Many investments are sold as “income” or “bond alternatives”: high-yield bonds, preferred shares, private credit funds, covered-call bond ETFs. Some have a place in a portfolio. Few behave like bonds when it matters. This last module puts each one through a single test, then you write your own one-page fixed-income plan.
High-yield bonds are the BB-and-below bonds from Module 4: loans to companies that rating agencies consider speculative. They pay more because more of them default, and because they behave badly at the worst moment.
When the economy weakens, two things hit high-yield bonds together. Defaults rise, and credit spreads widen sharply, pushing prices down. In 2008, US high-yield bonds lost roughly a quarter of their value while high-quality government bonds rose. In March 2020 they dropped sharply again in a matter of weeks.
That makes high-yield bonds something in between: their returns over time have sat between government bonds and stocks, and in a crash they act more like stocks.
Canada has one of the world’s larger markets for preferred shares, issued mostly by banks, insurers, utilities and pipelines. They pay a fixed or semi-fixed dividend, usually on a $25 par value, and rank between bonds and common shares: a company must pay its preferred dividends before any common dividends, but bondholders come first.
Example. A rate-reset preferred has a $25 par value and a reset spread of 2.5 points. If the five-year yield is 1.0% on the reset date, the new dividend rate is 3.5%, or $0.875 a year per share. If the five-year yield is 4.0%, it is 6.5%, or $1.625.
That design hurt investors twice. When five-year yields fell sharply, in 2015 and again in early 2020, rate-reset dividends were set to reset lower, and Canadian preferred share prices fell by double digits. They also tend to fall with stocks in a crisis, since they are shares, not loans. And the issuer can usually redeem them at par on a reset date, which it tends to do when that suits the issuer, not you.
On the plus side, their dividends are usually eligible dividends, taxed more lightly than interest in a taxable account (Module 9).
| Product | What it is | The catch |
|---|---|---|
| Private credit funds | Loans to private companies, held in a fund that is not listed on an exchange | Redemptions are often limited or can be suspended; prices are updated rarely |
| Private mortgage funds and MICs | Pools of private, often higher-risk mortgages | Several Canadian funds have frozen redemptions when borrowers fell behind |
| Convertible bonds | Bonds that can be swapped for the company’s shares | Behave increasingly like the stock; often lower-rated issuers |
| Covered-call bond ETFs | A bond ETF that sells options for extra income | Gives up price gains when rates fall, exactly when bonds are meant to cushion you |
Private funds deserve a closer look, because they often look safer than they are. A fund that values its loans only now and then reports smooth, steady returns. That is not the same as low risk. If you cannot sell on a bad day at a market price, you have no way to know what your holding is really worth, and you may not be able to get your money when you need it.
Before choosing anything, decide what job your fixed income has to do. Most portfolios ask it to do one or more of three:
| Job | What it needs | Good fits |
|---|---|---|
| Spending money for the next few years | A known amount on known dates; no price risk | GICs, a ladder, short-term government bonds, target-maturity ETFs |
| Shock absorber in a crash | Holds up or rises when stocks fall | High-quality government and provincial bonds, broad bond ETFs |
| Reserve for rebalancing | Easy to sell when stocks are cheap | Broad or short-term bond ETFs |
Everything in this course comes together in one page. Fill it in using the notes box on this page. The “+ Key rules” button adds a blank template to start from.
Example. A $200,000 portfolio with a 40% fixed-income target holds $80,000 in fixed income. If $30,000 will be spent over the next five years, that goes in a five-rung GIC ladder of $6,000 per rung. The other $50,000 sits in a broad bond ETF with a duration around 7, inside an RRSP, as the shock absorber and rebalancing reserve.
Educational purposes only; not financial advice. Any bonds, funds, tickers, rates and figures are illustrative examples, not recommendations. Interest rates, deposit-insurance limits and tax rules change, so confirm current details with the issuer, CDIC and your tax authority. Worked examples are not forecasts. Written by Elizabeta Dimoska. Always do your own research and consult a licensed advisor.