Bond Funds

Bond funds are a type of mutual fund that gives steady returns to the investors, without much risk to their investments. These funds invest the monies in bonds and generate income from interest on these bonds. Apart from bonds, they also invest in various debt instruments, including government and corporate bonds, and debts. Bond funds are also known as income funds.

Returns from bond funds are less spectacular when compared to returns from stock funds. But there are high yield bond funds as well as high quality bond funds. These may mean slightly higher risk, or an optimal blend of risk and returns.

Like any stock market derivatives, both long bond funds, and short bond funds are now available in markets. Long bond funds are mutual funds in which the investors who expect the bond value to increase over a period of time invest their monies. These bond funds therefore buy and hold the bonds. Unlike this, investors in short bond funds expect the bond value to come down, and therefore these bond funds sell the bonds at present to re-enter the bond at a future date. Similarly, there are bond indexes. These are lists of bonds that generate optimal returns in that combination. Bond index funds are bond funds that invest in accordance with such indexes. Like any other mutual fund, there are closed end bond funds, as well as open-end bond funds. In closed end bond funds, money is raised only once, and the number of units is fixed. The investors in this fund can sell bond funds at premium or loss as per the demand and supply in the market. Unlike this, in open-end funds, new investors can continue to enter the fund. Here, the mutual fund redeems the unit as per the net asset value determined based on prevailing market rates of bonds at the end of each day of trading. Even ETF bond funds are now available to the investors as an investment option. These are exchange-traded funds. Etf bond funds offer more liquidity to bond fund investor as these can be traded on stock markets like any other stock.

Bond funds decline when interest rates go up, and increase in value when there is any economic crisis, or interest rates are decreasing. This is because people tend to buy bond funds for steady and safe returns at such times. However, not all bond funds qualify as quality bond funds or safe bond funds. While bond funds that invest in government bonds and debts are less risky, there may be those that invest in corporate bonds and therefore have higher exposure to risk. If these bond funds invest substantial amounts in higher risk corporate bonds, these are referred to as junk bond funds. Highly rated bond funds are those bond funds that invest in less risky bonds and yet offer maximum returns. In addition, these funds may have bonds that will provide such returns for a reasonable term in future.

Low cost bond funds are bond funds that invest primarily in government bonds and therefore these are less risky with steady returns. Alternately, monies of these bond funds may have been invested in bonds that are not performing well (defaulting on interest) or do not fetch adequate returns when compared to other bond funds available in the market. Bond fund unit prices vary based on the returns. If the bonds held by the bond fund that were highly rewarding are reaching their maturity dates, and any new bonds that are available in the markets for investment are not carrying higher interest rates, then also the prices of bond fund units start losing their value. These are factors that should be kept in mind while buying bond funds.

Since bond funds are mutual funds, a professional manager undertakes the management of these bonds. On the face of it, it does not make sense to pay monies to a professional manager when the returns are steady, and anybody can invest in such bonds. But individuals can invest only in few bonds because of limited funds at their disposal. Therefore, risk is not diversified. Individual investors may also not be aware of any new bonds with higher interest rates in the market. It may be not viable to sell the bonds, and buy these bonds at individual levels. Similarly, individuals may find it difficult to keep track of their portfolio, which means loss of interest in interim period. Even the professional charges are distributed across the entire set of investors in the bond fund, making such charges negligible. All these factors make investment in bond funds a better option than investing in bonds directly.