Canadian Interest Rates Are Rising: Should I Sell My PH&N Bond Fund Units in My Pension Plan?

The Bank of Canada has raised its prime rate a couple of times so far in 2017. It might continue to keep raising the rate or it might keep it at 1% or it might lower it. If only I was psychic I would know what to expect ! Why does it matter? Because I still hold part of a defined contribution pension in the PH&N Bond Fund. Despite years of being told to dump it in case interest rates rise, I’ve held on. It means, though, that each year I end up asking myself the same question: Is it time to sell by holdings in the PH&N Bond Fund?

Why Does an Increase in the Bank of Canada Prime Rate Threaten my Bond Fund?

At first, it sounds like an interest-rate hike would be a good thing for bonds. If the rates go up, you should get more, right?

And that is true if you were buying a newly-issued bond that is offering a newly-increased rate.

The problem is that I own units in a fund that already owns bonds. The rates on those bonds will not increase–it was agreed on at the time they were purchased. That means that the highest interest rate I can earn with my bond money is already fixed, unless the fund sells some of the bonds it holds and buys some others.

So why don’t they just dump the lower-interest bonds they own and buy new ones with higher yields?

Because they would need someone who wanted to buy the lower yield bonds. Those buyers, though, could also buy some of the newly-issued higher yield bonds. The only way to encourage someone to buy the old bonds is to drop the actual price of buying the principal portion of the bond and the required price drop is calculated to make the overall yield on the deal equal the same as buying a new bond with a higher interest rate.

So my bond fund is essentially stuck holding existing bonds with lower interest rates or selling them for a loss of principal.

Can’t I Just Hold On to my Bond Fund Units at the Lower Yield? Why Do I Need to Sell?

If I’m ok with the lower yield of my bond fund units versus what a fund consisting of newer higher-yield bonds could offer, I don’t need to sell my units, do I?

Well, sort of. It is a “fund” not individual bonds that I hold. So if the other investors in the PH&N Bond Fund start to sell off their units, the fund managers may have to start selling off some of the actual bond holdings to generate the cash to pay them out. And that could mean dropping the performance of the remaining units in the fund, if they have to sell some of their better-performing assets.

In other words, if there is a run on redeeming units in the Bond Fund, I could watch my unit values drop quickly.

Will I Sell My Bond Fund Units in 2017?

I’ve been dithering about what to do with these units since 2013. I have not invested any new money in the fund since then. In fact, each year, I pull out in cash the growth experienced by that fund. In fact, over 5 years, I’ve pulled out cash equivalent to 25% of the amount I had in the Bond Fund in 2013. And the fund units I’m holding still have the same dollar value as they did then.

In other words, if I had $100 000 in the fund on January 1, 2013, I still have $100 000 in the fund now on October 14, 2017, but I also have taken out $25 000 and re-invested it elsewhere during that time.

(I do realize that $100 000 today does not have the same buying power as it did in 2013.)

I’m still not sure whether to start liquidating my bond fund units or not. I need a high percentage of our pension savings in fixed income as we are close to retirement: Picking where to keep that fixed income money is getting confusing !


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