When should I use the BMO Discount Bond Index ETF (ZDB)?
The BMO Discount Bond Index ETF (ZDB) has been slow to gather assets since its launch in early 2014. This may be due to investor inertia or confusion over the reasoning behind holding discount bonds. There are generally two situations in which an investor may want to consider investing in ZDB rather than the more popular BMO Aggregate Bond Index ETF (ZAG):
1. They hold all of their bonds in a taxable account
With bond yields hovering near record lows, some investors have opted to hold bonds in their taxable accounts and stocks in their RRSP accounts. The issue with this strategy is that lower bond yields do not necessarily mean lower bond coupons. ZAG and ZDB both have a yield-to-maturity of 2.3% (which is the best estimate we have of their future before tax returns). But ZAG has an average taxable coupon of 3.9%, while ZDB has an average taxable coupon of 2.3%. All else equal, an investor would be expected to pay less tax and have higher after-tax returns if they held ZDB rather than ZAG in their taxable accounts.
Example: Balanced portfolio using ZDB in a taxable account
| Exchange-Traded Fund (ETF) |
Allocation (%) |
Taxable Account ($) |
RRSP Account ($) |
| BMO Aggregate Bond Index ETF (ZAG) |
0% |
|
$0 |
| BMO Discount Bond Index ETF (ZDB) |
40% |
$40,000 |
|
| BMO S&P/TSX Capped Composite Index ETF (ZCN) |
20% |
$10,000 |
$10,000 |
| BMO S&P 500 Index ETF (ZSP) |
20% |
|
$20,000 |
| BMO MSCI EAFE Index ETF (ZEA) |
20% |
|
$20,000 |
| Total |
100% |
$50,000 |
$50,000 |
Sources: BMO Asset Management, PWL Capital
2. They hold some of their bonds in a taxable account
For investors that hold the same mix of bonds and stocks in their RRSP and taxable accounts, using ZAG in the RRSP and ZDB in the taxable account will also likely result in higher after-tax returns (all else equal).
Example: Balanced Portfolio using ZDB in a taxable account and ZAG in an RRSP account
| Exchange-Traded Fund (ETF) |
Allocation (%) |
Taxable Account ($) |
RRSP Account ($) |
| BMO Aggregate Bond Index ETF (ZAG) |
20% |
|
$20,000 |
| BMO Discount Bond Index ETF (ZDB) |
20% |
$20,000 |
|
| BMO S&P/TSX Capped Composite Index ETF (ZCN) |
20% |
$10,000 |
$10,000 |
| BMO S&P 500 Index ETF (ZSP) |
20% |
$10,000 |
$10,000 |
| BMO MSCI EAFE Index ETF (ZEA) |
20% |
$10,000 |
$10,000 |
| Total |
100% |
$50,000 |
$50,000 |
Sources: BMO Asset Management, PWL Capital
When does it not make sense to use ZDB?
As most investors know, “all else” is not always equal. The selection of discount bonds in the Canadian marketplace is slim pickings, making a discount bond ETF like ZDB more exposed to corporate issuer risk than a broad market bond ETF like ZAG. For instance, ZDB holds over 3% in Telus corporate bonds, whereas a typical bond ETF would have less than a 1% allocation to the same issuer.
If you hold all of your bonds in an RRSP account, it makes little sense to invest in ZDB. A plain-vanilla bond ETF like ZAG would be the preferred choice, due to its increased diversification.
| Exchange-Traded Fund (ETF) |
Allocation (%) |
Taxable Account ($) |
RRSP Account ($) |
| BMO Aggregate Bond Index ETF (ZAG) |
40% |
|
$40,000 |
| BMO Discount Bond Index ETF (ZDB) |
0% |
$0 |
|
| BMO S&P/TSX Capped Composite Index ETF (ZCN) |
20% |
$20,000 |
|
| BMO S&P 500 Index ETF (ZSP) |
20% |
$20,000 |
|
| BMO MSCI EAFE Index ETF (ZEA) |
20% |
$10,000 |
$10,000 |
| Total |
100% |
$50,000 |
$50,000 |
Sources: BMO Asset Management, PWL Capital