Advantages of Corporate Bonds vs. Bond Funds
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Corporate Bonds |
Bond Funds |
Higher potential investment returns |
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Pays
fixed coupon |
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Build a Portfolio Suited to Your Objectives |
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Lower fees |
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Returns principal at maturity |
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Superior and frequent financial
disclosures |
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Easier to buy & sell |
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Higher potential investment 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 to 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 -- not to maximize returns. Investors deserve better.
Corporate bond issuers file quarterly financials, enabling individual bond investors to compare a bond's price relative to par value, YTM, and credit spread to financial metrics such as leverage ratios. In doing so, investors can determine whether a corporate bond has upside potential and whether it can achieve a strong return.
Such investment analysis is not possible with bond funds, as they trade off an arbitrary net asset value per share and lack any financial metrics for investors to assess whether a bond fund is a compelling value.
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.”
Individual bond investors receive contractual coupon payments at specific times during the year. Income investors who count on bond interest payments need this level of security. Variable distribution bond funds don't cut it.
Bond fund holdings are ever changing, as are the distributions they pay investors. Bond funds typically pay dividends every month, but investors will not know how much they are set to receive each month until the payments are made.
The lack of contractual interest payments is one of the reasons we say, “bond funds take
the 'fixed' out of fixed income."
Build a Portfolio Suited to Your Objectives
Individual 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, credit spread, and many other pieces of information that help investors
assess a bond's risk and return. You can select the bond issuer's industry and follow Bondsavvy's fixed income investment analysis to assess a bond issuer's financial wherewithal.
Bond funds are essentially derivatives that contain hundreds or thousands 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.
Typically, six to ten dealers provide live bid-and-offer quotes on online bond trading platforms such as Fidelity.com, E*TRADE, Interactive Brokers, and Vanguard. This helps ensure a
competitive market for your corporate bond 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 previously presented Investment Transparency in
the US Corporate Bond Market for
Retail Investors to the SEC, which you can view along with the accompanying Bondsavvy SEC comment
letter.
When investors build their bond portfolios, it is crucially important they know the
specific securities that are in it to ensure their asset allocation is in line with their investment objectives and risk tolerance. This isn't possible with ever-changing bond funds.
For example, the popular iShares Core U.S. Aggregate Bond ETF (AGG) has often held 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.
Lower 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 each bond's $1,000 face value. 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.
In addition to bond fund management fees, 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. These undisclosed fees understate a bond fund investor's true cost of investing and can markedly reduce bond fund investment
returns.
Return of Principal at Maturity
Individual bonds are required to repay investors their $1,000 face value at maturity. This key term provides a level of certainty and security of principal that bond fund investors lack.
If you purchase a corporate bond today at a price of 90.00 and a five-year maturity, you know you will receive $1,000 for each bond you own in five years, provided the company does not default.
The same cannot be said for bond funds and bond ETFs. Suppose you purchase Vanguard Total Bond Market Index Fund, VBTLX, at a price of $10.00. Since bond funds do not have maturity dates, investors have no idea what the value of their principal will be in five years. This is why bond funds and bond ETFs are not fixed income investments, as there is nothing fixed about them.
Superior and Frequent Financial Disclosures
Corporate Bonds vs. Bond Funds and ETFs
Corporate bond issuers file quarterly financial statements with the United States Securities and Exchange Commission (SEC). They make additional filings any time there are material events (Form 8-K) such as an acquisition, divestiture, new financing, or changes in management.
These regulatory filings keep bond investors abreast of what is going on at the issuing company so they can assess whether to add to, hold, or sell corporate bond investments. In addition, since corporate bonds trade as a percentage of their $1,000 face value, investors can quickly begin to assess whether a bond is trading at a compelling value relative to the financial health of the issuing company.
These frequent disclosures are a world away from what bond fund and bond ETF investors receive. These investors typically receive semi-annual reports that disclose information about the fund, such as the fees it charges and the investments held in the fund. Since bond funds typically hold thousands of bonds, there are no financial disclosures related to the operating performance of the companies issuing bonds held by the fund. This makes it impossible to do any financial analysis on bond funds.
In addition, since bond funds trade off net asset value per share, investors cannot assess a bond fund's relative value.
Easier to buy and sell
Corporate Bonds vs. Bond Funds
Bond mutual 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 in 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 $1000 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 typically sell bonds before 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.