Bonds have not been particularly interesting for investors in the last 10 years as yields have touched historic lows, while equities have been experiencing strong returns. However, with greater market volatility in 2018 and a general trend of rate hikes by North American central banks, bonds may begin to look interesting again. 

Normally increases in interest rates will negatively affect bond prices resulting in a loss of capital for the bond fund investor. On the other hand, as the demand for bonds increases with the equity markets seeing uncertainty, funds flowing into bond funds can actually help lift bond prices and give bond investors some capital gains back and a higher overall yield makes it easier to justify owning the asset class. With an average yield to maturity for a broad-based bond fund around 3%, some investors would prefer these more certain returns if they are worried about another 2018 in the equity markets which has returned about -1.5% on the S&P 500 and -8% on the TSX year to date.   

This is not to suggest that the bull market for equities is over or even that rates are now on a definite long-term uptrend but the idea is that higher yields on bond funds are considerable for investors who are looking for alternatives with safer returns or even those re-evaluating their risk tolerance after recent market volatility. 

When comparing bond returns to returns of other asset classes we like to look at yield-to-maturity as it gives us a more accurate indication of the "total return" expected if bonds are held until maturity. This also takes into account expected increases or decreases in bond prices. Here’s a list of what bond ETFs are paying in terms of yield-to-maturity and coupon rates today:

The broad-based bond ETFs are highlighted in green to give an idea of what bond rates are looking like on average. One broad-based bond to point out is the U.S. Aggregate Bond Index ETF (CAD-hedged) - VBU which pays out about 3.6%, a bit more than its Canadian counterparts reflecting higher U.S. interest rates. Global bond funds are a good option for investors seeking higher bond yields and comfortable with a little bit more risk (highlighted in grey). 

In times of volatility, investors also turn to GICs and High-Interest Savings Accounts (HISAs) for protecting their funds while earning a return. See the chart below for a HISA, GIC and bond funds comparison, we also talk about this more in an upcoming issue of the ETF Update:

In our view, bond funds still leave something to be desired. It is important to note that this is not a comment against holding fixed income, bonds will always have a place in a portfolio for stability and returns/income streams that are reliable. At the margins though, when you have arguably safer investment options in the form of GICs that offer competitive if not more attractive yields and broad-based equities offering more tax-efficient yields (the TSX currently yields 3.6%) that are higher with better return potential through the equity exposure itself, the case for being overly excited for bonds remains difficult even with marginally higher rates. 

As interest rates continue to rise, fixed-income products become a more attractive asset class compared to others. For more than three decades now, investors have taken the trend of declining interest rates for granted and it has been the underlying assumption in constructing a portfolio. If this upward trend in rates continues, investors should be ready for these underlying assumptions to change. While fixed income will likely still offer far more stability than equities and alternatives, that stability might come at a cost. 

For more research on ETFs and to read the upcoming piece on money market funds, high interest savings accounts and GICs, sign up to the ETF Update today.