Fixed Income Choices February 2021

Fixed Income Investment Choices As of February 22 to 24th 2021

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.

Savings Accounts within Investment Accounts

For short term investments, TD offers TDB8150. It currently pays interest at the rate of only 0.25% annually. 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. Although the interest rate is extremely low, it is still better than the 0.0% that is currently paid on cash in TD investment accounts.

For U.S. funds, TD offers TDB8152 also currently yielding 0.25% per year.

TD also offers the ability to invest in similar bank accounts of other banks but none appear to be paying any more than 0.25% and the RBC version appears to be paying nothing.

GICs

Guaranteed Investment Certificates or GICs are available with fixed terms from 1 month to five years and also a few up to tens 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 February 22, 2021.) 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 0.15% to 0.25%. This is less than or equal to the bank account rate mentioned above.

For a one year term, TD Bank is offering 0.50% and the best rate available on the TD site is Equitable Bank at 0.67%.

For a three year term, TD Bank is offering 0.60% and the best rate is Equitable Bank at 1.07%.

For a five year term, TD is offering 0.75% and the best rate is Equitable Bank at 1.47%.

In my opinion, none of these are attractive. In my opinion, locking in for longer periods at these rates does not seem worth the extra return. I’d rather accept the 0.25% bank account rate and retain the flexibility to take advantage of possible higher rates in future. For those with very large portfolios that have at least several hundred thousand in cash more or less permanently parked, it might be worth locking in. But locking in could mean missing out on higher rates and precludes investing in something else.

Bonds

TD Direct offers a rather limited selection of bonds. I’ll discuss some of them below.

Overall, I find the yields on high quality bonds to be unattractive. This is mostly due to low interest rates. But, on top of that, in some cases there is a very wide bid / ask spread that arguably represents a sort of hidden trading cost and that further lowers the yield.

Government Bond Examples

Government of Canada bond maturing June 1, 2022 (just over 15 months). The coupon is 2.75%. This bond was issued in 2011 and but is now nearing maturity. Because the 2.75% interest yield is above the current market yield on such a government bond (which is apparently under 0.20%) you have to pay a premium above the face value of the bond to buy this bond.

For a $5000 face value the offer price was $103.74. So, you would pay $103.74 and receive total interest of about $3.44 over 15 months and then receive back the $100 face value. This is clearly a terrible investment and the overall yield is negative 0.204% per year. The sell price for $5000 of this bond was $102.74. That’s a buys/sell spread of 0.96% (considerably higher than the yield). The buy/sell spread cost is about $48 on a $5000 investment.

With bonds, unlike stocks, you get a better price if you invest a higher amount.

For a $100,000 face value purchase the offer price is $103.34 and the yield to maturity is 0.105%. This again is unattractive to most retail investors since bank accounts within an investment account currently pay 0.25%. The sell price for $100,000 of this bond is $103.135 for a bid/ask spread of 0.20% which amounts to $200 on $100,000 and can be considered to be a sort of “hidden” trading fee.

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 withy very large portfolios. The attraction of this investment would be its unquestioned safty and liquiity. Amounts above $100,000 do not qualify for deposit insurance and with very large amounts even bank accounts may not be considered safe enough. Also, consider that on, say $10 million it is better to receive say 0.15% or $15,000 as opposed to nothing.

Long term Government of Canada bond due December 1, 2048 (27.75 years). This bond was issued in 2014 as a 34 year bond paying 2.75%. The wholesale market yield on a bond of this long maturity is about 1.8% as of the day of writing this. For that reason, you would have to pay a premium above face value to buy this bond.

For a $50,000 investment, the offered price was $120.733. Specifically, you invest $49, 500.53 (plus a small amount of accrued interest), for $41,000 face value. You collect $1,127.50 per year in interest and then get back $41,000 principal in 2048. The yield to maturity is (a paltry) 1.798%. This does not strike me as a good investment. This bond is subject to substantial loss in market value if interest rates rise. And it is guaranteed to ultimately mature at a capital loss of $20.733 per $100 purchased. The selling price on this bond is $119.483 for a bid/ask spread of  (a hefty) 1.05%. That would amount to a sort of “hidden” trading fee of $525 on a $50,000 investment. It’s very interesting and important to note that the bid/ask spread on this bond is five times larger than on the 15 month bond discussed above. It appears that even Canadian government bonds can have vastly different bid/ask spreads which likely depends on their trading liquidity.

Corporate Bonds – Investment Grade

Looking at investment grade corporate bonds the yields on higher-rate bonds here are three examples:

TD Bank rated AA due December 9, 2025 (so roughly 4.75 years). The yield if purchased is about 1.19% to 1.20% for investments of $20k and $50k. And the buy/sell spread on the $50k is 60 basis points, so $300.

Equitable Bank rated BBB due November 26, 2025 (so 4.75 years) paying 1.876%. For $20k, the offer price is $99.744 for a yield of 1.932%. For $50k worth the price is $99.664 for a yield of 1.95%%. Interestingly there is no offer price. If you owned this in a TD investment account you would have to call the Fixed Income Desk to get an offer if you wanted to sell. The interest rate here is quite low. But this is a safe fixed income investment and the maturity is less than five years away. Some retail investors might find this to be a better alternative than sitting on cash at 0.25% and hoping for rates to rise.

The highest yielding investment-grade corporate bond that TD offers is the following:

Telus Corporation BBB (high) rated due November 7, 2030 (so about 9.7 years) paying 2.05%. The offer price is $96.99 for a $50k investment yielding 2.403%. TD does not show a bid price. This could be of interest for part of a large portfolio. 2.4% is certainly better than 0.25%. But this bond is subject to significant market value decline if interest rates rise. And selling it would likely incur a bid/ask spread as high as 1.0%. And November 2030 is a long time to wait for a chance to reinvest at a higher rate. 

At this time, TD is not offering any investment-grade corporate bonds with terms over ten years. 

High Yield Bonds

TD offers a small selection of “high-yield” corporate bonds from only 9 different corporations. There is a wide-range of term lengths from less than a year to almost ten years. The credit ratings range from BB (high) down to CCC / not rated. A complicating factor here is that many of these are callable before maturity. If called the yield is usually sharply 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 a Bombardier 7.35% Bond due December 2026. It’s selling at a discount to yield a hefty 10.28% and it’s not callable. That’s tempting. But Bombardier a junk credit rating of CCC for S&P and apparently DBRS declines to put any rating on it. Bombardier’s debts significantly exceed its assets. This is a highly risky investment. While governments will do all they can to protect jobs at Bombardier, governments have little interest in protecting bond investors. My feeling is that this is not suitable for the fixed income portion of a portfolio where safety is key. This is a speculative bet. If investing in this it should probably be considered as part of the equity or risk portion of a portfolio. 

From the TD high-yield list, I will highlight one that might be of interest.

TransAlta Corporation 7.3% due October 22, 2029 (8.7 years) rated BB+ by S&P and rated somewhat higher at BBB(low) by DBRS. Offered at $122.35 to yield 4.195%. I’m not a fan of the built in capital loss at maturity but the overall yield could be tempting. And, if interest rates are rising the 7.3% (5.97% of purchase price) coupon can be reinvested at higher rates. 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 f 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 4.7% convertible debenture issues by Alcanna (a liquor and Cannabis retailer). This matures in just 11 months on January 31, 2022. It’s convertible at $14.60 which is far above the current share price of $7.25 and therefore the conversion option is likely of no value and is not likely adding much if any to the trading price of the debenture. This debenture, as of the time of writing, trades at a bid of $100.01 and an offer of $100.99. Note that there is a difference in yield of about 1.0% between the bid and the offer. The offer price would be a yield of about 3.6%. I am not aware of the credit rating but considering the 4.7% yield and a maturity less than a year the market must consider this to be a higher risk investment.

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.

Here is one example:

Bell Canada due November 2041 (20.75 years). TD offers this at $38.599 to yield 4.6485%. It’s perhaps intriguing to invest $38,599 today and be certain (as long as Bell Canada does not go broke) of getting $100,000 in just under 21 years. In particular this is 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. TD offers to purchase this bond at $37.288. That’s a bid/ask spread of 3.5% or a sort of hidden fee of about $1300 on a $38,500. That seems quite excessive. If investing in this, you would want to contact the Fixed Income Desk and try to negotiate a better that and try to insist that the bid/ask spread be far 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.

TD Direct offered only one bond new issue as of February 24, 2021 as follows:

Province of Manitoba 2.05% due June 2, 2031 (10 years and 3 months) and rated A minus. The offering was at $99.723 to yield 2.08%. This is not highly attractive but may be preferable to accepting 0.25% and waiting for higher rates.

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 taxes as regular income. Capital gains adn 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 are low but there depending on circumstances and your outlook for interest rates, you may wish find some worthwhile choices. Be cautious because given the hidden nature of buy / sell spreads 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.

February 24, 2021.