Bond funds typically pay dividends quarterly or half-yearly that are made up of interest payments on the fund’s underlying securities, according to Alex Robertson, client portfolio manager of Royal London Asset Management.
Depending on their investment remit, bond funds may invest in bonds issued by governments, government agencies, companies or a combination of these.
There are funds that focus on investing in special types of bonds, such as as ‘inflation-linked bonds’. Others might just invest in bonds issued in emerging markets.
Some funds have the flexibility to invest in different kinds of bonds depending on where the fund manager believes the greatest opportunities to be.
The primary benefits of bond funds include diversification, accessibility and investment management expertise.
One of the main pros of Bond funds, according to Gareth Isaac, fixed income fund manager at Schroders, is that they are extremely liquid and provide investors with diversification. Instead of just holding one bond, a fund provides access to a pool of bonds with different maturities and coupons, thus spreading risk over a large number of issuers.
Smaller investors would also generally be unable to construct a diversified bond portfolio due to the larger sizes in which bonds are traded and they will have greater access to a wider variety of bond issues due to being part of a larger pooled investment structure, according to Mr Robertson.
Further, Mr Robertson adds that they do not have to worry about managing coupon and redemption dates for individual holdings, but instead receive regular distributions from the funds in which they invest.
On the other hand, Mr Isaac noted one of the cons of bond funds is that they expose investors to interest rate risk. Rising interest rates causes bond prices to fall in a ‘real’ sense, meaning that the shares of bond funds will drop in value.
Another downside for some investors is cost. Mr Robertson explains that investors have to pay an annual management charge, while income payments from bond funds will fluctuate as the composition of the underlying assets changes.
Indeed, unlike an investment in an individual bond, Annemarieke Christian, product specialist at Legg Mason, warns a bond fund investor may not receive either income or capital appreciation.
But Ms Christian says on the upside a bond fund is likely to display lower volatility over time, due to the diversified nature of the portfolio.
David Hooker, manager of the Insight Strategic bond and index-linked corp bond for BNY Mellon, warns bond funds were often thought of as being intrinsically ‘low-risk, low-return’ investments, which he said could be ‘misleading’.
He said: “High yield bond funds, for example, which invest in the debt of companies considered to be at a greater risk of being unable to meet their financial obligations... have shown the potential to generate very high returns.
“However, the flipside of this is that investors in these funds are also exposed to potentially significant losses.”
