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Opportunity in Real Return Bonds?

October 15th, 2008 ·

Regular government bonds have been a source of comfort for investors in the raging credit storm but there is one class of bonds that has been disappointing: real return bonds. Unlike regular bonds, the principal and interest on real return bonds is adjusted for inflation. Real return bonds are popular when the threat of inflation is upper-most in investor’s minds. Due to the credit crunch, investors are far more worried about the dreaded D-word: deflation. As a result, real return bonds have sold off sharply and these bonds now yield a real return of 2.4%.

[Bank of Canada 1-year chart of Real Return Bond Yields]

If the sell-off continues and yields reach 3%, it may not be a bad time to initiate or add to a position in this asset class. It is best to hold real return bonds in a tax-deferred account such as a RRSP as the interest payments and inflation adjustment is taxed at marginal rates. Bylo Selhi’s Real Return Bonds for Canadian Dummies is an excellent resource on this topic.

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8 responses so far ↓

  • 1 Dividend Growth Investor // Oct 16, 2008 at 10:22 am

    It’s very funny how things changed in 3 short months. In july Oil hit $147/barrel and we were going to see $200, $500, $1000 oil.. One quarter later oil has dropped over 50% and now all of a sudden we are worried about deflation.

    There’s one thing I don’t know about real return bonds - if there’s deflation do the adjust your principal downwards or do they keep it at the last inflationary hike? ( or should I say predeflationary levels).

    If they don’t adjust real return bonds for deflation, then go for it.. However it is during market crises like the one we are currently in when on realizes that diversification is important. It’s funny however that almost all assets including commodities, foreign and domestic stocks ( small, mid, large) are lower in 2008. The assets that are making money are fixed income and US dollars.

  • 2 Canadian Capitalist // Oct 16, 2008 at 12:16 pm

    DGI: Incredible isn’t it? So much for “decoupling”.

    I think in deflationary periods RRB principal is revised down. That’s why they have sold off. But I think a 3% real return is attractive even in a deflationary environment. Of course, regular bonds will do much better.

    Pretty much everything is on sale now — even with the USD strength, US stocks are still down a lot for Canadian investors. Only fixed income is doing well.

  • 3 Returns Reaper // Oct 16, 2008 at 1:03 pm

    Does anyone know what the options are for purchasing Canadian RRBs?

    Barclay’s iUnits Real Return Bond Index ETF (XRB) would be one way. I believe the MER is 0.35%.

    But I wonder what the options are for purchasing the bonds directly. The bylo FAQ indicates they can be purchased at ‘Most full service and discount brokers’. I tried digging around on E*Trade and they didn’t appear to offer them, unless they were hidden amongst the long lists of standard Canadian Bonds.

    Does anyone know which discount brokers sell Canadian RRBs?

  • 4 Phil S // Oct 16, 2008 at 7:50 pm

    I use BMO Investorline and I also manage my mother’s account in TD Waterhouse. You can purchase Government of Canada Real Return Bonds through both of them. I bought my GoC Real Return Bonds a few years ago and back then, I had to talk to someone at the bond desk to execute the purchase.

    While falling commodity prices might imply that there may be a deflationary period ahead… Judging by how much cash is being injected into the markets by governments around the world, I personally can’t envision how this supercharged money supply won’t ultimately create hyper-inflation as the world gets flooded with cheap money.

  • 5 Weekend Links - Oct 17, 2008 | Million Dollar Journey // Oct 17, 2008 at 6:30 am

    [...] Canadian Capitalist thinks that there might be an opportunity in real return bonds. [...]

  • 6 Big Cajun Man // Oct 17, 2008 at 8:57 am

    Didn’t know anything about this, good post! Thanks, C8j

  • 7 squawkfox » Hooters, Owls, and Woots Oh My! // Oct 18, 2008 at 4:08 am

    [...] Opportunity in Real Return Bonds | Canadian Capitalist [...]

  • 8 cg // Oct 27, 2008 at 5:04 pm

    RR bonds keep going down, so don’t understand when article says good to buy if yield gets to 3%. Sure, you get more interest, but your capital value of the bonds is dropping.

    I hold some RR Bond mutual funds that keep losing avlue (TD Fund), selling time?

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