Here at the ol’ FU machine we (me and my 14 cats) like to tell you kids about strange investing ideas. I told you to invest in a trust that owns the rights to more than 25,000 copyrighted songs. We talked about buying trailers and hard money lending in this post. And so on. There are other examples out there, but my laziness is already well established.
One asset class we’ve only slightly covered is municipal bonds. These are a very big deal in the U.S. There are dozens of ETFs that follow the U.S. muni market, breaking it down in every way imaginable. ETFs exist that only invest in one state, or that use leverage to enhance returns.
For the most part, U.S. municipal bonds have been a good investment, especially since many of them are tax-exempt. Not every municipal bond is tax free, but a large chunk of them are. That turns a 4% yield into something worth at least 5%, which all but ensures a healthy market for the bonds. And remember, a municipality’s ability to tax their way out of problems ensures the asset class as a whole is pretty safe, Detroit bonds notwithstanding.
The Canadian municipal bond market is tiny in comparison to the U.S. market. I’ve seen a few Toronto-area bonds that are out there, but that’s about it. The market is less impressive than a Toronto Maple Leaf powerplay. BOOM. STILL GOT IT.
ETF provider Horizons apparently noticed this, and in its zeal to create strange-ass products investors can use to track all sorts of indexes nobody cares about, decided we needed a Canadian municipal bond ETF. The symbol is HMP, and it trades on the Toronto Stock Exchange.
And by trades, I mean it exists. It currently has a market cap of $16.05 million and trades a whole 1,857 shares per day. Geez guys, calm down.
Anyway, let’s take a closer look at this here bad boy.
The Horizons Active Canadian Municipal Bond ETF came into existence on August 13th, 2015. It has a very reasonable management fee of 0.35%, with an objective to “provide unitholders with a high level of income by investing primarily in a portfolio of Canadian municipal bonds denominated in Canadian dollars.”
Thanks guys. Nothing quite beats a lawyer to make finance even more boring.
Let’s take a look at the holdings. See if you spot a common theme.
Geez, this thing is more Quebec than a greasy French-Italian eating poutine in his Expos hat from 2003. According to the fact sheet, about half of Canada’s municipal bonds are issues from Quebec. I’m not sure why this fund chose to include just Quebec-based issues, but it did.
According to the same fact sheet, Canadian municipal bonds offer an attractive risk/return profile since they tend to command higher yields than provincial or federal bonds.
But after looking at the first two dividends, these things still don’t offer a very exciting yield. The September dividend was 1.81 cents per share, while October’s was just 1.52 cents. That works out to a pretty yawn-inspiring 2.02% yield.
These new bond ETFs are a huge example of why fees matter. Without the 0.35% management fee (which, again, is not terribly expensive compared to its rivals), this fund would be yielding in the 2.4% range. You might not think the difference between 2.02% and 2.4% is much, but it represents a 14% reduction in yield.
To see whether Canadian municipal bonds are an exciting asset class, let’s compare this fund to the largest government bond fund out there, the iShares Canadian Government Bond Index ETF (TSX:XGB). Even after paying its 0.35% management fee, it has a 2.66% 12-month trailing yield or a 2.55% distribution yield. But the fund also has a 1.90% yield to maturity. And the government bond ETF isn’t almost 100% Quebec weighted.
There’s also a big difference between Canadian municipal bonds and their U.S. counterparts. Canadian munis aren’t tax-exempt. You’re paying the same amount of tax on a municipal bond issue as you’d pay for any other interest bearing investment. That takes away one of the big advantages for investing in the asset class.
In all, the Horizons Canadian Municipal ETF isn’t a bad product, but there’s really no compelling reason to choose it over a similar government bond ETF. The yield looks to be about the same, and at least the other choices offer liquidity. I’d probably pass on it and the whole Canadian municipal bond sector.