Bond funds vs Individual Bonds…
Is there really a difference?
Views expressed are those of the author, not necessarilyMorgan Stanley Smith Barney
LLC,member SIPC, andarenot a solicitation tobuyor sell any security. The investments
and/or strategies referenced herein may be speculative in nature, illiquid, subject to
VLJQLĆFDQW ULVNV LQFOXGLQJ WKH ORVV RI SULQFLSDO DQG DUH QRW VXLWDEOH IRU DOO LQYHVWRUV
'LYHUVLĆFDWLRQGRHVQRWJXDUDQWHHDSURĆWRUSURWHFWDJDLQVWDORVV 0RUJDQ6WDQOH\6PLWK
Barney LLC and itsWealthAdvisors do not provide tax or legal advice. Copyright 2013
Morgan Stanley Smith Barney LLC, member SIPC The appropriateness of a particular
investment or strategy will depend on an investor’s individual circumstances and
objectives.
Investors should carefully consider the investment objectives and risks as
well as charges and expenses of a mutual fund before investing. To obtain a
prospectus, contact your Financial Advisor or visit the fund company’swebsite. The
prospectus contains this and other important information about the mutual fund.
Read the prospectus carefully before investing.
Investments and services offered
throughMorgan Stanley SmithBarney LLC.Member SIPC. Bonds are subject to interest
UDWH ULVN :KHQ LQWHUHVW UDWHV ULVH ERQGSULFHV IDOO JHQHUDOO\ WKH ORQJHU DERQGVPDWXULW\
WKHPRUH VHQVLWLYH LW LV WR WKLV ULVN %RQGVPD\DOVREH VXEMHFW WRFDOO ULVN ZKLFK LV WKH ULVN
that the issuer will redeem the debt at its option, fully or partially, before the scheduled
PDWXULW\ GDWH 7KHPDUNHW YDOXH RI GHEW LQVWUXPHQWVPD\ ćXFWXDWH DQG SURFHHGV IURP
sales prior tomaturity may be more or less than the amount originally invested or the
PDWXULW\YDOXHGXH WRFKDQJHV LQPDUNHW FRQGLWLRQVRU FKDQJHV LQWKHFUHGLW TXDOLW\RI WKH
LVVXHU %RQGVDUHVXEMHFW WRWKHFUHGLW ULVNRI WKH LVVXHU 7KLV LV WKHULVNWKDW WKH LVVXHUPLJKW
EH XQDEOH WRPDNH LQWHUHVW DQG RU SULQFLSDO SD\PHQWV RQ D WLPHO\ EDVLV %RQGV DUH DOVR
VXEMHFW WRUHLQYHVWPHQW ULVN ZKLFK LV WKHULVNWKDWSULQFLSDO DQG RU LQWHUHVWSD\PHQWV IURP
agiven investmentmaybe reinvestedata lower interest rate.
“for larger investors I generally recommend the
useof an investment professional toassist in the
creationof adiversifiedportfolioof individual
bonds as opposed toowningbond funds”
O
ver the years, I’veobservedmanydebateswithin themedia as
towhether investing in individual bonds is truly interchangeable
with investing in bond funds. This article will address the
di erencesaswell as someof thepositivesandnegatives found in
eachof these two typesof investment vehicles.
Asageneral rule, bond fundso er investors theadvantageof a
simpleway to,withinone investment attempt toownadiversi ed
portfolio of bonds and/or other xed income holdings. Formany
individual investors with smaller portfolios, this allows for the
inclusionof these typesofholdingswithin theirportfolio insmaller
dollar increments and without being forced to actually do the
detailed research and ongoing monitoring necessary when
investing in individual securities.
Whilemanybond fundsstrive too er theattributes listedabove,
there are often some important potential drawbacks investors
shouldalsoconsider.Asopposed tobond funds,when investing in
individual bonds you have the advantage of knowing with
completecertainty several very important facts suchas:whom
Adam E. Carlin is aManagingDirector-WealthManagement, Financial Advisor, and
Senior PortfolioManagement Director at Morgan Stanley located in Coral Gables,
Floridaandmaybe reachedat (305)476-3302oradam.e.carlin@morganstanley.com
Wealt
h Management
by
Adam E. Carlin
Advertisement
speci cally you have lent money to (the borrower), exactly how
much in interest thatborrowermustpayyou (thecoupon rate)and
when theborrowercan (calldate)ormust (maturitydate)payback
yourprincipal. Knowing thesekey factso ers an investor acertain
degreeofpredictabilityof outcomeswithin theirportfolio.
Furthermore, having the knowledge as towho speci cally the
borrower isandwhen thematuritydate isonabondalsoallows for
themeasurement andcontrol of twovery important typesof risks:
creditordefault riskanddurationor interest rate risk. Havingaway
tomeasure these types of risks can help an investor understand
what the chances areof apotential default of aparticular security
aswell ashowmuchpricevolatilityan investor shouldexpect from
a securitywhen interest rates change.
As a result of this prolonged and very unique periodwe have
been living through inwhich investorshavebeen forced tochoose
income generating investments when interest rates have been
extraordinarily low, I am concerned about thepotential degreeof
both risksmentionedabove that investorsmayunknowinglyhave
incorporatedwithin theirportfolios.
Given the discussion above, for larger investors I generally
recommend the use of an investment professional to assist in the
creation of a diversi ed portfolio of individual bonds as opposed to
owning bond funds. For investors who choose to own bond funds, I
recommend the incorporation of a systematic process of having a
skilled professional review the individual funds owned to determine
whether each fund is still appropriate as well as examine the
diversi cationamong thedi erent fundsowned.
Therearehowever timeswhenabond fundmaybeanappropriate
investment vehicleeven for larger investors. Incaseswhenan investor
is looking toaddaveryspeci cor tacticalallocation toastrategywhich
requires the expertise of amanager who specializes in that particular
strategy, theuseofa fundmayoftenbe themoste cientande ective
investment choice. Examples when this may apply would be an
investor looking to add allocations to areas such as emergingmarket
debt and/ordistresseddebt to theirportfolio.
For those investors who wish to be proactive to determine the
appropriateness of their xed income strategy and holdings, I
suggest the following:
.
Askyour advisor to reviewyour xed incomeholdings todetermine
whether each isappropriategivenyourportfolio’s sizeaswell as
your investmentneeds.
.
Determinewhether anychanges shouldbemade to thoseholdings
inorder tobestmeet your investmentneeds.
