Corporate bonds are issued by large companies to raise money and work as follows
- They guarantee to retum a redemption value at the end of a fixed term.
- They guarantee to give the investor fixed regular payments (The coupon)
Funds that invest in corporate bonds make good long-term investments because they
- Provide a good investment yield i.e. they pay a regular fixed income (The coupon)
- Are less risky than shares
- Have a guaranteed value at maturity
- Can provide capital appreciation as well as income
- Tend to rise in value if the company is successful
- Tend to rise in value if interest rates fall
- Tend to rise in value when economic conditions improve
The price of a corporate bond will change from day to day according to market conditions. The price is usually less volatile than the companies share price because of the corporate bond's fixed income and guaranteed maturity value.
Less Risky than Shares
The company that has issued the bond is committed to paying the coupon at the set level. The income is therefore fixed which is why corporate bonds are classed as "fixed income securities". They give investors a guaranteed income.
Guaranteed value at Maturity
The company that has issued the bond, is committed to repaying a fixed amount at maturity. This can be more or less than the bonds current price.
The fund manager will look for companies that have good prospects. As the companies trading improves, it's credit rating will improve and this will have a positive effect on the price of any bonds it has issued.
Companies have a legal obligation to repay their bond holders at maturity. The price of a bond will depend on several factors including the risk that the company may get into trouble and be unable to meet it's obligations. As the company becomes more successful these risks reduce and the bond becomes more valuable.
Falling interest rates
If general interest rates fall, any asset that pays a fixed rate of return should rise in value
Good economic conditions reduce the risk of companies coming under pressure and makes it more likely they can meet their obligations without difficulty.
The guarantees are provided by the company issuing the bond. The risk is that if the company gets into trouble, it may be unable to cover it's guarantees. This is known as default risk (See below).
Corporate Bond Funds
By investing in a corporate bond fund, investors directly benefit from the advantages of corporate bond investment without hassle. The investment will be spread across many bonds, diversifying risk and the fund will be valued daily. Most importantly, the fund manger will be tracking the fortunes and prospects for each bond holding and trading each day to acquire the best bonds for the fund, selling off any that become less attractive.
So What are the Risks
The main risk with a corporate bond is default risk. This is where a company fails to pay a coupon. In such circumstances the company is likely to be insolvent and be put into administration. This is why it is risky to hold any one bond and better instead to hold a fund where a single default would have little impact.
Default risk affects the price of corporate bonds. If the credit rating of a bond is downgraded, its price will fall. This is why it is best to invest through a fund where the fund manger will seek to anticipate credit downgrades. On the other hand, if the credit rating of the bond is upgraded, it's price is likely to rise.
What else should I know?
In general, corporate bonds do not like risking interest rates. These often have a negative impact on the company that has issued the bond but more importantly make the fixed income from the bond less attractive. In a rising interest-rate market, the price corporate bonds and other fixed interest securities will tend to fall. On the other hand, in a falling interest rate market, the price of corporate bonds will tend to rise.
What other information is available?
Click here for information about Strategic Bond Funds
The value of units may fall as well as rise and past performance is not necessarily a guide to the future. We recommend investors do not choose funds based on yield alone as there are many factors to consider and that you take advice from us before investing.