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Canadian Bond ETFS – Best Fixed Income ETFS in Canada

Posted on May 30, 2021 by Nelson Smith

Many investors, especially ones new to investing in the stock market, don’t even bother to put bonds in their portfolio, using some perilous logic to rationalize their thought process.

Even with the ability to purchase a bond ETF and thus wide exposure in a single click, they don't.

Their thinking goes a little something like this.

"If stocks outperform bonds over the long-term, then why wouldn’t I have a portfolio stuffed full of Canadian stocks?"

After all, isn’t the whole point of investing to end up with the most amount of money?

There are a few things wrong with this line of thinking.

Firstly, as Warren Buffett likes to say, the first rule of investing is to not lose money. A good way to lose a lot of money is to aggressively buy stocks no matter what underlying economic fundamentals say.

Even "safer" investments such as blue-chip dividend stocks have significant volatility. Some investors just can’t handle the volatility of an all stock portfolio, and they’ll inevitably sell at the worst time.

Canadian bond ETFs are perfect for retirees

Mixing bonds into the portfolio is especially important as you approach retirement. The last thing you want is for your portfolio to implode 40% right before you hang up the proverbial skates. A healthy bond mix will protect your portfolio just when you need it the most.

Besides, it’s incredibly easy to buy bonds these days. Just a couple decades ago, it was impossible for a regular investor to build a diverse bond portfolio. They were forced to buy individual bonds at their local brokerage, something that cost a lot in commissions and was just generally inefficient.

Compare that to today with the emergence of Canadian ETFs, where anyone with an online brokerage account and a mouse can buy diverse bond ETFs that hold hundreds of different kinds of bonds for a tiny ongoing fee. In fact, we’ve quickly gotten to the point where there’s almost too much choice in the bond ETF market.

Let us help you cut through the noise.

Here are Canada’s 3 best bond ETFs

iShares Canadian Hybrid Corporate Bond ETF (TSX:XHB)

Top 10 Holdings:

wdt_ID Stock % Assets
1 Ford Credit Canada Limited 3.74% 1.42
2 Videotron LTD/ Videotron 4.5% 1.10
3 Ford Credit Canada Limited 3.35% 0.92
4 Inter Pipeline Limited 6.88% 0.86
5 Inter Pipeline Limited 6.75% 0.81
6 Ford Credit Canada Limited 2.77% 0.80
7 Health Montreal Collective 6.72% 0.75
8 Sobeys Inc 4.7% 0.70
9 Parkland Fuel Corporation 5.63% 0.68
10 Enbridge Incorporation 5.38% 0.67

One issue many investors have with bond ETFs is they usually prioritize safety over yield. Some people are more comfortable taking a little bit more risk with their bonds in exchange for more income.

If that sounds like you, then you’ll want to check out the iShares Canadian Hybrid Corporate Bond ETF (TSX:XHB), a security that invests in Canadian companies that aren’t quite as good of a credit risk. It buys the bonds of companies that have a BBB credit rating or lower.

The portfolio – which consists of almost 500 individual bonds – is an interesting mix of household names and risky bonds added in to really goose the yield. The ETF also increases its yield by holding bonds that don’t mature until 2070 or 2080.

This translates into a yield of right around 3.72%. That might not seem like a lot, but it’s a full 33-50% higher than the most popular bond ETFs.

That alone should be enough to get some investors interested.

There’s just one big problem with this unique product. Like with a lot of specialty ETFs (like say Canadian REIT ETFs,) the management fee is a little high. The current MER is 0.45%, which is much higher than the other two bond ETFs on this list.

iShares Core Canadian Bond Universe ETF (TSX:XBB)

Top 9 Holdings:

wdt_ID Stock % Assets
1 Canada (Government of) 3.5% 1.26
2 Canada (Government of) 1% 1.21
3 Canada (Government of) 1.75% 1.04
4 Ontario (Province Of) 2.9% 1.02
5 Quebec (Province Of) 3.5% 1.02
6 Canada (Government of) 2.75% .98
7 Canada (Government of) 5.75% 0.96
8 Canada Housing Trust 2.9% 0.96
9 Canada Housing Trust 2.4% 0.94

Next up is Canada’s oldest bond ETF, the iShares Core Canadian Bond Universe ETF (TSX:XBB), a behemoth fund offered by Blackrock.

It has net assets of more than $4.6 billion, with more than 1,300 different bonds in the portfolio. The vast majority of these are government bonds, issued either by the federal government or various provincial governments, but there are also some corporate bonds mixed in as well.

One big advantage this ETF has over some of its peers is its ridiculously low management fee. You’re paying a mere 0.07% of assets under management to get access to the entire universe of Canadian bonds. That’s a small price to pay.

Thanks to persistently falling interest rates, this ETF has provided a solid total return over the long-term.

If you reinvested your monthly distribution into more shares, a $10,000 investment made in this unsexy bond ETF would be worth just over $25,000 over the last 20 years. That works out to a 5.05% annual return. Not bad for something that you’d mostly own for protection.

Lower interest rates have slowly eroded the iShares Core Bond ETF’s payout over the years, but this security still pays a 2.61% yield. That compares rather nicely with other fixed income options, like GICs.

BMO Aggregate Bond Index ETF (TSX:ZAG)

Top 10 Holdings:

wdt_ID Stock % Assets
1 BMO Long Provincial Bond ETF 3.61
2 BMO Short Federal Bond ETF 3.57
3 BMO Short Corporate Bond ETF 2.83
4 BMO Mid Provincial Bond ETF 1.61
5 BMO Mid Federal Bond ETF 1.60
6 BMO Long Corporate Bond ETF 1.56
7 BMO Short Provincial Bond ETF 1.53
8 BMO Long Federal Bond ETF 1.32
9 Canada (Government of) 1.02
10 Canada (Government of) 0.75% 0.87

At first glance, the BMO Aggregate Bond ETF (TSX:ZAG) might seem like a carbon copy of the iShares Core Canadian Bond Universe ETF.

They both offer exposure to many high-quality Canadian bonds at a cheap price. ZAG has an ever-so-slightly higher management fee (0.08% compared to 0.07% for XBB), but that’s not enough of a difference to matter.

So, what vaults this ETF to the top?

It mixes in more corporate bonds into the portfolio, a move that increases yield without adding too much risk. That’s because the strength of top Canadian corporate bonds rivals the government; these A-rated corporations can borrow money almost as cheaply as the federal government or provincial governments can without much additional risk.

The spread between the two yields might only be 0.5% of so, but that’s enough to provide us with a little extra yield.

Remember, the iShares bond ETF pays a 2.73% yield. BMO’s flagship bond ETF does quite a bit better, offering investors a payout in the 2.87% range. That might not seem like much, but it still represents more cash in your pocket, today.

For a bond ETF, the BMO fund has delivered solid returns over the last decade. Total return has been 4.31% annually, which is enough to turn an original $10,000 investment into something worth just a hair under $15,000.

One last feature of note is this: like the other ETFs on this list, the BMO flagship bond ETF will likely see its yield continue to fall a little bit as existing bonds are replaced with new ones with a lower interest rate.

Which Canadian Bond ETF is right for you?

Ultimately, it comes down to whether you’re looking for income or stability.

If you’re interested in maximizing the income collected from the boring part of your portfolio, then choose the iShares Canadian Hybrid Bond ETF.

Just remember that this fund has the chance to perform poorly as the COVID-19 era continues. This is simply because of the higher profile of bonds within the ETF.

If stability is your chief concern, either the iShares Canadian Bond Universe ETF or the BMO Canadian Aggregate Bond ETF are good choices. ZAG is my favorite because it offers a slightly higher yield, but I wouldn’t fault an especially nervous investor for choosing XBB and its slightly better safety instead.

No matter what Canadian Bond ETF you choose, the real benefit in owning these comes when the next recession hits. While the rest of the market was imploding in both 08-09 and March of 2020 due to COVID, Canadian bonds were doing just fine. In fact, during COVID, XBB shares fell from $33 to $29. Although this is still a dip of 12%, it's a far cry from the 40% collapse of the TSX Index.

That’s the kind of stability we’re looking for.

Disclaimer: The writer of this article or employees of Stocktrades Ltd may have positions in securities listed in this article. Stocktrades Ltd may also be compensated via affiliate links in this post.

Nelson Smith

About the author

Nelson is a dividend value investor who insists on buying great dividend-paying companies when they are reasonably priced. He has been investing for more than 15 years and is now primarily focused on helping other investors build up a dependable stream of passive income. When he's not studying the markets, Nelson can be found relaxing with his wife and cat or watching the Toronto Blue Jays.