A popular type of fixed income holding used by many Canadian investors are aggregate bond ETFs, also known as "bond universe" ETFs. These ETFs often track popular fixed-income benchmarks like the FTSE Canada Universe Bond Index, which provides exposure to domestic government and investment-grade corporate bonds of various maturities.

However, these ETFs are constrained in terms of which issuers, geographies, and credit qualities they can hold due to the rules of their underlying indexes. For fixed income investors looking for additional sources of yield and returns, these types of bond ETFs can occasionally fall short. 

To remedy this, Canadian investors can make use of "core plus" bond ETFs, which has the potential to combine the benefits of a traditional aggregate fixed income index ETF with additional exposure to non-core fixed-income assets. Here's all you need to know about core plus bond ETFs and how they can be used. 

What is a core plus bond ETF?

Core plus bond combines the strength of a core bond portfolio with additional, off-benchmark, and sometimes higher-yielding fixed income securities to pursue returns and diversification. Typically, these ETFs have a dual mandate:

1. Provide exposure to a benchmark aggregate bond index as the "core" of its portfolio.

The "core" is often an aggregate bond market index, which typically consists of high-quality fixed income securities. This may include government bonds, investment-grade corporate bonds, agency bonds, and mortgage-backed securities. The core bond portion of the ETF aims to provide a solid foundation of high-quality Canadian bonds, and a regular income stream.

2. Provide satellite exposure to more non-core fixed income assets to pursue return and diversification.

The "plus" component may consist of riskier but higher-yielding fixed-income securities. Common examples include high-yield bonds, foreign bonds, and bank loans. The goal of the plus component is to layer on an additional source of income with low to negatively correlated positions to augment the ETF's overall performance. 

By doing so, a core plus bond ETF could potentially outperform traditional core bond portfolios by taking on slightly more risk, while still maintaining a diversified and balanced investment approach.

Advantages and use cases of core plus bond ETFs

Core plus bond ETFs can be a useful addition to a diversified portfolio or a substitute for traditional fixed-income allocations for the following reasons:

1. Enhanced returns potential: By investing in a mix of both investment-grade and higher-yielding bonds, these ETFs can potentially provide higher yields than traditional core bond portfolios.
2. Diversification: Core plus bond ETFs can expand an investor's fixed income holdings to non-core bonds, including high-yield bonds, foreign bonds, floating-rate notes, and bank loans; allowing for greater diversification possibilities. 

Core plus bond ETF example

A great example of a Canadian listed core plus bond ETF is the Franklin Bissett Core Plus Bond Active ETF (FLCP), which holds the Franklin Bissett Core Plus Bond Fund as its underlying asset. Despite being benchmarked to the popular FTSE Canada Universe Bond Index, this ETF differs in some significant ways. 

For one, FLCP currently overweighs higher-yielding provincial government and investment-grade corporate bonds in its portfolio, with the latter making up 50% of the ETF's weight as of March 31, 2023. The ETF also holds a 3.69% allocation in higher-yielding bank loans. 

Compared to the benchmark FTSE Canada Universe Bond Index, FLCP sports a higher yield-to-maturity of 4.90%[1]as of March 31, 2023, compared to 3.95% for the index. This is a result of its different composition and a greater allocation to higher-yielding bonds. 

Comparatively, both FLCP and the FTSE Canada Universe Bond Index possess an identical duration of 7.34 years as of March 31, 2023. 

With a competitive management expense ratio of 0.62%, FLCP could be a potent tool for Canadian fixed-income investors looking to reach outside the standard bond index benchmarks for enhanced returns. 

IMPORTANT INFORMATION

Commissions, trailing commissions, management fees, brokerage fees and expenses may be associated with investments in mutual funds and ETFs. Please read the prospectus and fund fact/ETF facts document before investing. ETFs trade like stocks, fluctuate in market value and may trade at prices above or below the ETF’s net asset value. Brokerage commissions and ETF expenses will reduce returns. Performance of an ETF may vary significantly from the performance of an index, as a result of transaction costs, expenses, and other factors. Indicated rates of return are historical annual compounded total returns for the period indicated, including changes in unit value and reinvestment distributions, and do not take into account any charges or income taxes payable by any security holder that would have reduced returns. Mutual funds and ETFs are not guaranteed. Their values change frequently. Past performance may not be repeated.

ETF units may be bought or sold throughout the day at their market price on the exchange on which they are listed. However, there can be no guarantee that an active trading market for ETF units will develop or be maintained, or that their listing will continue or remain unchanged. While the units of ETFs are tradable on secondary markets, they may not readily trade in all market conditions and may trade at significant discounts in periods of market stress.

Foreign Investment Risk. The value of foreign securities may be influenced by the policies of foreign governments and by political, economic, or social instability. There may be less information about foreign companies than North American firms and there may be lower standards of government supervision and regulation in foreign financial markets. The legal systems of some foreign countries may not adequately protect Unitholders’ rights. Some or all of these factors could make a foreign investment more or less volatile than a North American investment. If a Franklin ETF or the underlying fund in which a Franklin ETF invests holds these securities, the Franklin ETF may have difficulty enforcing legal rights in jurisdictions outside Canada.

REFERENCES

[1] Franklin Bissett Core Plus Bond Active ETF - Market Price Return as of April 30, 2023: 1-year 2.26%; 3-year -1.44%; since inception (07/08/2019) -0.08%