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Corporate Bond Fund Shopping Guide

Corporate bond fund investors have been issued with a check list of points to consider when shopping for a deal by financial watchdogs.

The Financial Conduct Authority (FCA) wants investors to be more aware of the risks and returns associated with corporate bonds, so has drafted the crib sheet to explain the details of corporate bond funds.

What is a corporate bond?

A corporate bond is issued by a company looking for cash to grow the business as an alternative to borrowing from a commercial lender or diluting the shareholding by issuing more equity.

The bonds often offer a fixed rate return and are generally tradable.

Recent issues include Lloyds Ban, Tesco and student living firm Unite.

What is a corporate bond fund?

Corporate bond funds are pools of investors putting money into companies with the help of a professional fund manager.

The bonds are rated low risk by credit agencies and tend to attract attention from retail investors. Funds have around 80% of their cash tied up in low-risk corporate bonds. The funds can provide a steady income stream at higher interest rates than cash left on deposit.

What are the risks associated with these funds?

Corporate Bond funds are not completely risk free for a number of reasons:

  • Access to cash – the bonds are illiquid and if an investor needs quick access to their money, they may not be able to sell at a good price as although they trade on markets, volumes are low. Fund managers should monitor this and limit the fund’s holdings in a single bond issue.
  • Interest rates – Fluctuating rates can affect bond and bond fund unit prices. The rule of thumb is as interest rates rise, the value of bonds fall as the gap between cash deposit returns and bond income returns closes. This can reduce the capital value of a fund unit, while cash deposit values stay constant.
  • Company defaults – The risk of default by a blue-chip company is low, but nevertheless still a risk. If a bond issuer defaults, the impact across a fund should be minimised as the risk is shared and limited for each investor
  • Economic factors – market confidence can influence fund prices

Corporate bond fund shopping checklist

Six points to bear in mind when considering a corporate bond fund investment:

  • Does the projected return match your investment objectives
  • Factor in a cash reserve so you can cover any drop in the value of corporate bond fund units you hold
  • Crunch the numbers on what will happen to your finances if you get a negative return from the fund
  • Consider the terms and conditions of each fund and the risk of their underlying holdings. Some have a more aggressive investment strategy than others that may not suit risk-adverse investors
  • Think about what happens if you need quick access to your cash

Always carry out due diligence before investing, and if in doubt, take professional, independent financial advice before committing any cash.

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