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After-Tax Returns of Strip Bond ETFs

December 22, 2014 - 3 comments

On June 11, 2013, First Asset released a new short-term bond ETF comprised entirely of strip bonds. It seemed like an odd choice at the time, seeing as there were already many short-term bond ETFs available to Canadian investors. Relative to the existing products, the First Asset 1-5 Year Laddered Strip Bond Index ETF (BXF) was expected to give investors a leg up when they held the ETF in their taxable accounts (Dan Bortolotti discusses the reasons for this in his blog post Why Use a Strip Bond ETF?).

Has this been the case in practice? Although it is too early to compare the after-tax returns for the 2014 tax year, we do have access to six months of data from July 2013 to December 2013. While I admit this is an extremely short time frame, it should give us some insight into whether the strip bond ETF has been more tax-efficient than other plain-vanilla bond ETFs.

Using the same methodology found in our white paper, I’ve calculated the after-tax returns and the tax cost ratio of various short-term bond ETFs. The results were not surprising; the strip bond ETF had a higher after-tax return and a lower tax cost ratio (which is a good thing) relative to the other ETFs. It also had a higher before-tax return, but this may be a result of its higher duration and First Asset’s no management fee promotion over the period.

Before deciding on which bond ETF to purchase, it is important for taxable investors to understand the impact that improper product location can have on their after-tax returns. Bond ETFs that trade at a premium to their par value (such as XSB, ZPS, VSB and CLF) should be restricted to tax-deferred and tax-free accounts. Strip bond ETFs (such as BXF) may be a more tax-efficient solution for investors who hold bond ETFs in their taxable accounts.

By: Justin Bender with 3 comments.
Filed under: Bonds, ETFs, Tax-efficiency
Comments
  14/03/2017 2:09:55 PM
Lyla
This is first year I have owned this fund. What type of tax document should I be expecting? Is there something different with regards to the ACB I should be aware of? Can I just follow your White Paper to understand this type of security?

Lots of questions...newbie, but learning thanks to all your help here and with CCP
 
  23/02/2015 10:37:34 AM
Justin Bender
@Park - First Asset has addressed this issue by distributing a quarterly dividend (they keep a small amount of cash available to do so).
 
  22/02/2015 12:34:20 PM
Park
With strip bonds, you pay tax every year, but you don't get any return until you redeem or sell the bond. So although you've solved the problem of premium bonds, you've created another one: you're prepaying tax.
 



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