Fixed Income Investment Choices As of March 11 to March 13, 2023
This article will look at some fixed income choices in the Canadian market. The examples are those available at TD Direct / TD Waterhouse accessible for those with investment accounts at TD Direct. Similar products are likely available at the other discount broker provides.
Interest rates and therefore the yields on fixed incomes and the prices change constantly. Therefore the following is indicative of the market as of the date written. The same products will be available over time but the prices and yields will change.
The following discussion is for investing in fixed income for interest yield purposes. Bonds can also be used to speculate on interest rates as discussed in our brief article on bond trading.
Taxation: Interest and foreign dividends are better earned in non-taxable accounts while Canadian dividend income is best placed in taxable accounts for those with taxable investment accounts.
Savings Accounts within Investment Accounts
For short term investments, TD offers TDB8150. It currently pays interest at the rate of 4.05% annually. That’s up from 0.25% in 2021! Although it is not a mutual fund, it is purchased on the TD site under the mutual fund category. This is a bank account product and therefore qualifies for Canadian Deposit Insurance for the first $100,000. The advantage of this product is that it is a bank account that can be accessed within the TD brokerage account system including within an RSP. There are many higher interest savings accounts “out there” but they simply cannot be accessed from within a TD investment account.
For U.S. funds, TD offers TDB8152 currently yielding 4.15% per year.
GICs
Guaranteed Investment Certificates or GICs are available with fixed terms from 1 month to five years and also a few up to ten years. In almost all cases the money is locked in for full term and they cannot be cashed early. The rates mentioned below are those that can be purchased within a TD Direct investment account. (This was as of March 11, 2023.) Small institutions may offer better rates if we invest directly with them. But we can’t do that if we wish to keep our investments with TD. I have no great loyalty to TD but I don’t want to get involved with multiple institutions. I prefer having all my investments visible in one place and all my tax slips available in one place.
GIC rates vary quite widely. Some institutions may not be interested in attracting for example 1 month or 1 year GIC deposits at this time for various reasons
For terms under one year, TD offers rates of 3.0% to 4.2%.
For a one year term, TD Bank is offering 4.8% and the best one year rate available on the TD site is Equitable Bank at 4.91%.
For a three year term, TD Bank is offering 4.15% and the best rate is Equitable Bank (and a few others) at 4.4%.
For a five year term, TD is offering 4.0% and the best rate is Equitable Bank and B2B Bank at 4.30%.
Until recently, GIC rates were too low to be of any interest (pun noted) to me. But now they can definitely have a place as part of the fixed income allocation in a portfolio. While grabbing the 4.8% one year term looks like a great option we don’t know if rates will remain this high a year from now. Therefore, placing some funds in the longer term GICs may be prudent.
Bonds
TD Direct offers a rather limited selection of bonds. I’ll discuss some of them below.
Government Bond Examples
An example is a government of Canada bond maturing April 1, 2024 (just over one year). The coupon is a lowly 0.25%. This bond was issued in October 2020 and is now nearing maturity. Because the 0.25% interest yield is well below the current market yield on such a one-year government bond (which is about 4.8%) you can buy this bond at a discount to its face value.
For a $20,000 face value the offer price was $96.415. So, you would pay $96.415 and receive total interest of about $0.25 per $100 par value purchased over 12 months and then receive back the $100 face value. The sell price for $20,000 of this bond was $$95.775. That’s a buy/sell spread of 0.65%. The buy/sell spread cost is about $130 on a $20,000 investment.
With bonds, unlike stocks, you get a better price if you invest a higher amount.
It may be possible to get a slightly higher yield by phoning in to the Fixed Income Desk of a broker (in this case TD Direct).
This short-term government of Canada bond would be purchased by institutional investors and corporations including banks and possibly some retail investors with very large portfolios. The attraction of this investment would be its unquestioned safety and liquidity. Bank deposits above $100,000 do not qualify for deposit insurance and with very large amounts even bank accounts may not be considered safe enough.
A 5 year government of Canada bond is currently yielding about 2.97% which is lower than the interest rate available on shorter term bonds and investments.
Most retail investors should probably stick with GICs and not invest in government bonds which are a more sophisticated investment. Also the GIC yields are high for terms up to 5 years.
Corporate Bonds – Investment Grade
Looking at investment grade corporate bonds the yields on higher-rated bonds:
The yields are not much over 4% for 5 or 6 year terms. That does not seem particularly attractive at this time compared to GICs.
A RioCan bond due in 6 years is yielding 5.0%.
Longer term bonds are generally yielding from 4.5 to 5% which may be attractive for some investors for a portion of a portfolio.
High Yield Bonds
TD offers a small selection of “high-yield” corporate bonds from only 15 different corporations. There is a fairly wide range of term lengths from less than a year to over six years. The credit ratings range from BB (high) down to CCC / not rated. A complicating factor here is that some of these are callable before maturity. If called the yield is usually reduced. The stronger the credit rating the more likely the company would be in a position to call the bond and reduce its borrowing costs.
Included in the list is an AutoCanada 5.75% bond due February 2029. It’s selling at a discount to yield 8.1% and it’s not callable. But be aware that bonds considered high yield are more risky.
These bonds can only be purchased by phoning the Fixed Income Desk. It’s not clear what bid/ask spread might apply. I would want to know that at purchase even if I intended to hold until maturity. The size of the bid/ask spread is effectively a “hidden” commission fee in my view.
Convertible Debentures
A category of fixed income that TD does not include on their Fixed Income page but which can be bought from any brokerage account is convertible debentures. These pay interest but also come with the option to convert into shares. The conversion price is typically materially higher than the stock price at issue and so the debentures would only be converted if the share price rises substantially. The word debenture signifies that these debt instruments are not secured by any particular assets but instead are based on the overall credit worthiness of the issuing entity. In general, these are less secure certainly than investment grade bonds. They are usually “subordinate” to other debt, meaning they have a lower claim in the event of a liquidation of the issuer. In most cases they could probably be considered to be a type of high yield debt. In many cases the issuer has the option to redeem the debt as shares (at a modest discount to the prevailing share price) rather than pay in cash at maturity. In that sense they are not as “fixed” as a bond. However, in most cases they will be redeemed in cash at maturity unless the issuer has run into considerable financial difficulty.
A big advantage of convertible dentures is that they trade on the stock exchange. This makes it easy to see the bid/ask spread – which should still be considered to be a sort of “hidden” commission fee. It is also easy to see and understand the trading liquidity.
My preference would be to buy these for the yield as opposed to the conversion option. If I I wanted to “bet” on a share price increase I could buy shares directly or even invest in options. Therefore, my preference would be to buy issues where the conversion option is far out of the money and seems unlikely to occur. I also prefer the issue to be trading at or under par value of $100. I don’t like the idea of buying a debt instrument that has a built in capital loss at maturity.
Unfortunately, I don’t know of any good listing of all the convertible debentures.
One that I am familiar with is a 5.1% issue by the Melcor REIT. It matures at the end of 2024 so has about 1.8 years until maturity/ It currently trades at $95 so the total yield to maturity is about 8.4%.
On its face this looks to me like an attractive Fixed Income option. But given the risk investors should also consider diversifying. My understanding is that there are many convertible debentures to choose from that offer what appears to be relatively attractive rates.
Strip Bonds
Strip bonds are interesting. There are no interest payments along the way. These bonds offer a known capital gain.
These are best suited to a non-taxable account. The capital gain on strip bonds is treated as interest income and the tax is payable annually on the imputed interest. Whether this is a good investment depends on the outlook for inflation and interest rates. The bid /a sk spreads on these can be high. If investing in these, you would want to contact the Fixed Income Desk and try to negotiate a better deal and try to insist that the bid/ask spread be lower.
New Issues
The advantages of buying bonds through new issues is that you avoid bid/ask spreads and that small investors get the same price as larger investors. In the case of new issues, the issuing company pays the commission.
To buy these, register with your broker to be alerted about new issues. A down-side is that you may have to prepared to act quickly as these can sell out quickly.
Those interested in bond investing should register to be alerted about new issues. A good variety of bonds will show up over time.
Taxation:
Bond interest is taxed as regular income. Capital gains and losses on bonds are treated like other capital gains and losses and taxed at half the regular rate. Note that strip bonds are taxed based on imputed interest. It’s preferable to hold bonds in non-taxable accounts if possible. Strip bonds in particular are best suited to non-taxable accounts.
Conclusion
Yields on fixed income including some cash accounts and including GICs have suddenly become attractive after many years at very low rates. Be cautious because given the hidden nature of buy / sell spreads on bonds it is easy to over-pay. Be cautious too in understanding the nature of the investment including its trading liquidity and its susceptibility to market value losses due to higher interest rates or a deteriorating credit rating. Interest rates can change rapidly and so the opportunities available do change over time.
END
Shawn Allen
InvestorsFriend Inc.
March 11 to 13, 2023.