The Safety of Short Term Bonds – Part 1

Economic CrisisBond funds have been out of favour these days, especially with the threat of rising interest rates. With dividend stocks paying juicy yields, and returning phenomenal capital appreciation, investors have been reluctant to purchase fixed income securities. Investors forget that when times are good, that all of that can change on a dime! This week the TSX and S&P 500 are already showing signs of a correction, with some dividend stocks off 10% from their highs. This should be a reminder to investors of why asset allocation is important.

That’s where short term bond holdings come into play! Bonds with a duration of 1-5 years, are in opposite movement with the stock market – in other words they are uncorrelated. When markets fall, short term bond funds do very well. And unlike corporate bonds or long-term bonds, short term bonds are less sensitive to interest rate increases.

Claymore 1-5 Year Govt. Laddered Bond ETF (CLF) is a short-term bond ETF, traded on the TSX, and a core holding in my portfolio. This ETF has a very low MER of only 0.17% with a current yield of 4.5%. It provides an excellent hedge against market declines, or a great place to park funds while you are waiting to purchase stocks at discount. I covered Claymore CLF back in October last year, in Buying Bonds? Think Short Term. I feel more than ever investors should take a second look at short-term bonds as a harbour of safety.

Disclaimer: I am long Claymore CLF

18 Responses to “The Safety of Short Term Bonds – Part 1”

  1. My Own Advisor

    Jun 08. 2011

    Great reminder my friend.

    Even us dividend-investors (who have some securities invested passively) need some bonds; at least I feel I do.

    I recently added to my CLF position: want to keep about 5-10% of my RRSP in that :)

    How about you?

  2. The Dividend Ninja

    Jun 08. 2011

    My Own Advisor, great minds think alike! :)

  3. Kevin

    Jun 10. 2011

    I am new to your website and reside in the US. Although I like to follow your philosophies, it would be nice if you provided NYSE CUSIPs in addition to the TSX CUSIPs. CLF took me to a different stock when I searched via Fidelity or Google. I also think it might help broaden your reader base.
    Thanks

  4. The Dividend Ninja

    Jun 10. 2011

    Hi Kevin,

    Thanks for reading, and thanks for posting! :) What I’ll do in the future is make a point to mention the security is traded on the TSX, to save my US readers the inconvenience. Good point!

    Cheers!

  5. BeatingTheIndex

    Jun 10. 2011

    This would have been a perfect addition right before the markets slide!

    I actually keep a healthy 30% in bonds in my retirement savings.

  6. The Dividend Ninja

    Jun 10. 2011

    Mich, thanx for posting :)

  7. Think Dividends

    Jun 11. 2011

    You really think you are getting 4.5% from CLF when a 5 year GoC Bond pays 3%.

    CLF has a Yield-to-Maturity of 1.843% according to the Claymore website. Y-T-M is what matters. They may be paying you a higher rate (4.5%), but your principal will decline as the bonds mature since they are all currently trading above their par value. Your real return from this product will be below 2%. The 4.5% “distribution yield” is just some clever marketing. Yield-To-Maturity is what serious bond investors look at.

  8. The Dividend Ninja

    Jun 12. 2011

    @Think Dividends,

    Claymore CLF is a laddered 1-5 year bond portfolio, which holds 28 short-term bonds ranging in yield from 2.00% to 6.10%. The weighted-yield (coupon rate) of the portfolio is 4.81%. Here are my calculations, from the holdings provided on their website:

    http://www.dividendninja.com/pdf/CLF-FundHoldings-20110612.pdf

    I think you are being very unfair with Claymore, 4.5% is the actual distribution yield the ETF is currently paying in monthly distributions. That information is available on any financial website – there’s no deception by Claymore on that.

    I am fully aware of YTM issues, which I suspect is irrelevant for Claymore CLF. I would expect they purchase bonds at par when they are issued (or very closely) and hold to maturity. So I think the premiums would be negligible in this case, certainly not a 2% spread. I’ll phone Claymore and confirm that with them on Monday.

    Over the last year my average cost for Claymore CLF is around $20.10 per share, it currently is priced at $20.12. This ETF trades in a very narrow range and is a great hedge against market declines, with its short-term bond holdings. But that’s for investors to decide for themselves – not everyone wants a 100% equity portfolio.

  9. Think Dividends

    Jun 27. 2011

    Timely article: Distribution rate does not equal yield
    http://thewealthsteward.com/2011/06/distribution-rate-does-not-equal-yield/

  10. The Dividend Ninja

    Jun 27. 2011

    Think Dividends,

    Thanx for posting ;) I know you are a pro and work in the financial industry, so I do value your input.

    The assumption here is that Claymore is purchasing all its bonds at premium, which if it did would certainly result in a continual capital loss when the bonds mature, or if they sell them early. The Canadian Couch Potato covered this issue for CLF.TSX and CBO.TSX as well. My Own Advisor is currently finding out from Claymore if this is indeed the case. If it is then you are completely correct.

    In the meantime my distribution rate is very close to the coupon rate (the 4.5%)and I haven’t noticed any significant captial loss over time in my shares. I really see the short-term bonds as more of a safety-net if/when markets turn sour.

    I know you hold 100% dividend stocks, and I know you have the expertise to determine which are the safest stocks etc. But I just don’t have the stomach for a 100% stock portfolio, or your’e expertise to pick exactly the right companies. SO I feel short-term bonds are a great hedge for me alongside my dividend stocks and index funds ;)

    Thanx for posting, I’d sure like to see you create a blog and share your knowledge with others.

  11. The Dividend Ninja

    Jun 27. 2011

    @Think Dividends, you are correct. YTM does matter, with interest rate increases there will be the potential for capital losses. CLF and CBO bonds are not bought at par/face value.

  12. Think Dividends

    Jun 28. 2011

    You can look up the current prices of the bonds in the portfolio at:

    http://www.pfin.ca/canadianfixedincome/Default.aspx

    A lot of the higher coupon bonds are trading at around $109 (GoC 2016, Ontario 2014, Ontario 2016, Manitoba 2014, BC 2014, MFAofBC 2016). The most expensive one is Quebec 2014 at $111.52.

    As new investors buy into the ETF, the manager must by the bonds at current market prices.

    Bond prices have been stable / moving up (rates haven’t moved and investors are seeking safety/quality) for the past year and only 20% of your portfolio matures every year (given the fact that it is a 5 year ladder).

    Therefore, the declines have not been noticeable thus far (some bonds have been appreciating, offsetting the ones that are maturing, keeping the portfolio’s value stable).

    Right now I am 100% equities, but I am patiently waiting to add some provincial bonds to the portfolio. I am waiting for rates that are more satisfactory, so I may have to wait several years. I owned a lot of fixed income in the 1990s. While I am biased towards dividends, I won’t invest in anything unless it meets a certain return objective and allocate my portfolio accordingly.

    I did run a successful blog in the past, but now have to keep it private due to my current employment contract.

    P.S. I am not trying to bash your blog; I’m just playing devil’s advocate.

    CHEERS

  13. The Dividend Ninja

    Jun 28. 2011

    @Think Dividends

    Thank you for posting and following-up! I do appreciate your feedback and expertise. No problem being a “devil’s advocate” and in this case you are correct. I was incorrect in my assumption. Now I understand why CLF has been stable in price.

    If markets perform poorly this Summer then CLF will be great hedge, and I can also buy some good companies on sale :)

    Cheers
    Dividend Ninja

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