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XBB vs. XSB

Written by Vicky at Vix Money.

I personally hold both XBB and XSB (I told you my portfolio is messy!), and I am curious to see how they stack up against each other.

XSB, iShares DEX Short Term Bond Index Fund, seeks to replicate the performance of the DEX Short Term Bond Index. It was introduced on November 20, 2000, and holds bonds that are issued domestically in Canada by all levels of government (federal, provincial and municipal) as well as corporate bonds. The main difference between XSB and XBB is that the focus of XSB is on acquiring bonds with a maturity less than 5 years.

What is in this ETF?

When you purchase a bond ETF like XSB, it is good to know who the issuers of the bonds are.

The top 10 holdings in this ETF make up about 22% of the total holdings, and it is represented mainly by the Canadian federal government. Overall, both the federal and provincial government in Canada represent approximately 64% of total holdings (as of June 11, 2012). Altogether, XSB currently owns 299 unique bonds compared to XBB’s 634 bonds. With almost twice as many bonds as XSB, XBB takes this round.

Which ETF to choose?

There are several factors to look at when comparing these two bond ETFs:

Management Expense Ratio (MER)

One of the biggest reasons to build an investment portfolio containing ETFs is that the costs of owning them are much lower. With XSB boasting a MER of only 0.28%, it beats out XBB’s MER of 0.33%.

Risk Factors

When you hold bonds, there are a couple factors that affect the prices.

The first factor is that the value of a bond is generally inversely related to interest rates. In other words, if interest rates go UP, the market value of the bond generally goes DOWN. The effect that small changes in the interest rates have on a bond’s price is called its duration, and comparing the weighted average duration can be used as a deciding factor between two ETFs. XSB’s current weighted average duration (as of June 15, 2012), is 2.80 years while XBB’s current weighted average duration (as of June 15, 2012) is 6.92 years.

The second factor to look at is the weighted average term of the bonds contained in the ETF. Bonds with a longer term generally have a higher yield, as your money is being used for a longer period of time. In XSB’s case, the weighted average term of its holdings is 2.96 years (as of June 15, 2012), with about 95% of its holdings maturing within 1-5 years. This is compared to XBB’s weighted average term of 9.78 years (as of June 15, 2012), with about 44% of its holdings maturing within 1-5 years.

Another factor affecting price is the credit quality of the bond. If the bond issuer is assigned a low credit rating, it means they are at greater risk for default. Credit ratings are based off of a grading system that ranges from AAA being the lowest risk bonds, all the way down to D. In XSB’s case, approximately 61% of the fund is rated as AAA, with almost 80% of the holdings having at least an AA rating. This is compared to XBB, with approximately 46% of its fund is rated as AAA, with almost 70% of the holdings having at least an AA rating (i.e. the risk of default is relatively low).

Something to keep in mind is that portfolios generally have a bond component to offset the risk of exposure to the equity markets. A general rule of thumb is that the bond market has a somewhat inverse relationship with the equity markets. In other words, when the equity markets decline, investors, in general, tend to head to bonds to hedge against the risk.

Not surprisingly, XSB’s focus on short term holdings makes it less risky than XBB.

Tracking Error

The purpose of XSB, like other bond funds, is to replicate the returns of a benchmark index. In this case, XSB is designed to replicate the performance of the DEX Short Term Bond Index. Therefore, the primary goal of the fund manager is to minimize the difference between the fund return and the index return. In order to determine how successful a fund manager is in accomplishing this goal, you have to look at the tracking error. Ideally, you want to purchase ETFs that have the lowest tracking error record.

The following shows the annual returns (in percentages) of XSB compared to its benchmark index. You can see that the tracking error when the fund first started out was higher, but in XSB’s favour compared to the index. The tracking error has improved as the years go by. XBB definitely takes this round though.

XSB Tracking Error

XSB tracking error

Return

How do the returns compare to each other?

XBB vs XSB Annual Returns

Annual returns for XBB vs XSB

Except for the years between 2006 and 2009, it looks like XBB takes this round. Another way of looking at it is this: say you invested $10,000 into each ETF the beginning of 2002 and left it to the end of 2011. At the end of 2011, the portfolio containing XSB will be worth approximately $16,288 and the portfolio containing XBB will be worth approximately $18,586.

Distributions

The following is a summary of the distributions for the two ETFs during the past 5 years:

XSB

XBB

Difference

2011

0.93313

1.12288

(0.18975)

2010

1.01242

1.22502

(0.21260)

2009

1.23454

1.31296

(0.07842)

2008

1.24334

1.32412

(0.08078)

2007

1.19099

1.27866

   (0.08767)

XBB’s distributions are higher than XSBs, so XBB takes this round as well.

Weighted Average Yield

To compare different bond ETFs, you may want to compare their yields. This yield is primarily from coupon payments of the bonds.

The current weighted average yield for XSB is 3.21% while XBB’s current weighted average yield is 4.04%. XBB takes this round.

Weighted Average Yield to Maturity

The average yield to maturity, which represents the true yield of a bond, includes the coupon income as well as any capital gains or losses that will be realized if the bond is held to maturity.

The current weighted average yield to maturity for XSB is 1.51% while XBB’s current weighted average yield to maturity is 2.25%. XBB wins again!

Results

Aside from a MER that is 0.05% less that its competitor and it being less risky, which is inherent in holding shorter maturity bonds, XSB kind of got smoked in this smack down.

Since we are in an environment with extremely low interest rates, it would be interesting to see what the next few years bring, and if a face-off between these two challengers will have similar results in 5 years time. In the meantime, if I were to purchase bonds, I will likely be adding XBB to my portfolio.

What do you think readers? Am I missing anything that can be used to distinguish between these two ETFs? Are there any other criteria you use when determining which bond ETF to purchase for your portfolio?

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29 Responses to "XBB vs. XSB"

  1. Vicky, excellent post and a great comparison!

    Since I already hold iShares CLF which is a 1-5 year laddered govt. bond ETF, XBB would make a lot of sense for my portfolio! What you have clearly show here, is the duration and yield difference between holding a short-term and longer-term bond ETF.

    While I have been thinking of purchasing XBB for a while now, you have convinced me. ;)

    Cheers

  2. adam says:

    I wonder how a comparison between XSB & VSB and then XBB & VAB would go?

  3. I’ve held XBB for some time, and probably always will – for many of the reasons you’ve outlined above.

    I’ve thought about holding XSB, but I like the balance that mid-range and longer-bonds can provide in a portfolio, hence, XBB is my bond ETF of choice.

    The 10-year performance of XBB is almost 6.5%, after MER is factored in, until month end May 2012. Pretty impressive. Most investors would have killed for that return over the last “lost decade.” Yet another example of buy a great product, and hold it for as long as you possibly can….that includes XBB.

    Nice stuff Vicky…this will definitely make my Weekend Reading roundup.

    Mark

    • Geodelover says:

      Bear in mind that that 6.5% return over the last 10 years was predicated largely on the drop of interest rates over the last 10 years, which helped to bring bond prices up.

      Not that XBB is not a great investment. I’m thinking seriously of buying into it myself, but I wouldn’t count on the continued 6.5% return..

      • Good point. With any bond ETF, you need to watch the coupons and what and when, they are maturing.

      • Hey Geodelover, that’s assuming you are only looking primarily at yield. ;) But if you consider the increase in share price as bonds are a hedge against declining equities – I wouldn’t be surprised all to see XBB continue with 5% returns (or more) per year. Hypothetical, but I think it is entirely possible.

        For 2012, I think it is quite possible bonds will return higher returns than equities (including dividend payers) to the surprise of many.

        Cheers

    • Vix Money says:

      I picked up some XSB to increase my exposure to short term bonds to hedge against interest rates rising. Unfortunately, I didn’t realize XBB had about 40% of their exposure in short term bonds already! I do like the blend with the mid-range and longer bonds, so I will definitely continue adding XBB to my portfolio.

      Thanks for the support Mark! Greatly appreciated!

  4. farcodev says:

    Thanks for this post Vicky !!

    I don’t know much about ETFs, even didn’t known there was Canadian ETFs… and your post motivate me to put my interest on these two ones. It’s a cool and cheap way to buy diversified bonds, instead of one with a requirement of $5000…

    DN website rocks ! :D

    • Hey Farcodev, thanx for dropping by! Just remember when you buy ETFs you have to pay a commisison just like stocks – though some Canadian brokers now offer comission-free ETF trading!

      You can always invest in the same holdings (as XBB) with TD e-series Canadian Bond Index Fund. It also follows the DEX Universe Bond index, and is a much cheaper way to purchase for smaller ammounts. You just reinvest your distributions into new fund units.

      Of course if your not Canadian, then its all foregin income. ;)

      Cheers

  5. Don says:

    Ninja,

    It’s important to understand what one is buying. XSB is essentially a short-term bond fund; XBB essentially a long-term (medium term) bond fund. The out-performance of XBB during 2010 and 2011 comes from the current, extremely weird, probably once in a *lifetime* situation we’re in, as long bond yields sank from around 3+% to now sub-2% levels.

    As to going forward, who knows what that will bring, particularly the when.

    But chase down these comments:

    - Buffett’s recent comments that long bonds are currently very dangerous (because he’s expecting yields to rise at some point)

    - Hussman’s comments from the last couple of weeks about why his portfolio duration is very short.

    - What happened to Japanese long bond yields (essentially flat, between 1 and 2%, for over 10 years):http://advisorperspectives.com/dshort/updates/Japan-Post-Bubble-Rallies.php

    • Don, it’s a good point. ;)

      I happen to have nearly all my bonds in short-term holdings through CLF (iShares 1-5 year Canadian Govt. Bond ETF), for this very reason.

      However we have been living with the the threat of rising interest rates since 2007, and look whats happened to interest rates since then – nothing. Bonds have been great investments! Interest rates will increase at some point, but until then I think holding bonds to dampen market volatility and protect on the equity downside is prudent. If we have another market slide, I don’t want to be holding a 100% stock portfolio.

      But your right, the 30 year bond bull market will come to an end at some point. ;)

      Cheers

  6. Eric says:

    I would say that safety is VERY expensive right now. XBB has a YTM of 2.3% and weighted ave term of 10 years. If inflation stays in the 2.5% to 3% historical ave than you won’t get much… Again investors look at past returns. If we enter a period that looks anything like the 1950-1980, long-term bond holders only lost money.

    • Hey Eric,

      One always pays a premium for safety, whether it is lower returns for less volatility, or a higher share price and lower yield for what are deemed safer stocks. There is no way around paying a premium for safety.There never has been a way around this one. ;)

      While I agree with what you are saying, how do you propose to hedge against market volatility, or unpredictable events such as the financial crisis of 2008 to 2009? Back in 2005 to 2007 people were suggesting bonds were terrible investments, and loaded up on equities. Invesors in their mid 50′s ended up with 90% equity portfolios before the crash. Bonds turned out to be great investments, and we are still waiting for interst rates to increase.

      For those who choose not to hold bonds to smooth out the ride, I am wondering what else they would suggest, other than a 100% equity portoflio.

      Cheers

  7. Eric says:

    If you need extra safe investment go for CDs from alternative financial institutions. In my portfolio I use ZCM (mid-term corp): 1.5% better than similar mid-term Gov. bonds and a YTM of 3.3% (above inflation). I have never own much bonds; retirement is in more than 20 years…..Once you stop looking at the short time, you realize that a well balanced portfolio does the job.

    Considering we had a tough decade and the superb performance of bonds, after 10 years (as of May 31st) TD(e) can index is ahead of the TD(e) bond index.

  8. Peter says:

    Wow, DN, has the bond market really been in a 30 year bull market? 30? That is impressive. I thought it was more like 10 years?

    Now, since it has done so well for so long, time to load up on more bonds! = ) (sarcasm)

  9. Saif says:

    Could you please tell me which broker/bank is recommended to buy either of these 2 etfs from [XBB and XSB]? And can they be traded (commission free:) in the secondary market?

  1. XSB vs. XBB says:

    [...] to do a smack down between the two to see which one stands up at the end. Check out the article here! I think I might even have convinced Ninja to pick up some of the winning bond [...]

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