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From The Financial Post

Bonds finally get respect

They let you keep your capital -- what a concept!

Jonathan Chevreau, Financial Post Published: Thursday, February 19, 2009

As the stock market tests new lows, bonds are getting more respect from investors. That's why the just-released second edition of bond guru Hank Cunningham's In Your Best Interest (Dundurn Press, 2009) should get more attention from suddenly risk-aware Canadian Baby Boomers.

An RBC poll yesterday found one in four Boomers are delaying retirement because of the troubled stock market and economy. Many are learning they cannot rely solely on equities for their retirement needs, Cunningham says. Once the mortgage is gone and the children grown, investors should start skewing their asset mix to individual fixed-income securities whose income stream and future value are known, he adds.

His two bedrock tenets of bond investing are to keep what you start with and earn a return on it. The new edition reviews what happened to Canadians who ignored this and reached for yield through income trusts: money that belonged in fixed income wound up in risky equity-type investments. Even worse was the licking investors suffered by reaching for a minuscule extra yield through asset-backed commercial paper or ABCP.

The Canadian bond market was worth $1.15-trillion at the end of 2007, according to the Bank of Canada. Because credit risk is paramount, Cunningham suggests sticking with government bonds and corporate bonds rated A or better, for those with at least $10,000 to invest. Investors should build bond "ladders" with maturities staggered over 10 years to diversify interest-rate and reinvestment risk. Ideally, he says in an interview, the first five years would be in corporate issues and the last five in provincials. Further out, he likes inflation-linked real return bonds, if held to maturity.

He dislikes high-fee bond mutual funds, whose future value and income levels are uncertain. Nor does he recommend bank term deposits or GICs, which are illiquid and too short-term for long-term planning. He also avoids hybrid structured products like principal-protected notes.

The book includes a primer on commission spreads, transparency, markups and commissions. Larry Swedroe's

The Only Guide to a Winning Bond Strategy You'll Ever Need

(St. Martin's Press, 2006) covers similar ground. A recent Swedroe essays warns the broker-dealer community often exploits individual investors with markups (when investors buy bonds) and markdowns (when they sell bonds), which are may only be the tip of the iceberg in bond costs.

Cunningham says corporate Canadian bonds currently offer 370 basis points (3.7%) more yield than government issues, but investors must pay close attention to credit ratings and not put more than 10% into any one corporate issue. The domestic corporate bond market is worth about $275-billion.

For purchases below $10,000, he prefers exchange-traded funds (ETFs), especially for foreign high-yield or "junk" bonds. The iShares CDN Corporate Bond Index Fund (XCB/TSX) holds 254 issues and has an MER of 0.4%, but 55% of the dollar value is concentrated in Canadian financial issuers. However, even its U. S. equivalent -- iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD/NYSE) -- is more than 40% in financials and exposes Canadian investors to currency risk.Bonds finally get respect

They let you keep your capital -- what a concept!

Jonathan Chevreau, Financial Post Published: Thursday, February 19, 2009

Unless you plan to retire in the United States, Canadians should stick to domestic bonds, since the loonie is likely to rise against the greenback, Cunningham says. What risk investors do take should be in U. S. dividend-paying stocks.

However, Dan Janis, manager of the MFC Strategic Income Fund, believes the loonie will fall from here to as low as US74? relative to the greenback. He thinks there are bigger opportunities in U. S. corporate bonds. The extra yield over government issues may be as high as 500 basis points, while high-yield U. S. bonds will yield 900 to 1,500 more basis points, says Janis, who runs Canadian and U. S. version of the funds for Manulife Financial.

But you have to do your homework, he concedes, a point that's all too clear in Cunningham's new edition.

jchevreau@nationalpost.com - Jonathan Chevreau is the author of Findependence Day and blogs at www.wealthyboomer.ca.

 You can also read more about this here at www.financialpost.com/analysis/story.html?id=37df9092-2cb0-464e-b27c-8df20c7cdf8

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