Buying strip bonds
Question: I recently received an intriguing question from a member of my Internet Wealth Builder newsletter, as follows: I am planning to purchase some individual strip bonds in my RRSP (probably issues that mature in 2014 or 2015) but am unsure whether to buy regular Government of Canada strips or Canadian Government Real Return Bond (RRB) strips. It appears that both are currently yielding somewhere around 5.5%.Given that both types of strips would be of equal quality (guaranteed by the feds), what are the criteria I should use to choose between them? Is it simply a matter of my inflation expectations? That is, if I believe inflation will stay low, I should buy regular strips, and if I think inflation will rear its ugly head in the next five years or so, I should buy RRB strips? Love to hear your analysis.” – T.B.
Strip bonds aren’t very popular these days with interest rates so low, but if you go out 10 or 12 years you can get some acceptable yields, at least by current standards. As long as you plan to hold until maturity, you’ll get the projected return. The danger is that if rates rise and you sell early, you’llake a big hit. So be sure you’re in for the long haul.
Now to the specific question. For starters, I could not find anyone who was quoting the same yield on regular Canada strips and on Canada RRB strips. The numbers I got from RBC Dominion Securities in mid-August were as follows:
Regular Canada strips maturing March 2015: 5.48%
Canada RRB strips maturing December 2015: 3.01%
Clearly, there is a huge difference. However, the yield on the RRB strips will rise with inflation over time. Whether it will ever match the return on the regular Canadas will depend on the inflation rate. That is unlikely to rise any time soon, but who knows where we will be in five years.
If the IWB member was being quoted similar yields on regular Canada strips and RRBs, I can only assume that the RRB yield was based on a projection that makes certain inflation assumptions. That means it is not guaranteed. Given the current investment climate, I’d be more comfortable going with the guaranteed return on the regular strips.
Usually, RRB strips are not recommended for RRSPs. Some institutional investors use them, but for active trading purposes with a view to making a capital gain on spread movements.
Anyone who is considering buying strips for an RRSP might want to look at other alternatives that offer higher yields. For example, a British Columbia strip maturing Dec. 15, 2015 was quoted to me in mid-August at a 5.86% yield. There’s slightly more risk here than with a Canada strip, but not a lot.
If you’re prepared to look at corporate strips, a Bell Telephone issue maturing in December 2015 was yielding 6.59%.
As for me, I bought a TransCanada Corporation strip maturing in 2017, with a yield of 7.4%. I’m sure TransCanada will still be around then. I hope I will be too. (Sept. 2003)
Adapted from an article that originally appeared in the Internet Wealth Builder, a weekly electronic newsletter the provides top-quality, conservative investment advice. To take advantage of a three-month trial subscription available to 50plus.com users for just $24.97 plus tax, go to http://www.buildingwealth.ca/promotion/50plusproducts.htm