Direct investments in individual corporate bonds can achieve a higher return on investment than bond mutual funds and bond ETFs. Investors can also better assess the risk of investing in individual bonds since they know a bond's maturity date, coupon, and credit risk prior to buying the bond. This investment information is not easily available for most bond mutual funds since they own thousands of bonds and frequently turn over their investments, resulting in high trading costs that are undisclosed and reduce investment returns.
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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 -- not to maximize returns. We founded BondSavvy
because investors deserve better.
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.
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.
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 SEC 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.
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.
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."
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 hidden bond fund fees hurt bond fund returns and are a key reason why a select portfolio of individual
bonds can outperform the leading bond funds.
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 before maturity can do so
without the excessive fees and transaction costs of many fixed income mutual funds.