Fundamentals on Bond Fund
Given the current market conditions, investors would need to restructure their existing portfolios into more balanced and therefore, demand for higher secured investment alternatives. That is one of the reasons for the bond funds to come in to satisfy investors’ needs. Bond/bond funds can be very helpful to anyone concerned about capital preservation and income generation.
So, what are a bond and a bond fund?
A bond is a loan that an investor makes to a corporation, government or other organization that has issued bonds to fund their operations or to finance specific projects. The bond issuer agrees to repay bondholders the original loan amount at a set maturity date. Consequently, bonds are sometimes referred to as debt securities. Bonds are also called fixed-income securities because issuers pay you interest based on a regular, predetermined interest rate – called coupon rate – that is set when the bond issued. It is important to understand the reverse relationship between interest rates and bond prices: if interest rates rise, bond prices usually decline, and vice versa. The longer a bond’s maturity, the greater the interest rates risk.
A bond fund pools money from many investors to buy individual bonds that meet the fund’s investment objective. Investing in a closed-end bond fund, common investors having limited sources of capital for investment can enjoy the important features of the fund like portfolio diversification, professional money management, liquidity and convenience. A closed-end fund has a specific number of shares that can be listed and traded on a stock exchange. The market price of closed-end funds’ shares, like stocks, is determined by the forces of supply and demand in the marketplace. Shares may trade at a premium (above Net Asset Value – NAV) or, more often, at a discount (below NAV).
Bonds versus Bond Funds
Understanding the differences between individual bonds and bond funds will help you decide which is the best investment option for you. You should consider following four factors:
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Individual bonds
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Bond funds
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- In Vietnam, primary market for bonds would likely limit only big players, and it is hard for individual & non-professional institutional investors, having limited sources of capital, to find a good deal on the secondary market.
- To diversify your portfolio of individual bonds, you need to have quite a huge of money for several purchases. |
- Bond funds provide common investors an access route to bond investments.
- With a single purchase, a bond fund, though often requires a minimum entry, provides you with instant diversification at a very low cost |
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Liquidity
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- The liquidity of individual bonds can vary considerably depending on the bond.
- Also, in developing market like Vietnam, it would take you longer and cost you more expensive to sell your illiquid bonds. |
- Shares of a closed-end bond fund, when listed on the Stock Exchange, can be traded at the market price determined by the forces of supply and demand in the marketplace. |
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Return of Principal
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- Unless there is a default, your principal will be returned when an individual bond matures, or is called.
- Individual bonds can be traded in secondary market, and if the price of a bond declines below par, you always have the option of holding the bond until it matures and collecting the principal. |
- Bond funds have no obligation to return your principal. The value of your investment, which can be higher or lower than your original invested amount, will be paid off to you at the fund’s maturity date. Risk, however, will still exist in the event of bond default.
- You can cash out the investment in the fund anytime by selling the fund shares at market price on the stock exchange, given availability of demand or supply. |
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Income
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- With individual bonds, you know exactly how much interest you will receive.
- Most individual bonds pay interest semiannually. |
- Bond funds would pay you interest regularly or NOT pay it for reinvesting to increase the fund’s NAV. This should be mentioned clearly in the fund’s prospectus. |
Bond closed-end funds are in place to provide individual and non-experienced institutional investors with an access route to bond investment market. Investors can enjoy its advantages:
- They offer a convenient and affordable way to invest in a diversified portfolio of bonds;
- The funds also set forth a variety of investment objectives. They might invest in a particular bond category (government, corporate, municipal) or a particular maturity range (short-term, intermediate, long-term);
- In ideal market conditions, their liquidity is considerably high. You can generally get your money out of the fund quickly and/or make additional investments in the fund by trading your fund shares in the stock exchange, given the availability of demand and supply; and
- The portfolio of bonds are professionally managed to optimize the return of the fund.
Our suggestion to investors
In any market situation, investors should determine a clear investment strategy to follow based on financial objectives & capability, investment time horizon, and tolerance for accepting a higher level of risk to get greater potential return. As the time horizon shortens, and with it there will be increased need for more stable & quality investments – for example, to the funds reserved for your child’s higher education and for your comfortable life upon retired – Bonds or bond funds investments are worth to consider.