Corporate Bond Funds jamei305

Have been looking at some managed corporate bonds funds and am wondering how these would behave if interest rates went up and/or the stock market went down.

If the stock market goes down will people be piling into corporate bonds so they should not see such severe losses?

Also if interest rates rise gradually they shouldn't be affected much because they still offer better returns than an extra 0.5% here or there on the bank rate.

During the last stockmarket crash, bonds went down too, but to a lesser degree. This is to be expected - when companies get into difficulties, both their shares and the bonds they have issued are at risk.

When interest rates rise, new bonds will tend to be issued at higher rates, so the price existing bonds can be traded at will fall (such that their yield for the new purchaser will be higher and in line with rates on equivalent newer bonds).

So in both situations capital losses can be expected on corporate bond funds. However, as bonds approach maturity, their capital value will stabilise and tend towards its par value, so if a bond fund is held for a sufficiently long period (i.e. longer than the average duration of the bonds within the fund), capital fluctuations will tend not to affect returns. The problem at the moment is that capital values are at unprecedented highs, so people buying in now may be exposed to a residual loss that will not be compensated for in the future.

Over the long term, corporate bond funds probably do offer better long term returns vs conventional savings accounts, but it is questionable whether they offer better returns than the market leading accounts if one is willing to shuffle money around to chase the best rates.

There are a wide range of corporate bonds with different performance characteristics. Masonic has mentioned the significance of the maturity date. Another key factor is risk. Bonds issued by a very safe company will tend to behave more like gilts where people are prepared to pay for security at the expense of return. At the other extreme are junk bonds where the return is high but so is the risk of total loss. Junk bonds can be expected to behave more like shares as in difficult economic times the risk of any one company defaulting is higher.

Bond funds will vary, some may be constrained by their remit. Others will change their investment allocation across the full range of maturity dates and risk according to their analysis of economic conditions.

Strategic bond funds are characterised by having a more flexible mandate than other bond funds but that doesn’t mean they necessarily offer wider diversification than non-strategic bond funds. Their flexible mandate can result in a narrow holding of bonds if the fund manager has a particular “high conviction” position.

What matters is the yield to redemption not the current income yield. If you are paying over par for the bond then you'll incur a capital loss on maturity.

Over recent years investors have been chasing yield. The danger is that rising interest rates will impact many asset classes negatively. There might be no where to hide.

You can mitigate the effects of rising rates to some extent by buying a fund that only invests in short-dated bonds e.g. iShares IS15 etf which invests in corporate bonds with 5 years or less to maturity. This obviously gives lower return than a long-dated bond fund but you will have less volatility in price.

Also worth checking the currency exposure as some bond funds will hedge (close to) all overseas fx back to Sterling whereas others - e.g. some strategic bond funds - will actively take currency bets too which could significantly drag on returns if they go wrong.

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