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BXF tears a strip off competitors

February 24, 2016 - 6 comments

Last year, I calculated the after-tax performance of ten short-term bond ETFs in an attempt to find the most tax-efficient of the bunch. The results were not even close – the First Asset 1-5 Year Laddered Government Strip Bond Index ETF (BXF) beat all other funds by a landslide (for the 2014 comparison, please refer to my past blog post, BXF no longer a strip tease). 

This was no surprise to me. Back in February 2013, First Asset asked Canadian advisors to tell them what’s missing from the ETF landscape. Although much sexier ETFs were proposed by much sexier advisors, I suggested a boring tax-efficient strip bond ETF…and somehow won (maybe having the word “strip” in the title made it sound sexier than it actually was). 

Fast forward three years. BXF has the lowest assets under management of all its peers, at a modest $62 million. It’s like watching your kid being picked last in sports. There’s only one difference – BXF is the better player (full disclosure: I was always picked last in sports – oh, and some of our PWL clients hold BXF).

Although it may not be the biggest ETF on the street, BXF has once again shown Canadian investors that size doesn’t matter. Not only did BXF have an after-tax return in 2015 that was more than a percent higher than the runner-up, it had a tax cost ratio of just 0.40% (a fund’s tax cost ratio is similar to a management expense ratio, but for taxes paid instead of management fees paid). It continues to gain recognition in 2016, when it was added to MoneySense’s ETF All-Stars list (Dan Bortolotti and I were part of the voting panel).

For investors who are looking for short-term tax-efficient bond exposure, BXF is expected to be the superior choice for taxable accounts. Investors and their advisors who ignore this innovative and simple product will likely continue to pay unnecessary taxes.

2015 Before-Tax and After-Tax Returns

Short-Term Bond ETF AUM (millions) 1-Year Before-Tax Return 1-Year After-Tax Return (Pre-Liquidation) Tax Cost Ratio
First Asset 1-5 Year Laddered Government Strip Bond Index ETF (BXF) $62 2.77% 2.36% 0.40%
BMO Short Federal Bond Index ETF (ZFS) $242 2.26% 1.24% 1.00%
Vanguard Canadian Short-Term Bond Index ETF (VSB) $806 2.41% 1.10% 1.28%
iShares Canadian Short Term Bond Index ETF (XSB) $2,265 2.33% 0.97% 1.33%
BMO Short Provincial Bond Index ETF (ZPS) $315 2.59% 0.99% 1.55%
Vanguard Canadian Short-Term Corporate Bond Index ETF (VSC) $731 2.55% 0.88% 1.63%
iShares Core Canadian Short Term Corporate + Maple Bond Index ETF (XSH) $411 2.62% 0.93% 1.65%
iShares 1-5 Year Laddered Government Bond Index ETF (CLF) $1,079 2.56% 0.76% 1.76%
BMO Short Corporate Bond Index ETF (ZCS) $883 2.58% 0.76% 1.78%
iShares 1-5 Year Laddered Corporate Bond Index ETF (CBO) $2,091 2.14% 0.03% 2.06%

Sources: CDS Innovations, BlackRock Canada, BMO Asset Management, First Asset ETFs, Vanguard Investments Canada, Canadian Portfolio Manager

By: Justin Bender with 6 comments.
  15/12/2016 3:50:43 PM
Justin Bender
@Kevin: The weighted-average coupon on a short-term bond ETF (like XSB) is about 2.65%, while it's yield to maturity before fees is about 1.41%. Until these two metrics are close to equal, BXF is still expected to be more tax-efficient.
  15/12/2016 2:04:23 PM

Will BXF keep it's tax advantage vs the others with the increasing rates we've recently seen?

Thank you for your thoughts.
  15/06/2016 12:51:48 PM
Justin Bender
@Eric - this is an issue when holding most bond ETFs (including VSC) in a taxable account. Although VSC has a net YTM that is about twice as high as BXF (1.8% vs. 0.9%), it also has a higher coupon of about 3.2%, which is taxable to the investor. It is this higher coupon that causes the tax-inefficiency (BXF is full of strip bonds, so you basically pay tax on the YTM).

I tend to also use GICs if I don't require the liquidity, as they have a higher yield than both VSC or BXF, and they do not have the same tax-inefficiency issues.

If you haven't done so already, please read through this article and try to work through the calculations in the examples:
  15/06/2016 9:50:48 AM
Hi Justin,

Really appreciate your continued analysis of tax advantaged fixed income options in the canadian market.

I'm curious why the return of BXF (even before tax considerations) is higher than all other competitors when most of those funds have much higher yields. I believe I also noted a similar pattern for ZDB.

In particular, I own BXF for its tax advantages, but would actually be comfortable with a bit more risk, so was considering a switch to VSC, which has 2-3x the yield. I thought this was sure to come out ahead of BXF even after tax considerations, but now this analysis is making me reconsider keeping BXF.

Or is the high performance of BXF these past two years a fluke of money flows and investor sentiment, and you think VSC (and the like) actually should outperform (as would be expected based on the higher risk) going forward?

Thanks for your thoughts!
  11/04/2016 12:31:20 PM
Justin Bender
@Chad - I'm not sure if your estimates are following my methodology. If we assume the highest combined tax rate in Canada for 2016 (58.75%), and subtract the MER of 0.11% from the YTM and coupon of VSC, we would end up with the following calculator inputs:

FV = 100
YTM = 2.09
Maturity = 3.40
Coupon = 3.19
PV = -103.79093 (solve for this)

If we assume that you invest $103,790.93 in VSC, and receive $100,000 back at maturity in 3.4 years, we would get the following:

Coupons = $10,846
Taxes = -$6,372
Capital Loss = - $3,791
Equals = $683.04, or about 0.19% after-tax per year (it would be higher if you could offset the capital loss against other gains)
  10/04/2016 1:19:47 PM

Interesting analysis as always.

While this article looks at the historic tax efficiency from the 2015 calendar year, I would also be grateful for your comments on how this analysis may be affected by the anticipated after-tax total returns of the respective investments.

Using the methodology detailed under the PWL blog "Can You Earn a Negative After-Tax Return on a Bond ETF?", VSC - for instance - appears to have an anticipated after-tax return of 1.42%, including the expected capital loss from a higher 3.3% weighted average coupon rate compared to the 2.2% weighted average YTM (using Feb 28 2016 data). Alternatively, BXF appears to have an anticipated after-tax return of 0.72%.

While tax efficiency is certainly important in taxable accounts, the YTM of BXF is currently 1.1%, suggesting that a more tax "inefficient" vehicle could yield a higher anticipated after-tax return.

Best regards

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