Tax efficient fixed-income investing
Bond funds with favourable after-tax returns
I am rarely one to let the tail wag the dog when it comes to taxes, but with yields on fixed income funds likely to be muted in the near to medium term, reducing potential taxes will become increasingly important for non-registered investors. This is because any distributions from fixed-income funds or exchange-traded funds (ETFs) are likely to be considered regular income, which is taxed at the investor’s highest marginal tax rate. So anything you can do to reduce the amount of taxable income paid will go a long way to improving your total return.
Unfortunately, there are not as many ways to reduce taxable income in corporate accounts as there used to be. With the 2018 tax season now a distant, unpleasant memory, I thought it might be timely to take a look at a few of the options available for fixed-income investors, to get ready for this year’s taxes.
Horizons Canadian Select Universe Bond ETF (TSX: HBB) – Offered by Horizons ETFs, this fund is designed to track the Canadian bond market as represented by the Solactive Canadian Select Universe Bond Index. What makes this fund unique is that it uses a total-return swap structure, which means there are no taxable distributions being generated by the fund. This means that the fund’s return will be treated as a capital gain rather than as interest income. The ETF carries a management fee of 9 basis points, plus a SWAP fee that will not exceed 0.15%.
Natixis Canadian Bond Fund – This Natixis fund offers a unique structure that allows investors to select the type of income they would like to receive: capital gains; dividends; or return of capital.
Within this structure, there are a few different fixed-income options, but the most attractive in my view is the Natixis Canadian Bond Fund managed by Toronto-based J. Zechner Associates. It invests in a diversified portfolio of predominantly Canadian bonds. At the end of May, it held roughly 35% in corporate bonds, 45%in governments, and the balance in cash. Performance has been middle of the pack, but when you factor in the ability to choose the type of income you are able to receive, the after-tax performance becomes considerably more attractive.
Dynamic Advantage Bond Class – This defensively managed bond fund has been one of my favourites for many years. Recent performance has lagged somewhat, given the defensive positioning of the fund. But because it is offered in a corporate class structure, net return to investors in taxable accounts is improved.
CI Investments – There are a couple of CI corporate class offerings that may be worth looking at in non-registered accounts: Signature Canadian Bond Class and Signature Corporate Bond Class. Managed by the Signature team at CI, these funds offer more tax-favourable exposure to Canadian bonds and high-yield fixed income.
CI Signature Corporate Bond Class has done better on both an absolute and relative basis than the Signature Canadian Bond Class. However, both funds have done better than many of their peers when the impact of taxation is taken into account.
Canoe Funds – Canoe also has a couple of funds worth taking a look at in the corporate class structure. Canoe Global Income is a go-anywhere global bond fund. It’s not the type of fund that will shoot the lights out, but it is expected to deliver steady, stable results over time, resulting in better risk-adjusted returns than its peers. Factor in the more favourable tax treatment and you have a fund definitely worth looking into for non-registered accounts.
Canoe Bond Advantage is another corporate class bond fund worth investigating in more depth. So far this year, returns have trailed, but the longer-term numbers have been above average. Again, factor in the more favourable tax treatment and the fund becomes even more attractive.
Canoe Credit Opportunities Portfolio Class is a high-yield offering that provides exposure to a diversified basket of global non-investment grade bonds. It’s managed by AEGON Investment Management. It wouldn’t be my pick in the space on a before-tax basis, but it is a solid offering after taxes.
While not a complete list of corporate class offerings, these funds should help you reduce the amount of taxes paid in your non-registered investments, at least when it comes to your fixed-income allocation.
Dave Paterson, CFA, is a money manager and an expert on investment fund research and due diligence on a variety of investment products.
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