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Fixed income solutions
Fees a critical factor

Since it is generally agreed that bond returns for the foreseeable future will be notably lower than that experienced in the last twenty years, I suggested last week that load bond funds are a thing of the past. Hence, this week I'll briefly review various other fixed income options.

Low fee bond funds

No load companies such as Beutel Goodman, Legg Mason Canada, McLean Budden, and PH&N each offer good core bond portfolios with MERs under 0.75 percent per annum. The first three companies even pay a trailer fee to advisors, ranging from 0.10 to 0.25 percent.

The downside is that, as with any fund, there is no real capital protection. Bonds are turned over so that a maturity date cannot guarantee any yield or rate of return for the investor.

iUnits bond funds

Barclays Canada's iG5 and iG10 exchange traded bond funds carry MERs of 0.25 percent per year and each hold just one bond, tracking the benchmark 5 and 10 year Government of Canada bond, respectively. While ETFs are otherwise thought of as index products, these funds are an exception. The Canadian bond universe is made up of both government (federal and provincial) and corporate debt.

These funds buy only single federal government issues. Plus, a brokerage fee is paid for each transaction. Finally, distributions are not reinvested. These funds' low MERs seem like a no-brainer on the surface. However, I prefer low fee actively managed bond funds to these ETFs for their greater diversification, lack of trading fees (though some brokers may charge you), and the ease of distribution reinvestment.

Investment grade bonds

Buying bonds directly is rarely a bad move. If held to maturity, the main advantage here is the certainty of the yield. If buying Canadian federal or provincial bonds, there is little practical risk of default. Juicing yields somewhat by looking instead to high-grade bonds issued by corporations involves a little more risk.

Only one mutual fund focuses almost exclusively on investment grade corporate bonds - TD Canadian Bond. Its Investor series units carry a 1.07 percent MER. However, accessing the services of a full service broker may be the better option here to get advice on individual issues.

High yield bonds

Individuals should almost never buy high yield bonds since there are too many details and risks involved. High yield refers to debt that is rated as speculative - or below investment grade bonds. Think of them as conservative stock investments because if all goes wrong (holders will usually salvage something on their investment. By contrast, stockholders usually end up with what amounts to souvenir wallpaper.

Only one no load high yield fund exists, PH&N High Yield Bond. Load funds from AIM-Trimark, GGOF, Northwest, and TD Asset Management are worth considering.

Preferred shares

For taxable portfolios, it makes little sense to hold fully taxable interest-bearing vehicles. This is true particularly in light of the tax credit that Canadian source dividends attract. Preferred shares, while they' re a bit riskier than bonds, are a good compromise between the safety of bonds, but with much more favourable tax treatment.

No mutual fund currently holds exclusively preferred shares. Some hold big amounts in preferreds but no pure fund exists. Diversified Preferred Share Trust (DPS.UN/TSX) is an example of a closed end fund investing in preferred shares. However, it's currently trading at a premium. When added to its annual fees and brokerage fees, it's not a cheap option at the moment.

If picking individual preferred shares, stick to higher quality issues (rated P1 or P2) and consider engaging the services of a full service broker to help with security selection.

Advice for advisors

Surely advisors (i.e. distributors) should not take the only haircut when it comes to fund fees. Last week's summary of bond managers' track record - even before fees - wasn't too flattering. Hence, portfolio managers and fund companies should share in any cut in fees on fixed income products.

Then again, there's nothing stopping advisors from continuing to use the same old load bond funds with fees of 1.6 to 2 percent annually. However, in five years you may well have some dissatisfied clients on your hands. It's your choice.

Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at dha@danhallett.com
 
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