Q: I want to take advantage of capital gains in bonds that I expect to occur as rates decline but I am unsure whether I will get that benefit with an ETF like XBB as much as with individual bonds. Can you tell me how that works with the etf? I assume as they buy new bonds at to replace their maturing ones, that will take away the capital gains advantage as they buy them at par in the higher rate market.
5i Research Answer:
Yes and no; with maturities and new purchases, yes, new bonds (at revised rates and prices) will be purchased, and these will not get the same benefit from lowered rates. But, XBB is a $6.4B fund, and its portfolio securities may not turn over as much as one expects. XBB buys can be matched with sells, and it is only when a mismatch occurs does the market maker need to be active in the portfolio. Thus, we would expect 'most' of the portfolio to still benefit from rate moves (assuming rates decline!). Nothing to write home about, but the fund is at least now UP on the year. Its average duration is 7.4 years, so it should have decent leverage to rates with that maturity.