Understanding the basics of bond investing

Whether you’re new to investing or looking to diversify your portfolio, understanding bonds is essential. So, let’s dive in.

What are bonds?

Bonds are bit like loans. Just like you and I would borrow money from a bank to buy a house or make some repairs, governments and companies also need to borrow money sometimes. To do so, they issue what’s called a bond. In return, they promise to pay back the borrowed amount, known as the principal, along with interest payments.

Not all bonds are created equal though, and while most are deemed less risky than stocks, they still carry the risk that the government or company will default on their loan.

Bonds will typically fall into two categories: government or corporate bond.

First, we have government bonds.

These are issued by national governments to finance their operations and projects. In developed markets they are considered relatively low-risk investments. You may hear them referred to as ‘sovereign debt’, ‘Gilts’ (UK) or ‘US Treasuries’. Since these loans are backed by governments, it’s not expected that investors will lose their money, but because there is less risk attached, it also means that the interest payments will be lower. Emerging market governments can also issue bonds, and because they are deemed to be riskier, their interest payments are usually higher.

FundCalibre doesn’t currently rate any explicit government bonds. However, the M&G Emerging Markets Bond fund can invest in both government and corporate bonds and currently has over 68% in government bonds.

Then we have corporate bonds.

These bonds are issued by companies. Corporate bonds offer higher yields compared to government bonds but come with an additional level of risk. Let’s explore two common types:

Investment-grade bonds are issued by financially stable companies with a lower risk of default. These bonds have higher credit ratings and are considered safer investments. They offer lower yields but are more reliable in terms of timely interest payments.

Some funds will invest specifically in this category of bonds – like M&G Corporate Bond fund. Alternatively, the GAM Star Credit Opportunities fund has a unique strategy that focuses on the ‘junior debt’ of investment grade companies. This allows the fund to generate a good income, whilst still keeping a high-quality portfolio.

High-yield bonds are issued by companies with lower credit ratings or higher risk profiles. These bonds offer higher yields to compensate investors for the increased risk. While they can provide greater returns, they also come with a higher likelihood of default.

The Baillie Gifford High Yield Bond fund offers investors access to a portfolio of predominantly UK, US and European high yield bonds looking to produce a combination of income and capital growth.

Lastly, there are strategic bonds. Strategic bond funds are the most flexible type of bond fund. They can invest in any type of bond – government, investment grade, high yield and emerging market, as well as other fixed interest investments.

It’s worth noting that due to their flexibility, no two funds in the IA Sterling Strategic Bond sector will be exactly the same. Some concentrate on generating income, while others are more concerned with capital preservation. It all depends on their stated aims and objectives.

The Jupiter Strategic Bond is one such fund. With no industry sector or geographic constraints, this fund has the freedom to explore opportunities across the entire bond universe. By spreading investments widely, the fund aims to manage risk effectively.

Bonds, or fixed interest as they are also called, are complex. These are just a few typical ways that investors can access the bond market, but there are many different types of bonds available. Remember, when considering bonds, it’s important to assess your risk tolerance, investment goals, and conduct thorough research. Bonds can be a valuable addition to a diversified portfolio.

To learn more about bond markets, including the different credit risk of different bond types, visit fundcalibre.com