Which bond ETF is the best buy for Canadian investors? By The Motley Fool

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© Reuters. ZAG vs. XBB: Which bond ETF is the best buy for Canadian investors?

Welcome to a weekly series where I break down and compare some of the most popular exchange-traded funds (ETFs) available to Canadian investors!

Canadian investors looking to maintain stability in their investment portfolio often opt for a fixed income allocation using bond ETFs. BlackRock (NYSE:) and BMO (TSX:) Global Asset Management offer a set of low-cost, high-liquidity ETFs that provide exposure to a portfolio of quality bonds.

The two symbols to consider today are the iShares Core Canadian Bond Universe Index ETF (:XBB) and the BMO Aggregate Bond Index ETF (TSX:ZAG). What is the best option? Keep reading to find out.

XBB vs. ZAG: Fees The fees charged by an ETF are expressed as a management expense ratio (MER). This is the percentage that is deducted from the net asset value (NAV) of the ETF over time, calculated on an annual basis. For example, an MER of 0.50% means that for every $10,000 invested, the ETF charges a fee of $50 annually.

XBB has an MER of 0.10% compared to 0.09% for ZAG — a $1 difference in a $10,000 portfolio. The two ETFs are nearly evenly matched, although if I had to pick a winner it would be ZAG but by a very small margin.

XBB vs ZAG: Size The size of an ETF is very important. Funds with small assets under management (AUM) may have low liquidity, low trading volume, high bid-ask spreads, and increased risk of being delisted due to lack of interest.

XBB currently has an AUM of $4.51 billion, while ZAG has an AUM of $6.40 billion. Both are more than enough for a buy-and-hold investor, but ZAG is more popular right now.

XBB vs. ZAG: Holdings When selecting a bond ETF, investors should pay attention to three considerations. First, check the credit quality of the bonds. Ideally, you want bonds rated BBB, A, AA, and AAA. You don’t want junk bonds, because our goal here is to reduce volatility, not increase it.

Second, check the composition of the bonds. Bonds are generally separated into corporate and government bonds. Corporate bonds have higher yields but also carry the risk of default, causing them to fall when stocks crash. Government bonds have lower yields but virtually no risk of default.

Third, check the effective duration of the deposit. It is a measure of the bond’s sensitivity to changes in interest rates. Bond prices move inversely to interest rates. For example, a bond with an effective duration of 8.46 years would lose 8.46% if interest rates increased by 1%.

XBB holds 34.94% federal government bonds, 35.86% provincial government bonds, 26.95% corporate bonds and 2.23% municipal bonds. The average effective duration of XBB is 7.78 years and it currently yields a yield of 2.74%.

ZAG holds 34.28% federal government bonds, 36.89% provincial government bonds, 26.61% corporate bonds and 2.22% municipal bonds. ZAG’s average effective duration is 7.83 years, and it is currently yielding a yield of 3.30%.

XBB vs. ZAG: Historical Performance One caveat before we dive into the details: past performance is not indicative of future results, which can and will vary. The portfolio returns presented below are hypothetical and retrospective. Returns do not reflect trading fees, transaction fees or taxes, which may result in drag.

The backtest I performed was not on bond ETFs in isolation, but on their performance when held as part of a balanced 60/40 stock/bond portfolio with quarterly rebalancing. This is a realistic representation of how bond ETFs are used by most investors.

Here are the flashbacks from 2011 to today:

Here are the annual returns from 2011 to present:

Both worked almost identically. Annual results may differ very slightly, but this is due to fund rebalancing, turnover and other portfolio management decisions.

If I had to pick one ETF to buy and hold, it would be ZAG for the very slightly lower MER and higher AUM. However, both ETFs have performed virtually identically over the past few years and will likely continue to do so in the future. If you like BlackRock, XBB is also a great choice.

The post ZAG vs. XBB: Which bond ETF is the best buy for Canadian investors? appeared first on The Motley Fool Canada.

Contributor jerk Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in the stocks mentioned.

This article first appeared on The Motley Fool

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