Bond funds: get stable returns

This course is reproduced from Morningstar and has been partially revised by Futu.

A bond fund is a fund that invests exclusively in bonds. In China, bond funds mainly invest in treasury bonds, financial bonds and corporate bonds. Usually, bonds provide investors with fixed returns and principal repayment at maturity, and the risk is lower than that of stocks, so compared with stock funds, bond funds have the characteristics of stable income and low risk.

To know how to choose a bond fund, you first need to understand what a bond is. Investing in bonds is equivalent to lending to the issuer of bonds, the principal will be repaid when the bond matures, and interest income will be earned on a regular basis, for example, every six months. How long the bond will mature and the issuer's repayment ability are the two most important factors for bond investment.

therefore,There are two major factors that affect the performance of bond funds, one is interest rate risk, that is, the sensitivity of invested bonds to interest rate changes (also known as duration), and the other is credit risk.

Therefore, when choosing bond funds, we must understand their interest rate sensitivity and credit quality. On this basis, you can understand how high the risk of the fund is and whether it meets your investment needs. Morningstar focuses on these two points when evaluating the investment style of bond funds.

How do interest rate changes affect bond funds?

The rise and fall of bond prices is inversely related to the rise and fall of interest rates. When interest rates rise, bond prices fall. To know the changes in bond prices, so as to know how sensitive the net asset value of bond funds to changes in interest rates is, duration can be used as an indicator.

The duration depends on three major factors of the bond: maturity, cash flow of principal and interest payments, and maturity yield. The duration is calculated in years, but it is a different concept from the maturity of the bond. With this indicator, you can see how much the funds under study have gained or lost as a result of changes in interest rates.

The longer the duration, the more sensitive the net asset value of the bond fund to changes in interest.If the duration of a bond fund is 5 years, then if the interest rate falls by 1 percentage point, the net asset value of the fund will increase by about 5 percentage points; on the contrary, if the interest rate rises by 1 percentage point, then the net asset value of the fund will suffer a loss of 5 percentage points. For another example, there are two bond funds with durations of four years and two years, respectively, and the net asset value of the former fluctuates about twice as much as the latter.

02 what is the credit rating of the bonds invested?

The credit quality of bond funds depends on the credit rating of the bonds they invest.

In the United States, for example, high-quality bonds issued by the US government have a credit rating of AAA, while high-interest junk bonds issued by companies with unstable credit have a rating of BB or lower. For the credit rating of bonds, reference can be made to the rating agencies' evaluation of the issuer's solvency. After carefully reviewing the issuer's financial information, rating agencies such as Moody's Corporation and Standard & Poor's will determine whether their bonds are "good money" or "bad currency".

AAA represents the highest credit rating, while D represents the worst credit rating. Bonds rated AAA, AA, An and BBB are investment grade bonds, and issuers are considered to be able to repay principal and interest. Bonds rated BB, B, CCC, CC and C are non-investment grade bonds as well as high-interest bonds, and rating agencies believe that their issuers may not meet their debt repayment commitments. In fact, only issuers who have failed to meet their debt repayment commitments will get the lowest rating D.

Morningstar has classified the credit quality of American bond funds as follows.

High credit quality: the average credit rating of its portfolio is AAA or AA.

Medium credit quality: the average credit rating of its portfolio is below AA, BBB and above.

Low credit quality: the average credit rating of its portfolio is below BBB.