Let’s bond: Getting started with bond investing

Buying a bond means an investor is lending money to bond issuers, usually for a fixed time period at an agreed rate of interest paid regularly.

Bond funds invest almost exclusively in bonds and can offer potential stability and reliability of income over time. Buying into a bond fund allows investors to place their money in a range of bonds with the aim of spreading risk and enhancing opportunity.  

Bond funds can:  

• Invest in government bonds and corporate (company) bonds  
• Invest in different regions, such as the eurozone, USA, or emerging markets 
• Have different maturities, in the short term and long term, and can be in different currencies  
• Pay fixed or variable interests.  

• Diversification^*; It allows investors to diversify^* and spread their risk because bonds tend to react differently than other investment types to macroeconomic, geopolitical and market events.
• Income preservation: Bond funds seek to offer a steady income through the interest payments.
• Active management: Although the interest (coupon) a bond pays is usually fixed, the market value of bonds can change over their lifetime because they react to changes in interest rates. Bond fund managers aim to take advantage of these price and interest rate changes to create higher returns or reduce risks for their investors.
• Accessibility: Bond funds allow investors to trade in and out of their investments at any time. Whereas buying individual bonds might tie an investor until the bond reaches maturity.

• Interest rates: Bond are quite sensitive to interest rates which is the major cause of volatility in bond markets. Bond prices generally decrease when interest rates rise and conversely they increase when interest rates fall.
• Credit risk: This type of risk is related to bonds issued by companies and reflects the risk of default of the issuer. The reliability of a corporate issuer is expressed with the credit rating.
• Inflation: The general increase in prices can affect bonds negatively as it erodes the real value of the income generated with bonds.

Bonds’ quality is represented by credit rating. A credit rating tells the buyer how much risk they are taking by buying the bond. If the credit rating¹ is high, say AA, the bond issuer is highly creditworthy and is expected to repay the debt and interests in full with no delays. These bonds are called ‘investment grade’.

If the credit rating is low, say CCC or D, the bond issuer is considered less reliable and will have to pay a much higher interest rate to the bondholders for accepting a higher risk. This type of bond is normally referred to as a ‘high yield’ bond.

Bond funds seek to offer capital preservation and a regular income. They can help you diversify^* your portfolio and mitigate the effects of inflation which erodes the purchasing power of cash.

1. Credit ratings are assigned by independent agencies like S&P, Moody’s or Fitch.

^* Diversification does not guarantee a profit or protect against a loss.