© Reuters. ZAG vs. VAB vs. XBB: Which Global Bond ETF is the Best Buy for Canadians?
Welcome to a series where I break down and compare some of the most popular exchange-traded funds (ETFs) available to Canadian investors!
Canadian investors looking for a hands-off, “buy the haystack” approach to their portfolio bond allocation can opt for a broadly diversified global domestic bond fund, which includes government and high-quality companies of all maturities.
Fund managers like Vanguard, iShares, and BMO (TSX:) Global Asset Management offer a set of low-cost, high-liquidity ETFs that provide exposure to a portfolio of these bonds.
The three symbols to consider today are Vanguard Canadian Aggregate Bond Index ETF (:VAB), iShares Core Canadian Bond Index ETF (TSX:XBB) and BMO Aggregate Bond Index ETF (TSX:ZAG). What is the best option? Keep reading to find out.
VAB vs. 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.
Both VAB and ZAG have an MER of 0.09% compared to 0.10% for XBB. All three are extremely inexpensive, costing around $9-10 in fees per year for a $10,000 portfolio. If we had to pick a winner, it would be either VAB or ZAG here.
VAB vs. 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.
VAB currently has an AUM of $3.2 billion, XBB has $4.5 billion, and ZAG has $5.9 billion. All three are more than enough for long-term buy and hold choices. If we had to pick a winner, it would be ZAG.
VAB vs. 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, we want bonds rated A, AA and AAA (investment grade). We don’t want junk bonds, because our goal here is to reduce volatility, not increase it.
VAB, XBB, and ZAG each contain 36%, 37%, and 37% AAA-rated debt, with an additional 35% each assigned to AA, and the remainder split evenly between A and BBB. All three funds are evenly split between federal, provincial and corporate bonds, offering a balanced combination of protection and return.
Second, check the effective term of the bond. 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 2.46 years would lose approximately 2.46% if interest rates increased by 1%. VAB, XBB, and ZAG have average durations of 7.6, 7.4, and 7.5, respectively, making them virtually identical.
Finally, we look at the weighted average yield to maturity (YTM) of bonds, which is the expected total return on a bond if held to maturity. This is influenced by the nominal price of the bonds as well as their coupon payments. VAB, XBB and ZAG have YTMs of 3.4%, 4% and 3.5%, respectively.
VAB vs. 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.
Here are the flashbacks from 2013 to today:
Here are the annual returns from 2013 to present:
The three aggregate bond ETFs performed virtually identically, except for some minor tracking errors in various years. I expect their performance to be nearly identical over time.
It’s a toss-up between VAB or ZAG for me, simply because either is just a tad cheaper (0.01%) than XBB. All three ETFs are highly liquid and popular and make excellent passive buy-and-hold choices for a balanced long-term portfolio.
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Contributor jerk Tony Dong has no position in any of the stocks mentioned. The Motley Fool has no position in the stocks mentioned.
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