What you need to know
- Ultra-low interest rates make it difficult for investors to earn yields in excess of inflation
- High yield bonds can be a source of income in today’s market
- RBC iShares offers bond ETFs that can help investors access the high yield bond market, depending on their needs and preferences
Throughout economic cycles, global and regional events can drive volatility in the financial markets.
An example of this is the extraordinary events driven by the global coronavirus pandemic, which injected sudden market volatility globally, and caused the most jarring asset price swings since the great financial crisis. In response, the Bank of Canada took action to provide stimulus to the Canadian economy to soften the impact of COVID-19, including cutting key policy interest rates to 0.25 percent, and buying bonds and other debt to help keep key funding markets functioning well.1 However, we are seeing inflationary trends through food prices, labour and commodities.
For savers, a low-rate environment means it is increasingly difficult to generate returns on bonds that overcome inflation. Consider that the Canadian consumer price index (CPI) rose 3.6% on a year-over-year basis in May, the largest yearly increase since May 2011. The real Canada 10-year bond yield based on CPI is now -2.11%.2
Higher-yielding bonds can help investors reach their fixed income goals, and this article walks through many of the common questions about how high yield bond exchange traded funds (ETFs) can fit into income-seeking portfolios.
Where’s the yield?
Source: Bloomberg Finance L.P., as at June 21, 2021. BoC Overnight Rate represented by the effective lower bound of the Bank of Canada overnight rate, 5 Year Bond represented by the Generic Canada 5 Year Bond Yield, Core Bonds represented by the FTSE Canada Universe Bond Index, IG Corporate represented by the FTSE Canada All Corporate Bond Index, High Yield represented by the ICE BofA Canada High Yield Bond Index. Index performance is for illustrative purposes only. Index performance does not reflect any management fees, transaction costs or expenses. Indexes are unmanaged and one cannot invest directly in an index. Past performance does not guarantee future results.
Role of fixed income in a portfolio
For starters, there are three primary roles that bond ETFs can play in a portfolio.
- Income: Bonds can be used for income, which in today’s market can help investors add credit risk to boost yield. Corporate bonds generally pay a yield above government bonds. The extra yield premium varies based on a corporate issuer’s credit risk, time to maturity and overall market conditions.
- Capital preservation: Bond prices tend to not fluctuate as much as stock prices and lower duration bonds can help preserve investors’ savings. If you are more concerned about return-of-capital rather than return-on-capital, sticking to bonds with shorter maturities might be a better option.
- Equity market diversification: Government bonds and investment grade securities tend to benefit from a flight-to-quality when the stock market declines. While these bonds yield less than below investment grade bonds, they have low correlations to the stock markets and can help balance out overall portfolio returns over time.
Investors generally need to balance out these competing roles in the portfolio to meet goals, since no single bond or bond fund can meet all these objectives. More fixed income-heavy portfolios (less than 30% stocks) will need more income to meet return objectives, while more stock-heavy portfolios (70-80% stocks) should have higher quality bonds to diversify equities. The world of ultra-low rates means that all types of investors are increasingly reliant on income to generate total return.
Different ways to invest in high yield bond markets with RBC iShares
RBC iShares offers varying exposures to the high yield bond market to help investors reach their goals, outlined below:
- Higher yield and income: iShares U.S. High Yield Bond Index ETF (CAD-Hedged) (XHY) seeks to track an index that offers exposure to a broad range of U.S. high yield, non-investment grade corporate bonds. It provides access to approximately 900 U.S. corporate bonds in a single fund with an attractive monthly income stream.
- Higher yield exposure with lower volatility: iShares Canadian HYBrid Corporate Bond Index ETF (XHB) offers exposure to both the investment and non-investment grade segment of the Canadian corporate bond market through exposure to BBB-rated bonds and lower. Crossover bonds (BBB/BB) straddle the line between investment grade and high yield and can offer higher returns with lower volatility.
- Short duration high yield: iShares Short Duration High Income ETF (CAD-Hedged) (CSD) provides exposure to below investment-grade debt securities and other select fixed income debt obligations including broadly syndicated bank loans. Lower duration can help mitigate interest rate volatility.