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Have you decided that an investment in fixed income is the right choice for you?
If so, the next thing to consider is your approach – place your money in individual bonds or select a managed fund?
Bonds tend to be issued by governments, companies or public bodies, and it is possible for an individual to invest in bonds directly. However, there are various things to consider, which we will come to later.
If you choose a bond fund, you’re investing in a professionally-managed portfolio of bonds that are selected on your behalf. Bond fund managers don’t usually hold the bonds until maturity, instead they trade them to make money for their investors..
Knowing what to buy and when
If you invest in bonds directly, you are wholly responsible for researching the risks facing the issuer of the bond, which can be very time-consuming. You will also need to decide when the best time to invest is, and then monitor the bond’s performance.
In the case of government bonds – both foreign and domestic – that means keeping an eye on the health of different economies, and the path of interest rates. For a corporate bond, you need to be aware of the company’s balance sheet and its credit rating, among other factors.
There’s also the question of whether to hold your bond until it matures or sell it in the secondary market.
If you do choose to sell it, you’ll need a good grasp of some basic tenets of bond investing, such as duration (the effect of interest-rate changes on a bond) and yield curves. For example, if you chose to sell a bond when it is trading at a discount to its face value, you’d realise a loss.
Managing the risks
Concentration risk is another consideration. Let’s assume you dedicate all your portfolio’s fixed income allocation to two or three individual bonds. If one of these issuers defaulted on their debt obligations, the performance impact on your portfolio could be severe.
To reduce the likelihood of this outcome, you’d need to spread risk by investing in a wide range of bonds. That means dedicating more time to researching the individual bonds and their respective market environments.
And then there is the issue of access.
Bonds are bought in two ways – in the primary market, directly from the issuer, or in the secondary market. Large, listed companies tend to issue bonds to professional investors, who commit to buying a significant amount of this debt.
This isn’t ideal for individual investors, who perhaps have less capital to invest. To buy bonds in both markets, it’s usually necessary to engage the services of a broker, which is another cost to consider.
The benefits of a bond fund
Issued by financial institutions or companies to fund their operations.
Investing in bonds via a managed fund offers a range of benefits:
1. Convenience
Few individual investors have the required skill to analyse bonds or the time to monitor news and developments that can drive their performance. Investing in a managed bond fund gives you access to bonds that have been thoroughly researched, all in just one transaction.
2. Professional management
Managed bonds funds are generally run by experienced portfolio managers, often with the support of dedicated teams of analysts and experts in specific markets or industry sectors. These teams undertake detailed research, thoroughly analysing the risks and opportunities of each bond to determine which they believe are most likely to perform over time.
3. Less admin
Managing bonds directly can be time-consuming and can involve a fair amount of administration. Every transaction produces a statement, so multiple investments can generate a large amount of paperwork. With a managed bond fund, you have one unit price so it’s much easier to track the value of your investment.
For less experienced investors, these can be big attractions.
What about income?
When choosing individual holdings or selecting the best bond funds to invest in, another factor to consider is income.
An individual bond generally pays a fixed income every six months. However, in a managed fund (depending on the manager), there is usually the option to arrange more regular income payments, in the form of ‘distributions’ from the fund.
This article is written by Fidelity International.
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