How to Save 86% on Your Core Fixed Income Fees*

Key Takeaways

• An all-in-one fixed income solution at a target MER of 0.09% for the F-Series²
• An effective core portfolio building block for your fixed income sleeve
• Invests in all domestic investment grade bonds with full-term exposure
• Fund invests 100% of assets in the BMO Aggregate Bond Index ETF (Ticker: ZAG), which provides consistent monthly income, with an annualized distribution yield of 3.47%, as of April 6, 2023³

A decade ago, our ETF team launched the BMO Aggregate Bond Index ETF (ticker: ZAG). What is the rationale for offering this strategy in a mutual fund version? And why now?

MM Over time, ZAG has become a leader in the Canadian fixed income space. With more than $6 billion in assets under management, it’s recognized as the largest fixed income ETF in the country—and I think that speaks volumes.⁴ Now, investors who want the mutual fund wrapper can get that same aggregate bond exposure at the cost of nine basis points for the F-Series.¹ That’s an 86% discount to the Canadian industry average,¹ so the BMO Aggregate Bond ETF Fund is well positioned relative to our peers. Opening the door to the mutual fund investor base is something we’ve wanted to do for a long time. We saw tremendous volatility in fixed income during the past two years, and many investors were caught on the wrong side of a yield or duration trade. But the importance of diversification came back into the limelight, as did a focus on cost efficiency, and the time seemed ripe to ensure Canadians continue to get the best of both ETFs and mutual funds.

“Canadian Fixed Income” is the third largest mutual fund category by assets. It is a core portfolio building block. How does this mandate improve on what’s already available?

MM For clients who are looking for an aggregate bond exposure, the Fund provides a great landing spot—and that’s coming from a cost, allocation and size perspective. We diversify by sector, maturity and credit, so there are elements of the portfolio that will perform well in any environment, and that’s really what you want from your core positions. Depending on what the market is doing, you could then complement the core to be more tactical in the current climate. Getting exposure at the lowest cost in the category, at just nine bps for the F-Series, allows you to complement with more attractive, potentially more costly, satellite holdings. Essentially, ZAG can provide low-cost beta in your portfolio for that foundational building block of fixed income allocation.

What about Advisors who prefer an active fixed income approach?

MM It’s not necessarily active versus passive. At BMO Asset Management, we look at the two parts as being complementary to each other. And what’s great about this is that we can pair active and passive where we see the value. That’s where ZAG can really be beneficial. Getting the core of your fixed income portfolio at a low cost allows you to make more active decisions or take bigger risks around the periphery and be more tactical.

For example, as a portfolio manager, if you believed the market was undervaluing an opportunity in Canadian corporate bonds, you could simply add a tactical sleeve like the BMO Corporate Bond ETF Fund to implement that viewpoint. Or if you wanted to reach for higher yields through options strategies, using something like the BMO Premium Yield ETF Fund, you could dial that exposure up or down as the market changes. In either case, the core of your portfolio would remain broadly diversified, providing a counterbalance to your active positions.

As mentioned, the Fund invests 100% of its assets into ZAG. Can you provide an overview of the types of bonds held within the underlying ETF?

MM Absolutely. ZAG invests in a diversified portfolio of Canadian federal, provincial, municipal and corporate bonds. From a quality perspective, it’s 100% investment grade—that’s a BBB rating and above. As a whole, the average credit quality of the Fund is AA, so you’re getting very high-quality exposure. The allocation skews heavily towards government issuances—you generally get about 40% federal, 30% provincial and municipal combined, with the remaining 30% corporate. To summarize the weighted average duration, you’re getting about 7.3 years.⁵ The Fund invests in bonds of all maturity levels: long, mid and short.

The portfolio tracks over 1,400 bonds across Canada. Can you break down the process for selecting what goes into the portfolio?

MM At the end of the day, our job is to track the underlying index to the best of our ability. The portfolio currently has about 1,478 bonds, whereas there are about 1,662 in the index. To align with the benchmark, we look at several metrics—including duration, sector, subsector, yield, key rate, quality and issuer risk—and create a threshold for each characteristic to ensure we are not too overweight or underweight in any individual aspect. The way the underlying index works is that there is a daily rebalance. Anytime an issue comes to market, as a management team, we must decide whether it will benefit the portfolio from a tracking perspective. That’s how we deliver value for clients—by constantly looking for ways to add new securities and provide the most index-like exposure possible.

The last few years have been a rollercoaster for fixed income investors. How has the underlying ETF performed recently?

MM Last year was an extremely challenging time for many investors, as the Canadian fixed income universe saw the worst returns on record. We saw stocks and bonds go down simultaneously, an event that has only happened three times in 150 years. From a tracking perspective, ZAG was very tight to the index. As we look forward, however, there are a lot of opportunities in the space—some, that we haven’t seen in a while. To think, the last time we saw credit yielding where it is today was in 2007. During that year, the Canadian Bond Universe returned 3.68% while the S&P/TSX Composite also delivered gains of approximately 9.83%. However, in the following year, the equity index saw a significant negative return, whereas the fixed income index was largely positive. Year to date, we have seen a bounce back in fixed income performance, with the Canadian Universe returning 3.4% in just over four months (as of April 21, 2023). We are also starting to see stability in interest rates, with the Bank of Canada pausing hikes, which should lead to some strong performance for the remainder of the year. With exposure to corporates and the long end of the curve, we believe ZAG is well positioned for the environment ahead.

Matt, one last question. We often ask our portfolio managers to provide a book or podcast recommendation that they think our Advisor audience would enjoy. What has piqued your interest lately?

MM I think Young Forever: The Secret to Living Your Longest, Healthiest Life by Dr. Mark Hyman is a must-read for anyone looking to improve their quality of life as a driven professional. How we eat and exercise supports sustainable health practices, creating simple rules to live by, and helping us de-stress after a long day. Finding the right balance can set us up for success throughout the week, particularly when life gets busy. Remember, health is wealth.