Bonds,,, James Bonds,,,,

Bonds, you say??  Remember the stiff paper Canada Savings Bonds you grandparents bought you?  An institution for sure.  Over the last year and a bit as people try to shake that post traumatic stress out of their portfolio's there has been much-a-do about fixed income and bond funds.  I thought I'd do a little 101 on bond funds and what terms like "spread" and "Yield" mean.

I have to do math in round numbers or else I get really flustered so for argument sake lets take $100 and invest it in a bond. That bond has a "coupon" of $5 when it matures at some pre determined point in the future..  So, it has a return of 5%.  With me so far?  Good.  So what happens when investors go crazy for things other than bonds, such as stocks?  Well the demand for the bond goes down, so now that bond is only worth $95, but the coupon is still $5, thus the return or yield is now 10%.  Make sense?

So what happens when everyone flocks to bonds??? Ahhhh  good question.  The opposite.  The coupon is still $5 but the bond price may now be $104 due to robust demand so the yield is only 1%.  The difference between the bond price and the bond yield is called the spread.

Then how do you make money with bonds when they are in demand?  The trick is to use a good fund manager.  That person is going to take a look at the supply and demand aspects of how bonds are priced and will choose bonds that mature in a short period of time and bonds that mature over a longer period of time.  Banks, corporations and provincial and federal governments are always issuing bonds for sale.  More or less they are saying, if you give us a sum of money today, we promise to give you a sum of money at a certain period in time in the future.  Some times the spreads for having some of your money are quite attractive, even if it is just for a short period of time and other times you will have to wait it out to get your money.  Good bond fund managers will do the analytics and hold the right amount of short term and long term bonds.

Check out the gang at Beutel Goodman to see what can be achieved when bond fund trading is done well.  Their Corporate/Provincial Active Bond fund has returned over 7% in the past 10 years.  The TSX certainly has not!!  Holding some bond funds in your savings portfolio is a smart idea.  Whoda thunk they could be that interesting??

Over and out,,,,