Types of Bonds

Bond and Bond Funds

Bond Funds: Convenient, Affordable Way to Invest in a Diversified Portfolio of Bonds — With Some Differences

Bond funds offer a convenient and affordable way to invest in a diversified portfolio of bonds, but a bond fund investment can differ from a bond investment in ways that are important to understand.

Bond funds, like share or mutual funds, offer professional selection and management of a portfolio of securities. They allow an investor to diversify risks across a broad range of issues and offer a number of other conveniences, such as the option of having interest payments either reinvested or distributed periodically. When you invest in a bond fund, your money is pooled with that of other investors to be invested in an array of bonds by fund managers. Typically, bond funds invest in different regions, such as Europe, or a specific country such as the UK and usually in one type of bond, for example, corporate bonds, high yield corporate bonds, securitisation or structured credit bonds or government bonds - although there are funds that combine criteria. (Note that in some countries, such as the UK, there may be tax favourable provisions for investors using some funds.) A critical difference between investing in a bond and in a bond fund is that in a bond fund there is no fixed redemption date as there is in a single bond, when the bond is repaid at face value with a compound total return. In a bond fund, the value will fluctuate depending on factors such as the type of bonds, decisions of the investment professionals managing the fund, and market conditions.

Because a fund is actively managed, with bonds being added to and eliminated from the portfolio in response to market conditions and investor demand, bond funds do not have a specified maturity date. With “open-end” funds, you are able to buy or sell your share in the fund whenever you choose. But because the market value of bonds fluctuates, as previously described, a fund’s net asset value will change from day to day, reflecting the cumulative value of the bonds in the portfolio. As a result, when you sell, the value of your investment - as reported in most daily financial newspapers - may be higher or lower, depending upon how the fund has performed since you purchased your share. “Closed-end” bond funds have a specific number of shares of bonds that are listed and traded on a stock exchange. Because the fund managers are less concerned about having to meet investor redemptions on any given day, their strategies can be more aggressive.

There are numerous sources of bond fund information available, including major personal finance magazines and investor education websites, the business pages of your daily newspapers, and investment company websites. Some European mutual fund research firms provide detailed analyses by subscription. In addition, rating agencies also evaluate bond funds for credit and safety.

Note that bond funds contain risk.  Investors should not automatically correlate the higher rate of return or income as being “better” than one offering lower rates of return or income. Often the higher the rate of return or income that is offered, the higher the risk contained in that bond fund.

Most funds charge annual management fees averaging 1-1.5 % in Europe, while some also impose initial sales charges or fees for selling fund shares. Because annual management fees will lower returns, sometimes quite significantly, investors need to be aware of the total costs when calculating their overall expected returns.

Selecting bond funds requires investors to consider multiple factors carefully. Studies show that investors in different European countries have different preferences and make different choices in the way they invest in bonds.  Consult a financial advisor if you have questions about investing in bond funds.

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