In February 2014, BMO released a more tax-efficient version of their flagship BMO Aggregate Bond Index ETF (ZAG). They called their new fund the BMO Discount Bond Index ETF (ZDB). The fund’s strategy was to buy Canadian government and corporate bonds that were trading at par or at a discount to their par value (for a more detailed discussion of ZAG vs. ZDB, please refer to Dan Bortolotti’s blog post, New Tax-Efficient ETFs from BMO). By purchasing lower coupon bonds, the ongoing interest received would be lower than traditional bond ETFs, resulting in a relatively lower tax liability for taxable investors). Clever strategy in theory, but let’s see whether this more tax-efficient structure actually worked out for investors.

The Results

Using my after-tax rate of return calculator, I’ve compared the returns of five plain-vanilla broad market bond ETFs that were available during the entire 2015 tax year. Before-tax, ZDB returned 3.60%, placing it in first place. After-tax, ZDB maintained its first place ranking, returning 2.52%. Its 2015 tax cost ratio (which is similar to a management expense ratio, but for taxes paid instead of management fees paid) was also the lowest of the group, at 1.04%.

2015 BEFORE-TAX AND AFTER-TAX RETURNS

BROAD MARKET BOND ETF AUM (MILLIONS) 1-YEAR BEFORE-TAX RETURN 1-YEAR AFTER-TAX RETURN
(PRE-LIQUIDATION)
TAX COST RATIO
BMO Discount Bond Index ETF (ZDB) $184 3.60% 2.52% 1.04%
iShares Core High Quality Canadian Bond Index ETF (XQB) $307 3.38% 1.87% 1.46%
Vanguard Canadian Aggregate Bond Index ETF (VAB) $581 3.48% 1.91% 1.51%
BMO Aggregate Bond Index ETF (ZAG) $859 3.24% 1.61% 1.58%
iShares Canadian Universe Bond Index ETF (XBB) $2,042 3.14% 1.39% 1.70%

Source: CDS Innovations, BlackRock Canada, BMO Asset Management, Vanguard Investments Canada

In the chart above, it is also interesting to note that only $184 million is currently invested within ZDB (which is less than 5% of the total assets under management of all five bond ETFs). Hopefully this analysis will help to alert investors and their advisors to more tax-efficient alternatives to their current fixed income picks.