Some important considerations if you have or are planning to invest in corporate bond funds.
What is a Corporate Bond Fund?
Corporate bond funds typically invest at least 80% of their assets in low risk categories of corporate bond securities. These bonds are rated as being relatively low risk by credit rating agencies. Corporate bond funds have attracted large investments by retail investors. This is likely the result of the steady income that these funds can deliver, which is higher than some alternatives, such as deposit accounts.
Most corporate bond funds are largely unaffected by currency movements and experience low impact from company defaults. This means that there is limited risk to capital. However, these funds are not risk free and the risk factors associated with them should be taken into account when deciding if they represent an appropriate investment opportunity.
What are the risks associated with these funds?
Corporate Bond funds are not completely risk free for a number of reasons:
- If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds – and the market for underlying bonds has shrunk in recent years. Fund managers manage this risk for you, by monitoring the values that can be bought and sold in each bond and limiting the size of funds’ holdings in any one bond. Most of the time fund managers ensure that investors are able to buy and sell their units on any day. However, in very extreme market conditions fund managers could become unable to sell sufficient quantities of bond holdings to fulfil redemption orders, leaving investors unable to sell fund units.
- Interest rate movements have an impact on corporate bond and fund unit prices. So for example, as interest rates rise, bond prices fall. This is the key difference to deposit accounts, where the capital value is constant.
- Corporate bond funds mainly invest in bonds where the risk of default is low. However, company defaults can impact the level of returns generated by the funds. An unexpected default reduces income and the capital value of a bond holding. Also, market expectations about economic conditions and the likely number of corporate defaults drive bond and fund prices.
What should you consider if you have or want to invest in Corporate Bond Funds?
- Consider whether the return you expect will deliver to your investment objectives.
- Make sure that you can financially withstand a fall in the value of your units.
- Consider whether a likely return close to or greater than your expectations is enough to justify the risk of a negative return.
- Examine the individual fund characteristics to make sure that the level of risk – and the financial losses these could produce – are acceptable. These characteristics should include whether some of the fund is invested in higher risk instruments, such as high yield bonds or derivatives.
- Consider whether you need to be able to take your money out quickly.
If you decide that corporate bond funds are suitable it is essential to perform due diligence on individual funds to assess whether their investment strategies meet your requirements. If you are having difficulty understanding corporate bond funds, you should seek professional advice.