Fixed Income Investment Choices As of July 20, 2024
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 4.3% 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.
For U.S. funds, TD offers TDB8152 currently yielding an attractive 4.9% per year.
These accounts can be very useful to “park” cash. Cash provides stability in a portfolio and provides immediately available “dry powder” in case bargains appear.
All the other Canadian big bank discount brokers offer very similar high-interest savings accounts for investors. Sadly, these accounts are not available not available in bank savings accounts but only available in investment accounts.
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 July 20, 2024.) 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 4.6%.
For a one year term, TD Bank is offering up to 5.0% which is the best one year rate available on the TD site.
For a three year term, TD Bank is offering 4.4% and the best rate shown is Fairstone Bank at 4.4%.
For a five year term, TD is offering 4.35% and the best rate is HomeEquity Bank at 4.44%.
With interest rates expected to decline, some investors may wish to lock in these rates. A laddered approach using, for example, one, three and five year GICs is often seen as a prudent approach.
Bonds
TD Direct offers a rather limited selection of bonds. I’ll discuss some of them below.
Government Bonds
Government bonds currently have lower yields than GICs. But they offer the ability to sell and liquidate the investment at any time. They also fluctuate in market vale as interest rates change. That can provide the opportunity to make a capital gain.
Its important to understand that bonds trading at above the par price of 100 will suffer a capital loss when the ultimately mature at par value. Therefore their effective yield to maturity is lower than their coupon interest rates. Conversely, bonds trading at prices below the par value of 100 will provide a capital gain at maturity and therefore their effective yield to maturity is higher than their coupon interest rate. Canadian government bonds are considered to be extremely safe.
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).
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 3.39% 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.
If you do wish to purchase government bonds, it may be be best to stick with new issues only. That way you buy at or near par value and you avoid hidden commissions associated with bid / ask spreads in the secondary market.
Corporate Bonds – Investment Grade
Corporate bonds offer a higher interest rate but are less safe.
Investors should stick with the bonds of high quality companies with strong credit ratings.
If you wish to purchase commercial bonds, it may be be best to stick with new issues only. That way you buy at or near par value and you avoid hidden commissions associated with bid / ask spreads in the secondary market.
High Yield Bonds
TD currently offers a small selection of “high-yield” corporate bonds from only 11 different corporations. The maturity lengths are short and the maximum available is under five years. The credit ratings range from BBB minus and BB (plus) down to BB minis. Only one of the eleven companies listed is considered to be investment grade. 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 a Parkland corporation 6.0% coupon bond with a BB credit rating maturing June 23, 2028 and trading at about par value. 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.
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 /ask 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 become attractive after many years at very low rates. And now with interest rates expected to decline it may be a very opportune time to lock in today’s yields before they head lower. 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.
July 20, 2024.