Before you readCapital at risk. The value of investments and any income from them can fall as well as rise, and you may get back less than you invest. This is information, not advice.
In one paragraphYou can own a single bond, which is one loan with a known end date, or units in a bond fund, which owns many loans and has no end date. A single bond is simpler to understand. A fund spreads the risk and does the choosing for you, but its price moves every day and it has ongoing charges.
Everything in the previous chapters describes a single bond: one borrower, one coupon, one repayment date. Most people who invest in bonds actually hold them through a fund, and a fund behaves differently in ways that matter.
How does a bond fund work?
A bond fund pools money from many investors and uses it to buy many bonds, often hundreds. You own units in the fund, not the bonds themselves. The fund's price is worked out every working day from the prices of everything it holds, so your units rise and fall with the bond market.
The interest from the bonds is passed on to you. Income units pay it out. Accumulation units add it back into the fund, which raises the unit price instead.
How do the two compare?
| A single bond | A bond fund | |
|---|---|---|
| End date | Yes. Repays on a set date, if the borrower pays. | No. The fund keeps buying new bonds as old ones repay. |
| Price | Moves, but only matters if you sell early. | Moves every day, and there is no date when it returns to what you paid. |
| Income | Fixed and known in advance. | Varies as the fund's holdings change. |
| If one borrower fails | You bear the whole loss on that bond. | The loss is shared across the whole fund. |
| Choosing | You choose the bond, and you need to research it. | A manager chooses, or the fund tracks an index. |
| Costs | Dealing costs when you buy and sell. | A yearly charge, taken from the fund, plus any platform fee. |
What kinds of bond fund are there?
In the UK, bond funds are grouped into sectors so that similar funds can be compared. Roughly in order from the shortest loans to the longest, the main sterling sectors include:
- Short-term money market and standard money market: very short loans, closest to cash.
- Sterling high yield: mostly bonds from companies below investment grade.
- Sterling strategic bond: managers can move between different kinds of bond as they see fit.
- Sterling corporate bond: mostly investment-grade company bonds.
- UK gilts and UK index-linked gilts: UK government bonds, often with long durations.
There are global sectors too, which hold bonds in other currencies.
Active or tracker?
A tracker fund holds the bonds in an index, so it goes wherever the market goes. The catch is that a bond index is weighted towards the most indebted borrowers, because the companies that borrow the most issue the most bonds.
An actively managed fund has a manager who chooses which bonds to hold and switches them as conditions change. Active management costs a bit more, and there is no certainty it will do better. However, an active manager can adjust for duration and credit quality quickly throughout the market cycle.
That is the case for active management in the high yield and strategic bond sectors in particular, where whether a borrower repays is a question of research, not of its weight in an index. It is also why charges differ between funds, and why the research you do before buying matters more here than almost anywhere else.
Whichever you hold, two big forces move bond prices: interest rates and inflation. The final chapter looks at both.