This post is the first in a planned series called Under the Hood, where I’ll take a detailed look at a specific ETF or index fund.
The fund: Claymore 1–5 Year Laddered Corporate Bond ETF (CBO)
The index: CBO tracks the DEX 1-5 Year Corporate Bond Index, which appears to have been custom-made for this fund. The index lays out a set of rules for building a laddered portfolio of short-term, investment-grade corporate bonds. It includes 25 bonds divided into five equal “buckets”: five of the bonds have a term to maturity of 1–2 years, five others have terms of 2–3 years, and so on up to 5–6 years.
The cost: The MER is 0.28% as of June 2009, including a management fee of 0.25%.
The details: Claymore launched this ETF just over a year ago and it has been very popular, with an average daily trading volume of about 115,000 shares. It’s a well-designed index: the laddering technique is an excellent way to achieve a balance between good yield and a minimum of interest-rate risk. (In most cases, bonds with longer terms have higher yields, but their market value will fall more sharply when interest rates go up.)
CBO currently pays a quarterly distribution of $0.24, which works out to a yield of about 4.6%. However, the average yield to maturity is about half that. Without getting too deeply into bond math, what this means is that all of the bonds were bought at a premium (a price higher than their face value). Eventually the fund will probably suffer a series of small capital losses as these bonds are sold, so the total annual return on the ETF may be lower than that 4.6% yield suggests. That’s not a knock against CBO specifically: with interest rates at rock bottom and likely to rise this year, just about every bond fund is in this boat.
I was confused when I looked at the individual bonds in this fund. Because this is a short-term fund, I was expecting to find only bonds with maturities between 2010 and 2015. In fact, one matures in 2020, and two are dated 2049. I contacted Claymore to ask why, and they explained that these bonds are callable within five years, which means that the issuer can redeem them before the maturity date. In the past, these bonds have always been called by the banks after five years, so for all intents and purposes, they behave like short-term bonds.
The alternatives: CBO’s closet competitor in the marketplace is BMO’s Short Corporate Bond (ZCS). BMO’s fund is more diversified (it holds 66 bonds rather than just 25), but it’s also more expensive (0.35% MER) and it doesn’t use the laddering strategy.
iShares Canadian Corporate Bond (XCB) and iShares Canadian Short-Term Bond (XSB) are similar, but with important differences. XCB holds mid- and long term corporate bonds as well those with less than five years to maturity; XSB is about 70% government bonds and only 30% corporates.
The bottom line: Claymore’s 1–5 Year Laddered Corporate Bond ETF is an excellent choice for the corporate bond portion of a Couch Potato portfolio. I feel that its low cost and laddered structure give it an edge over its competition. It’s also eligible for Claymore’s dividend reinvestment plan (DRIP), which is a nice feature in a bond fund that pays a substantial yield.
Disclosure: I own CBO in my own portfolio.