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Direct versus managed fund bond investment

by Elizabeth Moran | Oct 29, 2013

Key points:

1. Having a direct bond portfolio gives investors control over companies they invest in, the bonds’ risk, return and maturity date profiles.

2. Managed fund investors usually pay annual fees for fund management as well as a buy/sell spread when they purchase the bonds. Direct bond investors just pay the one-off brokerage fee.

3. Direct bond investors need between five and ten bonds to achieve sufficient diversification, lower than the 15 needed for shareholders as bond prices display much lower volatility than shares.

Investors who want to invest in fixed income often ask “is a direct bond portfolio or a managed fund best?” It really depends on the sort of investor that you are; how much you want to invest and the goals you want to achieve.

Investing in managed funds is the easier option. The fund manager makes the decisions about which bonds to buy, the weighting to various industrial sectors, the maturity and risk profile of the portfolio. In return you give up some of the major benefits of owning bonds outright. The most obvious is that you give up control. You won’t necessarily know the full list of investments of the fund and you won’t have any input into the investment mix. One of the other major sacrifices is losing the natural maturity dates of the bonds. Investors in managed funds have to make the decision to sell to recoup capital. A known maturity date is far better if you have specific expenses that you need to meet. Some investors will be comfortable with the managed fund unit-based price structure but there’s a degree of uncertainty of the unit price on any given day when you may need to access your funds.  

Generally managed funds will be liquid (they often hold large allocations to government bonds as they are very liquid instruments) but some have been “frozen” when markets have been distressed. The freeze on redemptions allows fund managers to sell assets to meet redemption requests. Investors in frozen funds are swept along with the masses and even though it may not be their choice to sell assets at that particular time, the fund in effect becomes a forced seller.

One of the counter arguments for managed funds is the diversification they can offer your portfolio. But owning bonds is not like owning shares; you don’t need to hold 15 to have a diversified holding as bond prices display much lower volatility than shares and as such you are better able to rely on the price of the bonds should you need to sell. The more bonds you hold the better, but we’d normally suggest between five and ten is sufficient for good diversity. Remember there are many bonds issued by companies not listed on the ASX, so you can achieve a natural diversification away from your equity investments.

If you have a managed bond fund investment its worth checking whether it is actively or passively managed. Active management should deliver greater returns although you are likely to pay higher fees. Both fund managers and individual bond investors will pay a buy/ sell spread on acquisition and sale of bonds. Investors in managed funds pay ongoing fees but if you buy direct, you just pay the one-off brokerage fee.

Weighing up which option is best for you really depends on your investment psyche. Managed funds need less effort but you hand over control. Smaller investors can access managed funds from as little as $5,000.

If you have your own SMSF, you’re more than likely an active investor that wants control over your portfolio.

You can own bonds in your own name or in the name of your SMSF and you can control which companies you invest in, the bonds’ risk, return and maturity date profiles, when you buy and if you hold to maturity. Or trade for a better opportunity. 

Good bond brokers will help you learn about the asset class and offer portfolio suggestions.

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