, I am staying with them and adding.

I still feel we are in for a Market correction of at least 10%.

Date: 06-Mar-99 - 8:43 AM
Subject: Re: In defense of bond funds
From: mikale


According to the March '99 edition of Investment Executive in an article authored by James Langton, CanPx Corp may be coming to life this month.

"The advent of CanPx should finally make the bond business fairer for investors. The deal will establish a central system for collecting and displaying price and other trading information from the IDBs [Inter-Dealer Bond Brokers] - giving both brokers and investors a shot at better, more efficient bond pricing."

Date: 06-Mar-99 - 9:02 AM
Subject: Re: In defense of bond funds
From: I'm Howard

mikeale, I still maintain that it is not the ability to buy Bonds but what type and at what maturities, and when do you change the maturities.

All the Funds have equal access but some are laggards while others perform.

Date: 06-Mar-99 - 9:05 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi

Thanks mikale. It's about time. I wonder if they'll set up a website so we all can see what's going on?

(For those who want to read the entire piece it's on p. 18.)

Date: 06-Mar-99 - 9:07 AM
Subject: Re: In defense of bond funds
From: Bylo Selhi

Howard, I suspect the diversity of returns has a lot to do with the managers' egos, i.e. in thinking they can forecast interest rate movements. Many try. Few succeed.

Date: 06-Mar-99 - 9:47 AM
Subject: Re: In defense of bond funds
From: mikale


A bond fund manager can only add value to the portfolio through 2 basic strategies:

1. Interest rate anticipation (referenced by Bylo), or
2. Spread trading.

FWIW, It seems to me that trading spreads between federals, provincials and corporates is more likely to add value due to economy of scales than adjusting duration. Altamira is the exception, not the rule. Whether Marcus is an ex-ante exception (statistical outlier) is the $1M question.

Date: 06-Mar-99 - 10:33 AM
Subject: Re: In defense of bond funds
From: active

Regarding the sale of strip bonds: Is there any broker known to be more moderate with the spread than others or do you really have to call one after the other?

Which of the brokers is having the biggest volume in strip bond trading?

Date: 06-Mar-99 - 10:59 AM
Subject: Re: In defense of bond funds
From: fitzbri

Altamira has pretty well bet on Cdn long bonds. Over the past 5 years interest rates have declined a far bit .This has provided an excellent enviroment for long bonds. If current rates continue upwards look out.

Date: 06-Mar-99 - 12:52 PM
Subject: Re: In defense of bond funds
From: I'm Howard

like I said Fitzbri, that was Marcus' strategy until year end. I was asked not to repeat the conversation other than to comment that Marcus is very confidant for this year. I bought more last week. Don't agree about limitations, Provincials, Corpoate, junk, Currencies, terms. Lots of variables.


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