News flash: Bonds to trade on the TSE; Did you know that bonds, in the form of bond ETFs, are already trading on the TSE - Exchange Traded Funds

"Bonds to trade on the TSE." If this headline ran in today's newspaper, it would be big news. Bonds trading on the TSE? The truth is that bonds have in essence been trading on the TSE since November, 2000, in the form of bond exchange traded funds (ETFs).

Bond ETFs share many similarities with their equity-based ETF cousins. Both trade continuously throughout the day, stock trading techniques apply (ie. stop orders, limit orders, etc.) and each are cheaper relative to traditional active and index mutual funds. The average annual MER on an active bond fund, an index bond fund and a bond ETF are 1.79%, 0.94% and 0.25% respectively. Currently, there are only two fixed-income ETFs. They are the first in the world and are run by Barclays Global Investors Canada. The iG5 (TSE:XGV) and iG10 (TSE:XGX) each own a single Government of Canada bond with approximately a five-year (iG5) or 10-year (iG10) year term to maturity. This exposure is maintained by exchanging the current bond holding for a new one, approximately once a year.

For the individual investor the advantage of using ETFs versus the bonds themselves is two fold. Institutional pricing means the bonds are bought at the best possible price and therefore the highest possible yield within the ETF Also covered by the paltry 0.25% MER are the "roll costs," or the costs that would otherwise be incurred to sell the current bond and buy the replacement bond each year.

Traditional active and index bond funds consist of a diversified portfolio of bonds. This makes sense when you wish to hold bonds of varied credit quality. Diversification reduces the risk. However, evidence shows that bonds of a similar quality and maturity vary little in terms of risk and returns. They tend to act as a group, rising and falling together in response to changing economic conditions or interest rates. If you want to hold long-term government bonds in your portfolio, for example, it is therefore not necessary to hold several bonds - a single bond will give you the benefits you desire. Holding a great number of bonds will simply produce higher expenses.

For many investors, bond ETFs belong as the "core" of the fixed income portion of the portfolio. Used in conjunction with individual bonds and active bond funds in a "core and explore" arrangement, bond ETFs will keep costs down, allow for risk management and should yield better overall results. These are still early days in ETF offerings. So stay tuned, because the next headline you are likely to see will involve new fixed-income ETFs, possibly on both sides of the border.

Howard Atkinson, CFA, CIMA, is author (with D. Green) of The New Investment Frontier: A Guide to Exchange Traded Funds for Canadians. He is also the National iUnits Marketing Manager at Barclays Global Investors Canada, Ltd. Phone 416-594-4404.

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