Q&A: Bond funds

Question: I would like to increase my bond exposure through ETFs and I am considered iShares DEX Universe Bond Index Fund (TSX: XBB) or the iShares DEX Short Term Bond Index Fund (TSX: XSB). What I am concerned about is if interest rates begin to rise the price of the fund will drop in order to increase yield, eroding the principal invested. Since this would be done for registered accounts I would end up losing capital. Given my late 50s age this would impact my RRSP and I would not able to write off the capital loss. Is there a safe way to invest in bonds without this risk? I would seem to me that this is a substantial risk at the present time. – Charles S.

Gordon Pape answers: All bonds carry the type of risk you describe. However, the shorter the term to maturity, the less the risk. Therefore it follows that a short-term bond fund such as XSB would be less risky than a universe bond fund such as XBB. That said, neither fund has ever posted a large loss over a 12-month period. The worst year for XBB was the 12-month period to June 30, 2006 when it dropped 0.98%. XSB had its worst year at the same time, losing 0.52%.

If you want to consider a mutual fund, Fidelity Canadian Short Term Bond Fund is a good bet. Its worst 12-month performance since its launch in early 1995 was -0.13%, also in the period ending June 30, 2006. HSBC Mortgage Fund and National Bank Mortgage Fund have never had a 12-month losing period.