Despite experiencing their worst loss in decades throughout 2022 due to rising interest rates, bonds may be better positioned to outperform in 2023 as yields are now higher. With higher yields, bonds can once again serve as an attractive source of income for investors.
As fears of a recession continue to linger in the U.S. and Canada, bonds could once again recapture their status as a "flight to safety" asset. Should the economy take a downturn, bonds can provide reductions in volatility thanks to steady interest payments and high credit quality.
While aggregate bond ETFs from large fund managers like Vanguard, iShares, and BMO (TSX:BMO) are highly popular, those willing to look beyond these mainstream choices can find some highly effective hidden gems. Here's a look at some of the interesting bond ETFs listed on the NEO exchange.
Going global with bonds
As noted earlier, most Canadian investors opt for an aggregate bond ETF, which consists of government (federal & provincial) and investment-grade corporate issues averaging out to an intermediate (5-7 year) duration. This approach is low-cost and transparent but can fall short.
Namely, by buying bond ETFs that only hold Canadian bonds, investors are overly exposed to risks in the Canadian economy, such as high domestic inflation and rising interest rates. By diversifying a bond allocation globally, investors can hedge against this (as noted in this Vanguard whitepaper).
Today, both Vanguard and iShares offer global bond ETFs listed on the NEO exchange. Both ETFs are hedged to the Canadian dollar to mitigate currency volatility.
Up first is the Vanguard Global Aggregate Bond Index ETF (NLB:VGAB). This ETF uses a fund-of-funds structure to hold two U.S.-listed Vanguard ETFs covering U.S. aggregate bonds (52%) and global ex-U.S. bonds (48%). For a 0.33% expense ratio, investors receive exposure to over 16,000 global government and investment-grade corporate bonds.
For investors that dislike corporate bonds, iShares offers the IShares Global Government Bond Index ETF (NLB:XGGB) (XGGB). This ETF holds government-issued bonds from the U.S., Japan, France, Italy, Germany, Spain, the U.K., China, Canada, and many more countries. Right now, the ETF charges a 0.23% expense ratio, with an average duration of 7.36 years and a yield-to-maturity of 3.36%.
Choosing active management
Bond ETFs that track an index might be cheap, but there is a downside. When the index does poorly, the corresponding bond ETF will do so as well. By tracking an index, the bond ETF is exposed to all of its downsides, and the ETF manager cannot implement defensive measures.
On the other hand, actively managed or "unconstrained" bond ETFs are free to hedge or seek opportunities as they see fit. These bond ETFs can dynamically shift their credit quality, duration, or issuers to target the best opportunities available at the moment.
A great example is the Ninepoint Diversified Bond Fund (NLB:NBND) (NBND). This ETF focuses on active risk management, low volatility and capital preservation by investing in global bonds with a North American focus, with 82% of its portfolio held in Canadian issuers.
For a higher 0.75% expense ratio, investors get some interesting exposures. As of January 31st, NBND's largest holdings are in investment-grade corporate bonds at 75%. The ETF also holds 21% in high-yield bonds, which can offer investors greater returns at the cost of higher risk.
There's also the AGFiQ Global Multi-Sector Bond ETF (NLB:QGB) (QGB), which is Canada's first ETF to use a systematic, multi-factor approach. The majority of the ETF's exposures are from U.S. issuers (62%), with treasury and corporate bonds making up 54% and 38% respectively.
As of January 31st, 2022, QGB charges a 0.45% expense ratio, which is much lower than comparable actively managed bond ETFs in the Canadian market. The ETF currently maintains a duration of 6.22 years and a weighted average yield-to-maturity of 3.41%.
This content was originally published by our partners at the Canadian ETF Marketplace.