Investors who do not want to adjust their risk profile should try to shorten the duration of their bond portfolio. Shorter-term bonds pay less interest than longer-term ones, but have less potential for capital losses if rates soar. Consider bonds with higher yields, such as high-yield (junk bonds) or investment-grade corporate bonds, or ETFs holding them.
Note VAB is roughly half in shorter-term bonds, but has a healthy smattering of bonds maturing anywhere from five to 20 years or more from now. Vanguard’s popular Asset Allocation ETFs hold VAB as a major part of its domestic fixed income, along with U.S. and foreign equivalents. Most of the equivalent AA ETFs from iShares, Horizons and BMO are in the same boat.
So it was with interest that I noted the announcement from Vanguard’s U.S. parent company of a short-term actively managed bond ETF which addresses some of these concerns. The Vanguard Ultra Short Bond ETF (VUSB) invests primarily in bonds maturing in zero to two years. It’s considered low-risk, with an MER of 0.10%. There are no immediate plans to launch the equivalent in Canada, says Vanguard Canada spokesperson Matthew Gierasimczuk. Of course, Canadians are free to buy the U.S.-dollar equivalent, just as they can any foreign ETF trading on American exchanges. Just be aware of the added layer of currency risk.
Can funds like this allay the above concerns, or are investors better off leaving some of their cash equivalents in short-term GICs or highly liquid, relatively high-yielding daily interest savings accounts?
Here’s what ETF All-Star panellist Ben Felix, of Ottawa-based PWL Capital, has to say about VUSB: “I don’t think a fund like this replaces a high-interest savings account or GIC because its price can fluctuate. If someone has a fixed cash need this might not be ideal.”
Felix says VUSB’s investment objective is to provide current income while maintaining limited price volatility. It invests in a diversified portfolio of high-quality and, to a lesser extent, medium-quality fixed income securities and is expected to maintain a dollar-weighted average maturity of 0 to 2 years. It invests in money market instruments and short-term high-quality bonds, including asset-backed, government and investment-grade corporate securities.
“Although short-term bond funds tend to have a higher yield than money market funds, their share price fluctuates,” Felix says, “Because the Ultra-Short Bond fund will subject investors to principal risk, the fund shouldn’t be viewed as a substitute for a money market fund. Additionally, increases in interest rates can cause the prices of the bonds in the portfolio, and thus the fund’s share price, to decrease.”
That said, Felix is not too concerned about rising rates. “Bonds are never a good place for cash needs. If rates rise, prices drop, and yields rise. Maturities and coupons get reinvested in higher yielding bonds. As long as the duration of the bond fund isn’t too out of line with the investor’s horizon, it shouldn’t be too bad.”