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New bond ETFs a rung higher than funds

There are two new reasons for investors to consider exchange-traded funds before they so much as touch a mutual fund.

One is the Claymore Premium Money Market ETF, which will be listed for trading on the Toronto Stock Exchange on Feb. 19. The other is the Claymore 1-5-Yr Laddered Government Bond ETF, which began trading last week under the symbol CLF. Both are low-fee options in categories where cost is the crucial difference between products.

The money market ETF is meant to be used in the same way as any counterpart offered by a mutual fund company. It's designed as a safe parking place for cash and holds a mix of Treasury bills and banker's acceptances (a bank-guaranteed way for a company to raise funds). There's no asset-backed commercial paper, which is a riskier type of investment that some money market funds have used to boost returns.

The management expense ratio (MER) of this money market ETF will be 0.25 per cent, which means the gross returns of the underlying investments are reduced by just one-quarter of a percentage point.

The average Canadian money market fund has an MER of 1.04 per cent, which is one of the worst fee grabs in the investing world when you consider how low interest rates are.

Low MERs are the key in choosing money market funds, which are basically a widget-like product that leaves little room for one fund manager to beat another. Interesting side note: The Claymore money market ETF is actively managed and does not track an index, as almost all of these funds do.

The new Claymore bond ETF is a low-cost alternative as well, and we'll get to that in a moment. But first it's worth looking at how this product has been designed to assume the problematic but important job of setting up a bond ladder.

Laddering means dividing the money you invest in bonds or guaranteed investment certificates into five equal portions that go into terms of one through five years. Each year, you roll a maturing bond or GIC into a new five-year term, thereby ensuring that you get a piece of the action when interest rates are rising, and that you're not too badly exposed when rates fall.

There are two difficulties with laddering that the new bond ETF addresses. One is getting a decent yield on your bonds - retail investors usually pay a premium price for bonds, while an institutional investor like Claymore gets a better deal. The higher your price for a bond, the lower your yield. Also, it's tricky to add new money to a bond ladder. Do you split the new funds among all the maturities, or do you make a guess about which one to overweight?

Claymore's new product tracks the DEX 1-5-Year Laddered Government Bond Index, which is made up of bonds issued by federal and provincial governments and agencies. Claymore said the index has been constructed to exactly reflect the process by which an investment adviser would maintain a bond ladder for a client, which means annual rebalancing.

The new Claymore fund's competition in the ETF world is the iShares Cdn Short Bond Index Fund (XSB), which focuses on an index tracking one- through five-year bonds. There are technical differences between the two funds, but for retail investors the big issues are cost, liquidity and index composition.

Claymore's bond fund has an MER of 0.15 per cent, aggressively undercutting the market-leading iShares fund's 0.25 per cent. Trading volumes for the Claymore fund so far are much lower than the iShares product, and this is reflected in a larger bid-ask spread (the gap between the highest amount investors are offering to buy shares and the lowest price at which they're willing to sell). Larger bid-ask spreads can add to your costs, which means they're a consideration.

As for index composition, the Claymore fund goes with safe government bonds, while the iShares includes somewhat riskier corporate names that could help push up returns a bit.

Both the Claymore and iShares bond ETFs are a better choice than pretty much all short-term bond funds, which carry MERs averaging an utterly deplorable 1.61 per cent. As with money market funds, high fees are a killer with bond funds.

Claymore has produced some research showing that the 30 largest funds in the Canadian fixed-income category had almost one-third of their gross returns eaten up by fees over the past three years on average.

This would be an ideal point to note that the iShares Cdn Short Bond Index Fund has averaged 4.4 per cent annually over the past five years, which beats all but one of the 50-odd funds in the Canadian short-term fixed income category.

It's great to see Claymore and the iShares family from Barclays Global Investors battle each other on fees, as they're doing with their short-term bond ETFs. The more business these firms soak up, the more pressure there is on the fund industry to do something about its fees.


Mutual funds versus ETFs

With interest rates as low as they are, smaller fees help maximize your returns from bond funds. Here are some details on how bond ETFs compare with traditional bond mutual funds.

Short-term bond funds

MER (%)1-year Return (%)*
Mutual fund average1.612.64
iShares CDN short bond index fund (XSB-TSX)0.253.75
Claymore 1-5-Yr laddered government bond ETF (CLF)0.15n/a

Broad market bond funds

MER (%)1-year Return (%)*
Mutual fund average1.741.9
iShares CDN bond index fund (XBB)0.33.3

Long-term bond funds

MER (%)1-year Return (%)*
Mutual fund average1.032.6
iShares CDN long bond index fund (XLB)0.352.9

Real-return bond funds

MER (%)1-year Return (%)*
Mutual fund average1.391
iShares CDN real return bond index fund (XRB)0.351.2

*To Dec. 31


© 2007 The Globe and Mail. All rights reserved.

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