Personal Finance & Money Asked by Daniel Valland on March 28, 2021
Obviously the bonds will lose value if the issuer defaults, but if there is a stable, predictable number of defaults in the fund’s bond holdings, how does a bond fund fall in value? I know that the face value of the given bonds will move in the opposite direction of the interest rate. But would it not be the case that this decrease in value will only be realized if the bond is sold/traded before maturity, and so, if one simply continue to hold the bond until maturity, you should continue to receive the fixed interest…
Because you are mixing the bond value with the fund value.
The fund will have a mix of assets, for a "bond fund", it will be almost all of them bonds (see the specifics for each fund on what securities it can invest on).
As pointed out by Tom's answer, The risk inherent to interest rate fluctiations can change the value of the bonds, because of opportunity costs of holding the bond.
The fund value can also fluctuate due to external factors not related to the bonds, for example withdrawals. If there are several big withdrawals from the fund, and the fund does not have available cash to pay for those withdrawals, then it will have to sell some securities/bonds to cover those withdrawals. This can happen at a sub-optimal time, and the fund value can drop more than the underlying bonds.
Correct answer by Mindwin on March 28, 2021
Well, the bond funds are "marking to market" when they figure out the net asset value of the fund. As interest rates rise, the market value of the bond drops and the NAV falls to match this.
Funds that hold mostly long term bonds feel this a lot more than funds that hold short term bonds. If you want a more stable fund value, you need to go to short duration funds that invest in bonds that come due in a few months. The price for this is that the return on short term funds is lower.
Answered by zeta-band on March 28, 2021
Bond funds go up and down depending on whether the underlying bonds go up or down in value. One reason that bonds may go down is, as you said, the risk of default.
Besides defaults, the other main risk is interest rate risk. Bonds pay interest rates prevailing on the day that they were issued. If interest rates suddenly go up, the bonds have to go down enough so that their "old" rates yield as much interest as the "new" rates. That, and not default risk, is the main reason that bond funds go down.
Answered by Tom Au on March 28, 2021
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