Re: Real Return Bonds - Availability from BMO

"investmentpro_not" <[EMAIL PROTECTED]> wrote in message news:<[EMAIL PROTECTED]>...
> "Greg Goss" <[EMAIL PROTECTED]> wrote
> >
> > "Stripped" Real return bonds are considerably rarer, but more
> > convenient.  I hold both 2026 whole RRB and stripped 2021 RRB in my
> > TDW account.
> >
> > If you can find 2021 strips, your entry
> > point can be much less.  My strips were bought for $3500 or so.
> 
> I don't fully understand RRB,s. Could you explain just how these work (whole
> & stripped)?
> 
> Lets say I buy $20,000 in whole & same in stripped today. Say 2026 bonds.
> 
> What will the return be in each case based on current interest and inflation
> rates?

You are guaranteed a real return of 2.9% say: the face value is
increased by the increase in the CPI every year (if the CPI is
negative, the face value is reduced-- I don't know if it can drop
below 100, right now these bonds have a face value of c. 120 so you
could lose money on the principal for, say, 10 years straight).

You can't know what return you will get, in nominal terms, because you
cannot forecast inflation.  My bet is that, long run, with the Baby
Boomers aging, the country cannot afford to have less than 2%
inflation (there has to be a wealth transfer from the holders of fixed
income assets and especially government debt, to borrowers) and so we
will not have less than 2% inflation.

There is a calculation called 'breakeven inflation rate': if inflation
was below this number, you were better off buying the equivalent
maturity straight bond.  With current breakeven inflation rate at
about 2.0%, AFAIK, I am pretty comfortable that the value I gain from
holding an essentially riskless asset is great enough that I am
willing to take that risk that inflation stays very low.  When you
speak to the broker, they should quote you a real yield and a
breakeven inflation rate on the bonds you are considering buying.

I honestly think these are the only bargain I can find in financial
markets right now: I have a holding of about 40% of my RRSP (the rest
in dividend paying Canadian stocks, where I think it is likely the
dividend will be held and grow over time, even if the share price goes
down) and expect to hold these until 2026 (I am 45 now).  They have
huge value to defined benefit pension funds (because the fund sponsor/
employer can guarantee a return ie have no risk of a pension fund
deficit-- this is particularly attractive for schemes closed to new
members) and I expect over time, this will become a very important
factor to Defined Benefit pension fund sponsors, to the extent that
they will move a very large fraction of their assets over to these
instruments.

Although in the short run higher interest rates will hit these things
(they are what is called long duration investments) in the long run I
expect them to trade down to real yields of sub 2%.  I could see
something like a move back to real yields of 3.5% and then a drop
below 2%: but timing such a move is too difficult, so I will simply
hang on.

There is a new investment book by Zvi Bodie (a well known professor of
finance and investments at Boston College) that recommends a 100%
allocation in TIPS (the US equivalent).  Although I am not that
bullish (and US TIPS pay lower real rates) I think an investor can
safely put 20% of their portfolio in this instrument.

> 
> How often is interest distributed?

Semi-annual coupons I believe (from memory, mine pay in January and
July).  Mine (2026 maturity) pay about 3% of the face value of the
bond (the rest of the return comes at the end, but you are taxed as if
you received the cash up front: this is why you have to hold these in
an RRSP/ RRIF).

> 
> Can these be traded in the normal way?

Yes, but it is a thin, illiquid market: as a retail buyer, if you are
not doing 'buy and hold' strategies, then you are likely to lose quite
a bit of the benefits.

Avoid the TD RRB fund, by the way, as Greg points out, the MER kills
your returns, and the fund in no way adds value vs. direct ownership.