So what makes this an attractive investment option, and why don?t we just buy bonds or bank bills directly from the issuer? One significant downside to the debt security market is that potential investors need a significant amount of money and a lot of information about the issuer in order to effectively make a bond investment. This is because bond issues come in higher denominations, e.g. one unit of a bond may be priced at $1,000 or even up to $25,000. Apart from this, a corporate bond (unlike Government Bonds) comes with significant counterparty risk and might not be as safe for the average investor.
This is where bond funds could help. Bond funds pools investors? monies, so they have the capability to tap into the wider bond market. A fixed income fund buys securities and issues them as units of smaller denominations which make it accessible to a wider pool of investors. Moreover these funds use professional managers who rely on sophisticated research to analyze an issuer?s credit risk so they are better equipped to make buy/sell decisions on your behalf. That said, investors pay for this management which is why bond funds have investment fees associated with them.
Apart from accessibility into the bond market, fixed income funds are a means of portfolio diversification. A single fund will hold bonds issued by several different institutions, so it might not hurt as much financially if one or two of them default. In effect, diversification is achieved with a small investment, which is highly unlikely if one is buying bonds directly.
Article updated 07/06/2012