The Government of Canada RRSP Bond

With RRSP season upon us, and Canadians investing billions in their RRSP accounts, the Government of Canada is entering the market to compete for those investment dollars. The Government has introduced the Canadian RRSP Bond. It is design for the conservative investor, with a long-term investment horizon.

After the success the new Canadian Investment and Savings Agency had marketing the 'step-up' Canadian Savings Bond in October, 1996, there was renewed optimism that a new product aimed at the conservative investor could be developed for the RRSP market. The new Canadian RRSP Bond is the first new product, developed by the Canadian government, aimed at the retail investor in 50 years.

The aim of the product is to put more of the Federal Government's debt in the hands of Canadian investors. There are a couple of reasons why the Finance Department would like to see Canadians hold a larger portion of the Government's debt:

• The foremost reason is to reduce the Government's dependance on international investors in order to fund the budgetary shortfalls each year. By reducing dependance on foreign investors, the Government hopes to mitigate some of the volatility exhibited by international flows of capital. Currently, over 40% of the Federal Government's debt is held by foreign investors. This is a costly burden. The fickle international investor, looking for the best returns today, may not favour the same investment tomorrow, causing rates to increase as positions are sold back into the market, pushing up the cost of servicing the debt.
• Also, by putting more of the debt in the hands of Canadians, the Government can reduce its borrowing costs. If foreign capital does not have to be lured away from other markets with the promise of higher real interest rates, then the cost of financing Canada's debt may be reduced. This, in turn, reduces the burden of servicing the debt on Canadian tax payers.

The new Canadian RRSP bond is a fixed income instrument with a maximum ten year term. The structure of the bond is based on a step function of increasing coupon payment structures roughly based on the current Canadian term structure of interest rates.

The new bond is different from its Canadian Savings Bond (CSB) counterpart in one significant aspect. The RRSP bond is redeemable only on the anniversary dates of the issue. Which means on the first day in March each year an investor may cash in the bond and receive all accrued interest payable up to that point in time. The CSB, on the other hand, is redeemable at any time. Thus the CSB is convertible to cash on demand. This should not be an issue of concern for the investor with a long-term view to managing their portfolio.

The current pricing, as illustrated above, shows the aggressive nature of the initial rate structure. With current one year GIC rates below 2.50% in Canada, the Government has priced the issue to attract initial retail interest. Many point to the fact that current five year GIC rates offered by major Canadian banks (approximately 5%) is a more attractive investment. This is due to the fact that it takes until the sixth year of the RRSP bond to attain the same return. What they fail to mention is that the consumer is taking on the credit risk of the bank issuing the GIC. Whereas, the RRSP bond is backed 100% by the Government of Canada.

One commentator indicated that a larger compound return may be generated if an investor purchases a Bank of Montreal (BMO) Rate Raiser GIC. The same ten year term nets a 6.35% return with the BMO product versus 6.01% for the RRSP bond. However, the investor should also be aware that they are assuming the Bank of Montreal's credit risk, as well as, a redemption period offered once every two years as opposed to the annual redemption option for the RRSP bond.

The new RRSP bond offered by the Canadian Government to retail investors for either their standard or self-directed RRSP's should be a successful offering to those who are confused by the host of mutual fund claims and offers. The conservative investor may be comforted by this product, which offers an annual redemption feature and a Government guarentee.

As with any investment, check what is available, do some reading and research and consult with an investment professional to be sure that the investments you are considering are appropriate for your risk levels.

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