Best UK Bond Funds – 2022

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What is a bond fund?

A bond is a financial instrument that represents a loan made by a government or organization. When a government or company wants to raise capital for projects they might have, one method of generating money is to issue bonds.

So, let’s say you bought a UK government treasury bond. You would essentially “lend” money to the government to use on public works. You will generally receive regular interest on this bond, called the coupon, and a fixed expiration date for the bond.

When this bond expires, you will usually be refunded the amount you invested. This is how bond traders make a profit – they accrue interest on top of the initial investment.

Meanwhile, a fund works by pooling money from multiple retail investors and then trading different financial instruments. A fund is usually overseen by a fund manager, a professional who will make decisions about the fund’s underlying holdings.

Since a fund provider will invest in a wide variety of different assets, you essentially get broad diversification from a single investment, as the fund is exposed to a number of different assets.

So when you combine the two, you get a bond fund.

As the name suggests, a bond fund is simply a mutual fund that takes your money and invests it in a number of different bonds. These work in the same way as equity funds, although instead of investing in publicly traded companies, they hold bonds bought in the bond markets.

You can either speculate on bond funds by buying a stake in them and then selling them later for a profit when the price rises. Alternatively, you can hold them for a long time and count on a fixed income from the fund.

These regular payments are called “dividends” and the income from them generally depends on the performance of the fund. This can make them useful additions to income portfolios.

Are bond funds good investments?

First of all, I cannot stress enough the importance of diversification for your portfolio. Ideally, you want to spread the risk of your investments across several different areas and sectors; that way, if the worst should happen and the stock market crashes, your portfolio won’t be as negatively affected.

Bond funds are a way to potentially diversify your portfolio. In fact, bond prices tend to move inversely to interest rates – when interest rates rise, bond prices tend to fall.

Since central banks – in the case of the UK, the Bank of England – tend to raise interest rates during periods of rising inflation, this means that bond prices tend to rise. to lower.

Thus, rapid movements in interest rates bring additional risk when it comes to investing in bond funds – a phenomenon known as “interest rate risk”.

Although bonds generally offer lower returns than stocks and shares in stock markets, they generally carry lower risk. Indeed, an expiry date is given to you and you know exactly when you will receive your investment.

In addition, the stability of a bond is usually based on the stability of the issuing company or the government. For example, if you have invested in US government bonds, they are unlikely to default because the US government is considered relatively stable.

Of course, while all of this should give you a rough idea of ​​the appeal of bond funds, there are many different types. Some may suit you better than others, so keep reading to learn about the different types of bond funds you can invest in today.

What are the different types of bond funds?

Several times in this guide, I’ve mentioned the different types of bonds a fund can invest in. Here, you can learn more about the different types of bonds listed on the market, and the pros and cons each brings.

Corporate bond funds

As the name suggests, a corporate bond is a loan issued by a company to raise capital for any projects it may have planned. So a corporate bond fund is simply a fund that invests in those corporate bonds.

A corporate bond fund tends to focus on higher quality, higher quality bonds. Compared to higher-yielding bonds, corporate bonds tend to have a lower risk of default because companies are more likely to be able to repay their debts. However, a result of this lower risk is that they tend to offer lower returns.

High Yield Bond Funds

Another type of bond fund you can invest in is a high yield bond fund. These invest in bonds that offer a higher annual return, in compensation for the additional risk you take. These bonds are usually issued by companies that may be less likely to repay their debts, which means there is a higher chance that the bond will default.

While these types of bond funds may look promising, it’s worth considering your risk appetite. If you don’t think you can handle the added pressures of high-risk investments, you should avoid them.

Government Bond Funds

Government bonds are simply bonds issued by a government to raise funds for any projects it might have.

In the UK and several other Commonwealth countries, government bonds are commonly referred to as gilts. So, as you can imagine, a government bond fund is a pooled investment that will invest in government bonds.

Since governments tend to be more stable than corporations, you may find that gold bond funds have lower default rates, but also lower potential returns, than corporate bonds. However, it should be borne in mind that bonds issued in emerging markets may present higher default risks since these governments are considered “less stable”.

Strategic bond funds

A strategic bond fund, on the other hand, is a fund that has the freedom to invest in a plethora of different instruments. For example, a strategic bond fund might invest in a combination of government bonds, corporate bonds and high yield bonds.

Strategic bond funds tend to have different objectives – some may be focused on high returns for their investors, while others may be more suited to protecting their investors’ wealth.

Global Bond Funds

As the name suggests, a global bond fund invests in different types of bonds issued around the world. They will generally diversify their investments by buying bonds in currencies other than sterling, which gives them exposure to foreign currencies.

For example, a global bond fund may invest in sterling and dollar-denominated corporate bonds to hedge against both currencies. And, like strategic bond funds, a global bond fund can invest in different forms of bonds, including government, corporate, and high-yield bonds.

Index Bond Funds

Finally, an index bond fund is a fund that invests in bonds, but also aims to track rising costs as much as possible by paying inflation-adjusted coupons.

These indexed bond funds will track an indicator of inflation, such as the Consumer Price Index (CPI), and then pay investors the actual return plus any accumulated inflation.

Since bond prices tend to move inversely to interest rates, and therefore inflation, an indexed bond fund could make a potentially important investment in times of high inflation.

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