What is a bond fund?
A bond fund is a type of mutual fund that keeps its money mainly in debt: government treasury bills and bonds, corporate bonds, sukuk and term deposits. You buy units in the fund, and your share of the interest or profit it earns, and of the rise and fall in its bonds’ prices, shows up in your unit value (NAV).
A bond bought directly has a maturity date: if the issuer pays as promised, you get your money back at the end. A bond fund usually has no maturity date. As old bonds mature, the fund buys new ones, so there is no promise of a set amount back on a set day.
Say Rafiq lends his brother money for two years, with the terms written down: the money comes back at the end. That is like a bond. Now say Rafiq and many others form a pot that lends to hundreds of people at once over different terms, and lends again as soon as old loans are repaid. Rafiq’s share is valued every day, but there is no set date on which he gets a set sum back. That is a bond fund.
Why it matters to an investor
- “Fixed” does not mean guaranteed: there is no set rate as with an FDR. When interest rates rise the NAV can fall, and if an issuer fails to pay, there can be a loss.
- Many bonds for a small sum: a fund spreads a small amount across many bonds, more simply than buying treasury or corporate bonds on your own.
- Easy access: open-end fund units can usually be cashed in at any time at a NAV-based price, though at whatever the NAV is then.
- What’s inside, not the name: some “fixed-income” funds can hold a large part in shares too. To understand the risk you need to look at the portfolio.
Why the NAV moves when rates change
When market interest rates rise, new bonds pay more, so older bonds with lower interest fall in price. When rates fall, the opposite happens. A bond fund holds many bonds, so these price changes flow straight into its NAV. In an example from the US SEC, a $1,000 bond paying 3% falls to about $925 when market rates move to 4%.
A rough guide to how much it will move is “duration”, which may be given in the fund’s fact sheet. As FINRA explains it, with a duration of 10 years a 1% rise in rates could cut the fund’s value by about 10%; with a duration of 2 years, by about 2%. Funds of long-term bonds therefore swing more, and funds of short-term bonds less.
Fixed-income funds in Bangladesh
According to a November 2024 report, six open-end fixed-income funds had launched in Bangladesh over the previous two years. Most of their assets were in government treasury bills and bonds; treasury bond yields had risen above 12.5% at the time. Five of the six showed annualised returns of roughly 9% to just over 10%.
The same report showed one fund’s return falling to about 4.5% after its capital shrank, and another “fixed-income” fund holding about half its assets in shares. In other words, funds with the same label can carry very different risks and results. These figures are from one point in time; future returns will change with rates.
Worked example
- Say a bond fund’s NAV is Tk 10 a unit, its duration is 4 years, and its bonds yield 10% a year on average. You hold 10,000 units, worth Tk 1,00,000.
- Market rates suddenly rise by 1%. Rough guess: the NAV falls about 4% to Tk 9.60. Your units are worth about Tk 96,000.
- The upside: the fund now buys new bonds at about 11%. With roughly 1% a year of extra income, making up the 4% loss can take about as long as the duration, roughly 4 years.
Result: when rates rise, a bond fund can lose money in the short run, while higher yields can make up for it if you hold for long enough. If your time horizon is shorter than the fund’s duration, the risk is greater. The numbers are only an example, and the duration rule is only a rough guide.
Common mistakes
- Treating a bond fund like an FDR with a set rate. The NAV can fall.
- Assuming the last few months’ annualised return will continue. When rates change, returns change too.
- Assuming from the name that a fund holds only bonds. Some funds keep a large part in shares.
- Putting money needed soon into a long-duration fund, then cashing out at a loss when rates rise.
A bond fund is a basket of bonds with no maturity date: when rates rise its NAV falls, and duration gives a rough idea of by how much.