| Corporate Bonds | Bond Funds | |
|---|---|---|
 Higher potential after-tax returns |
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 Less downside |
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 Easier to buy & sell |
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 Greater transparency |
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 No recurring fees |
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 Pays fixed coupon |
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 Returns principal at maturity |
Higher potential after-tax returns
Individual Corporate Bonds vs. Bond Funds
Investors in individual corporate bonds have a key advantage
over bond mutual funds and ETFs: the ability to be selective and find bonds that can appreciate in value and achieve
strong investment returns. Many bonds
trade at a discount to par value, which is where BondSavvy focuses its bond investment recommendations.
Since bond funds are so big and have to own so many bonds, they often own bonds priced at significant premiums to
par value with little upside opportunity. Many of the largest bond mutual funds and bond ETFs are index funds
that invest to follow a market benchmark. These index funds often have low returns, as evidenced by the world's
largest bond fund, the Vanguard Total Bond Market Index Fund, achieving a 1.63% average investment return from 2015-2018. We founded BondSavvy
because investors deserve better.
Less downside
Individual Corporate Bonds vs. Bond Funds
When we present new bond investment opportunities, we advise subscribers to make an initial investment and then, over
time, add to that position based on the performance of the company and the pricing of the company's bonds. This helps
limit our downside as, in the case of falling prices, we can continue to buy in at lower prices that, over time, will
help our investments achieve strong returns Further, since individual bonds all trade on the same par-value scale,
the value of an individual bond investment is more transparent than that of a bond mutual fund, which trades relative
to its net asset value, or NAV. A bond fund or bond ETF could trade at 10, 50 or 100, and the investor never knows
whether he is investing at a compelling value or not.
Investors in individual bonds limit their downside by knowing exactly what they are investing in and the price at which
they are investing in a specific bond. The same cannot be said for bond mutual fund investors.
Easier to buy and sell
Individual Corporate Bonds vs. Bond Funds
Bond funds are still larger than exchange-traded funds (ETFs), which means most fund investors still can't buy and
sell intraday. The corporate bond market is dynamic and always changing. There are earnings announcements, mergers,
and news that investors must digest real time. Executing an individual corporate bond trade takes seconds and you can
trade any time during the day. Owning individual corporate bonds enables you to act more quickly -- and precisely --
to events that impact your corporate bond investments.
Since individual bonds trade relative to their par value, investors are provided a higher level of bond pricing transparency than bond funds, which trade relative
to a fund's net asset value. Bond fund and ETF share prices have no benchmark whatsoever, so investors cannot gauge
the value at which they are purchasing bond fund and ETF shares.
We believe it often makes sense to sell bonds prior to maturity to maximize investment returns. Knowing how the bond is trading relative to its par value is one of several factors
we examine when deciding when to sell bonds we have previously recommended.
Greater transparency
Individual Corporate Bonds vs. Bond Funds
When you own individual corporate bonds, you know exactly what you are investing in. You know the issuer, the
yield, the maturity date, the price, and many other pieces of information that help investors assess a bond's risk
and return. Typically, six to nine dealers are quoting each corporate bond, which helps ensure a competitive
market for your order. In addition, investors can compare current bond quotes to recently executed trades on
FINRA's Trade Reporting and Compliance Engine (TRACE), which is available on most online brokerages. Our founder
Steve Shaw recently presented ' Investment Transparency in the US Corporate Bond Market for Retail Investors' to the SEC, which you can view along with the accompanying BondSavvy comment letter.
Bond funds are essentially derivatives that contain hundreds of bonds that can change every day. There are very
few 'pure play' corporate bond funds. Rather, most bond funds own an assortment of securities, including Treasury
bonds, corporate bonds, municipal bonds, common stocks, preferred stocks, and cash.
When investors build their portfolios, it is crucially important to know the specific securities that are in it.
For example, the popular iShares Core U.S. Aggregate Bond ETF (AGG) often holds more than 10% of its portfolio in cash.
An investment in this bond ETF immediately over-allocates investors to cash. If you own individual corporate
bonds, you can ensure you are investing in what you want.
No recurring fees
When investors own individual corporate bonds, they pay a transaction fee to buy and a transaction fee to sell. On
platforms such as Fidelity.com and E*TRADE, this fee is $1 per bond. Therefore, if you own a portfolio of 100
bonds and sell it after three years, your total fees paid would have been $200. This represents significant savings
to bond funds, many of which charge 1% management fees. Had an investor opted to put $100,000 into a bond fund
charging 1% during this three-year period, he would have paid $3,000 in fees (+/- depending on investment returns)
compared to the $200 paid by the individual corporate bond investor.
Had this investor subscribed to BondSavvy,
his total fees paid, including the $200 transaction fees, would have been a fraction of what a 1% management fee fund
investor would pay. In addition, there are hidden bond fund fees embedded in bond funds and ETFs that are not disclosed to investors.
These trading-related fees are due to the high turnover of many bond funds, understate a bond fund investor's true
cost of investing, and markedly reduce bond fund investment returns.
Pays a fixed coupon while bond funds and ETFs take the "fixed" out of fixed income
The entire premise of fixed income investing is that you receive a fixed coupon payment twice per year and the return of your principal at maturity. It’s why they call it “fixed income.” Investors receive this when they invest in individual bonds. They don’t receive either in bond funds, which is why we say “bond funds take the 'fixed' out of fixed income."
Individual bond investors are treated more fairly than bond fund investors
In the world of mutual funds, it’s an alphabet soup of investor classes and fees, which typically translates into smaller
investors paying a higher percentage of their investment in fees than larger investors, which is a regressive tax in
our book. For example, the BlackRock High Yield Bond Portfolio has an A, B, B1, C, C1, K, R and an Institutional Class.
Those in the lowly C Class paid 1.64% of their investment in fees during the year ended September 30, 2018 while those
in the Institutional Class only paid 0.61%. In addition, B Class holders are subject to a sales fee when they sell.
Apart from these stated fees, the fund has significant hidden trading fees, as the BlackRock High Yield Bond Portfolio
had turnover of 90% for the twelve months ending September 30, 2018. These trading fees hurt fund returns, as
we explain in this blog post.
It’s a very different story when investing in individual corporate bonds, as someone investing $5,000 can pay the same
price for a bond as someone investing $250,000. In addition, with bid-offer spreads typically between one-quarter to
a full point, investors electing to sell bonds prior to maturity can do so without the excessive fees and transaction costs of many fixed income mutual funds.