Latest crop of ETFs keeps up pressure on fees

With interest rates rising it’s imperative to keep fixed income investment costs as low as possible

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With interest rates certainly having bottomed in the U.S., we are at a key juncture in the bond market. The U.S. federal reserve has raised interest rates twice in three months, and two more hikes are expected this year.

All of this is to say it’s a challenging market for fixed-income holdings. In this environment it is imperative to keep costs as low as possible to preserve whatever returns these investments are offering. Fixed-income exchange traded funds (ETFs) have the edge in this regard.

Investors then might welcome more low-cost options. So it’s worth noting that low-cost leader Vanguard (with BlackRock’s iShares hot on its heels) nearly doubled its lineup of domestic fixed-income ETFs in February, its first new offerings in the category since 2014.

Roughly one in five of the 525 ETFs trading on Canadian stock exchanges are in fixed income. Despite their smaller numbers, they account for 30% of ETF assets and 40% of cash flow, according to Tim Huver, head of product, Americas, for Vanguard Investments Canada Inc.

Vanguard’s lineup previously included two short-term bond index ETFs, an aggregate bond index ETF and two currency-hedged foreign bond ETFs. The new funds add coverage to government and corporate bonds, long-term bonds, and to domestic short-term government bonds. Here are the names, ticker symbols and Management fees:


ETF Ticker Management Fee
Vanguard Canadian Corporate Bond Index ETF VCB 0.23%
Vanguard Canadian Long-Term Bond Index ETF VLB 0.17%
Vanguard Canadian Short-Term Government Bond Index ETF VSG 0.18%
Vanguard Canadian Government Bond Index ETF VGV 0.25%

The expanded lineup is “great news for investors,” says David Kletz, associate portfolio manager with Kelowna, B.C.-based Forstrong Global Asset Management Inc., one of the firms participating in the MoneySense ETF All-Stars advisory panel.

The four segments targeted are “generally underserved by Canadian ETF issuers, and the new additions will heighten price competition and ultimately put downwards pressure on management expense ratios (MERs.)” By giving bond investors more targeted exposure, Kletz says investors get an “efficient means to adjust the duration, credit and issuer profiles in their portfolios.”

You can find the full list, including the four new products, here.

How rising rates affect fixed income ETFs

The category most impacted by interest rate rises is the Canadian Long Aggregate market, comprised of long-term-to-maturity (10 years and over) investment-grade bonds issued by Canadian governments and corporations. Vanguard’s new VLB has a modestly higher credit quality profile and lower exposure to corporate bonds than iShares’ XLB, Kletz says.

In an interview, Vanguard’s Huver couldn’t say when or if Canadian rates would start to move up in sympathy with the hikes expected this year in the U.S.  But historically, he said, Canadian rates have moved in lockstep with U.S. ones.

Generally, the lag time is nine to 18 months. Vanguard senior investment strategist Todd Schlanger says a “gradual increase in interest rates” in the U.S. is a good thing for long-term investors because ultimately higher rates translate into higher returns for investors down the road.

Schlanger doesn’t expect short-term rates in Canada to rise in anytime soon, but when or if they do, that too would be good for investors. He doesn’t dispute the fact we appear to be at the end of a 30-year bull market in bonds, but Vanguard still believes bonds play a significant role as risk dampeners in portfolios. “At least in the next 10 years, high-quality bonds should play an important role in diversification and dampening risk for clients.”

How do the new ETFs compare

While the new bond ETFs came too late for consideration for the 2017 edition of the MoneySense ETF All-Stars (five of the 14 ETF All-stars are fixed income) and given their narrower focus, it’s not clear we would have included them as All-star picks right out of the gate.

Dan Bortolotti, a Toronto-based investment adviser with PWL Capital Inc. and one of the six All-Star panelists, said the new Vanguard lineup “seems fine, though I don’t think there’s anything new here that you can’t already get from iShares or BMO.” Forstrong’s Kletz agrees, pointing out there was already at least one ETF in each of the four All-Star categories.

Canadian Short Government bonds

Vanguard’s new VSG adds to an already crowded segment: the Canadian Short Government bonds (Canadian government-issued bonds with maturities of five years and less). This also happens to be the one least sensitive to rises in rates. Vanguard’s VSG has a similar duration, but higher credit quality and exposure to federal government issued debt than to its two closest rivals, First Asset’s FGB and iShares’ CLF, Kletz says. It’s worth noting that CLF has a slightly lower MER of 0.17%, versus VSG’s management fee of 0.18%.

Canadian Broad Government Bonds

In the Canadian Broad Government category—Canadian government-issued bonds across all maturities—the new Vanguard VGV is considerably cheaper than iShares’ XGB, but “almost identical in terms of duration, credit quality and issuer profile,” Kletz says.

Vanguard is also undercutting rival iShares in the Canadian Broad Corporate bond segment, but the differences are slightly greater: iShares’ XCB has a duration that is 0.6 years longer than Vanguard’s VCB, and VCB has better credit quality, with higher allocations to AAA and AA rated debt; still, overall, the two are “very similar,” Kletz says.

Another panel member, Mark Yamada, president of Toronto-based PUR Investing Inc. says Vanguard is mostly filling in gaps in their product lineup but there were a couple of surprises. While Vanguard is the acknowledged cost leader, at least one competitor has fixed-income ETFs with slightly lower fees.

BMO ETFs’ Long Federal Bond Index ETF (ZFL) and the BMO Mid Federal Bond Index ETF (ZFM) with management fees of 0.20% and posted MERs of 0.23% are versus the 0.25% MER of VGV, says Yamada. Still, VGV is cheaper than iShares XGB (MER of 0.39%) or Powershares Ultra Liquid LT Gov’t Bond (MER 0.28%.)

 

Canadian Broad Government


Ticker Name MER1 Duration1 AAA2 AA2 A2 BBB2 Federal/ Agencies2 Provincial/ Municipal2 Corporate2
VGV Vanguard Canadian Government Bond Index ETF 0.25%3 8.0 54% 42% 4% 0% 51% 49% 0%
XGB iShares Canadian Government Bond Index ETF 0.39% 7.9 55% 28% 16% 0% 51% 49% 0%

Canadian Broad Corporate

Ticker Name MER1 Duration1 AAA2 AA2 A2 BBB2 Federal/ Agencies2 Provincial/ Municipal2 Corporate2
VCB Vanguard Canadian Corporate Bond Index ETF 0.23% (3) 5.5 7% 30% 24% 40% 0% 0% 100%
XCB iShares Canadian Corporate Bond Index ETF 0.44% 6.1 4% 25% 34% 38% 0% 0% 100%

Canadian Short Government


Ticker Name MER1 Duration1 AAA2 AA2 A2 BBB2 Federal/ Agencies2 Provincial/ Municipal2 Corporate2
VSG Vanguard Canadian Short-Term Government Bond Index ETF 0.18% (3) 2.7 77% 18% 4% 0% 74% 26% 0%
FGB First Asset Short Term Government Bond Index Class ETF 0.25% (3) 2.9 72% 17% 12% 0% 71% 29% 0%
ZFS/L4 BMO Short Federal Bond Index ETF 0.23% 2.6 100% 0% 0% 0% 100% 0% 0%
ZPS/L4 BMO Short Provincial Bond Index ETF 0.28% 3.0 9% 55% 36% 0% 0% 100% 0%
CLF iShares 1-5 Year Laddered Government Bond Index ETF 0.17% 2.5 61% 21% 18% 0% 49% 51% 0%

Canadian Long Aggregate


Ticker Name MER1 Duration1 AAA2 AA2 A2 BBB2 Federal/ Agencies2 Provincial/ Municipal2 Corporate2
VLB Vanguard Canadian Long-Term Bond Index ETF 0.17% 14.8 32% 54% 8% 6% 26% 64% 10%
XLB iShares Core Canadian Long Term Bond Index ETF 0.18% 14.4 29% 30% 33% 9% 24% 54% 22%

1. MER and duration data as of February 28, 2017
2. Credit quality and issuer breakdowns are approximate and based on the most recent publicly available data from the ETF issuers
3. Represents management fee only, as an audited MER is not yet available.4. ETF offered in both distributing units and accumulating units (L)

Sources: BMO Capital Markets, National Bank Financial, ETF Issuer Websites

Jonathan Chevreau is founder of the Financial Independence Hub and co-author of Victory Lap Retirement. He can be reached at jonathan@findependencehub.com

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