Bond Funds, like Stock Funds offer professional selection and management of a portfolio of Bonds for a fee. Through a Bond Fund you can diversify the risks across a range of bonds pre-chosen by the manager.
Some funds are designed to follow a market, often called an Index Fund. Other Funds are actively managed according to an objective, with the component Bonds purchased and sold at the discretion of the fund manager.
The down side is, unlike owning a Bond directly, a Bond Fund does not have a specified maturity date. Upon maturity, the individual Bonds within the Fund are sold or traded then reinvested into other Bonds. The Fund will add and change Bonds in response to market conditions and investor demand. Furthermore, some Funds have a more aggressive style and can take on leverage to boost their performance.
As an investor you can buy or sell a share/unit in a Fund at any time for the Fund’s net asset value, but because the market value of Bonds fluctuates, a Fund’s net asset value will also change to reflect the aggregate value of the Bonds in the portfolio. This means when you decide to sell, you will not know what your units in the Fund are worth, if there is high demand for the Fund, the price will be high and if there is low demand the price will be less, which might be more or less than your initial investment. There is also, in certain Funds the need for another investor to replace your position which could take time.
As a result, the value of your investment in the Bond Fund may be higher or lower than the original purchase price. Because the Fund Managers are less concerned about having to meet investor redemptions on any given day, their strategies can be more aggressive. Exchange-traded Funds or ETFs, are similar to Closed-end Funds, but have transparent portfolios which are generally passively managed. In addition, rating agencies also evaluate bond funds for credit and safety as there is a chance the fund itself can go bankrupt.
Most Funds charge annual management fees and some also impose initial sales charges or fees for selling shares. When all of it taken into account, fees and sales charges will lower your overall returns. You will need to be aware of total costs when calculating expected returns.
Like individual Bonds and other investments, Bond Fund investments entail risk. Investors should not automatically conclude that a Fund offering a higher rate of return or income is better than a Fund offering lower rates of return or income. Like most investments, the advertised rate of return is only a small part of what to look for, you need to investigate the other aspects of the investment including total costs, credit quality, manager quality, risks and the ability to exit these Funds before making investment decisions.