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Canadian Business Article re: Bond Funds

Time to flock to mutual bond funds?
Calvin Leung
Canadian Business Online, March 10, 2006

"It's never a good time to invest in actively managed mutual bond funds," says W.H. "Hank" Cunningham, author of In Your Best Interest: The Ultimate Guide to the Canadian Bond Market and the senior vice-president of the Toronto-based Blackmont Capital, an independent investment dealer. Such funds rely on investing professionals to deliver above average returns, by buying and selling bonds at the most profitable times. But according to Cunningham, the owners of these products are "paying an average of 1.8% [of the value of their holdings] per year for the privilege of having somebody guess and gamble with your money." As interest rates go up, bond values fall, and vice-versa. He points out the well-known fact that "nobody has been able to predict the direction of interest rates 100% of the time." Cunningham claims most bond mutual fund managers make the right call three-quarters of the time, but that those decisions don't make up for their mistakes, dooming unit holders to returns below those of benchmark indices. "I'm not making this up," he insists. "I was a mutual bond fund manager for 10 years."

By contrast, a passively managed mutual bond fund simply mimics the performance of a benchmark index by essentially mirroring its holdings. Cunningham sees these types of investments as a far better choice than actively managed mutual bond funds. Cunningham suggests the passively managed iUnits Canadian Bond Broad Market Index Fund (5-year compounded annual return 7.0%, as of January 31, 2006). He points out that the fund trades on the Toronto Stock Exchange under the ticker XBB, tracks the performance of the bond market by mimicking the Scotia Capital Universe Bond Index and charges only a 0.3% annual fee.

Cunningham says building a "bond ladder" is an even better moneymaking strategy than investing in a passively managed mutual bond fund. Basically, you take a sum of money, divide it into ten equal parts and then invest one portion into a bond that will mature in one year, another portion into a bond that will mature in two years, and so on, up to a final portion in a bond that will mature in 10 years. When your first bond matures, you re-invest the money into a bond that will mature in 10 years. Then, when your next bond matures, you again re-invest the money into a bond that will mature in 10 years, and so on. Cunningham goes into the details of this approach in his book, In Your Best Interest, and lays out its benefits, like reducing the impact of changing interest rates on your returns and adding a degree of certainty to your investments.

Given his opinion on the unpredictability of interest rates, Cunningham doesn't believe there's a right or wrong time to be invested in bonds. He champions always owning a diversified mix of cash, stocks and bonds that match an investor's expectations on returns and stomach for risk.

Of course, Cunningham represents just one opinion on investing in bonds. Mutual fund guru Gordon Pape believes the professionals in charge of the actively managed Philips, Hager & North's Total Return Bond Fund deserve their 0.61% annual fee. The fund boasts a 5-year compounded annual return of 7.1% (as of January 31, 2006) and is Pape's top mutual bond fund pick for the long-term. He points out investors will need $25,000 to open an account with PHN. For those without that kind of cash, Pape recommends the TD Canadian Bond fund (5-year compounded annual return of 6.7%, annual management fee of 1.39%).

Like Cunningham, Pape believes investors should always have a diversified portfolio that includes bonds to reduce risk. So if you don't own any now, the right time to invest in some appears to be yesterday.

Calvin Leung is a staff writer with Canadian Business and writes about investing and other topics. Prior to joining the magazine, in 2005, he worked in sales at Procter & Gamble, in marketing at Unilever and in advertising as a freelance copywriter.

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