The Scam of the Century

As I have been researching fixed income investments over the last few months I have come to the conclusion that, “Fixed Income Mutual Funds are the Scam of the Century”. My research has confirmed my assumptions that every single Canadian fixed income fund has under preformed the Scotia Bank Universe Bond Index over the last 10 years. The simple reason for this problem are the exorbitant MER “Management Expence Ratio” which fund companies charge investors. The MER on Canadian fixed income mutual funds ranges everywhere between 1% to 2%. In a world of of low yield which currently preside, where the Canadian 10 year bond is currently yielding 4.017% an investor is loosing 25 to 50 percent of their profit to management fees while the rest of the profits are lost to inflation and taxation. Furthermore fixed income managers add little value since most investments constitutes government bonds which are risk less and do not require any risk analysis. “If an investor wants exposure to fixed income the investor should manage it individually“.

The Following are some steps an individual can take:

1) One option is to simply take out a bank CD and renew it once it matures. While the yield on CD may be slightly lower than current interest rates it is still better alternative than a fixed income mutual fund. With yields at chartered banks currently above 4.5 % it beats any fixed income fund.

2) The second option is to buy a Canadian Fixed income ETF through the Canadian iShares ETFs. These Exchange Traded Fund will track the fixed income indices, while boasting reasonable MERs between 0.30% to 0.40% making them a much better alternative than buying a fixed income mutual fund while achieving the diversification. Furthermore ETFs are tax efficient and generally more efficiently managed than mutual funds. The following are the current Canadian Fixed Income ETF’s.

a. CDN Bond Index Fund (TSX:XBB)
b. CDN Corporate Bond Index Fund (TSX:XCB)
c. CDN Government Bond Index Fund (TSX:XGB)
d. CDN Long Bond Index Fund (TSX:XLB)
e. CDN Real Return Bond Index Fund (TSX:XRB)
f. CDN Short Bond Index Fund (TSX:XSB)

3) The third alternative to a fixed income mutual fund is to buy preferred shares which pay a fixed dividend per share per year. While you can buy a preferred share ETF, which is the Claymore S&P/TSX CDN Preferred Share (TSX:CPD), I would rather pick individual preferred shares. In next week’s post i will further describe the benefits of preferred shares and reveal my preferred share picks for 2008.

4) The fourth option is to buy a TSX listed capital trust from a major Canadian financial firm such as BNS Capital Trust (TSX:SBA), Manulife Financial Capital Trust (TSX:MFT), RBC Capital Trust (TSX:RYT), TD Capital Trust (TSX:TDD). When you buy a unit of this trust your lending money to these major banks/insurance companies. In return your will get around a 7% yield instead of the 4% you get from a GIC from the bank as a retail consumer. These capital trust are similar to bonds as they pay regular interest income and they will mature at a future date.