Is the SBI bank account good or bad

Are bond funds being phased out?

If interest rates rise, bond prices fall and vice versa. This inverse relationship between the development of market interest rates and the value of bonds has made bond funds difficult for some time. Bond funds have only become really popular in the past 20 years, when interest rates have gradually fallen from their highs. During all this time, investors have got used to bond funds that have produced nice returns year after year.

This is over. The probability that interest rates will continue to fall successively is practically zero given the low interest rate level that has now been reached. Conservative funds in particular, which mainly rely on very good debtors (investment grade), no longer pay off for investors given the very low interest rates. Let us analyze three typical examples of Swiss bond funds as they are offered in the market:

Funds

index

TER

Yield to maturity

Oblifonds A

SBI Domestic AAA - BBB

0.90%

0.15%

Oblifonds B

SBI Foreign AAA-A

0.86%

0.82%

Oblifonds C

SBI Foreign AAA - BBB

0.80%

1.54%

TER = total expense ratio

With bond funds A and B, it is noticeable that the costs measured by the TER (Total Expense Ratio) are no longer covered by the yield to maturity. In concrete terms: if an investor invests in such a bond fund today, he will make a certain loss if market interest rates remain the same. For fund A this would be -0.75% per year (0.15% - 0.90%, for fund B -0.04%! Only fund C still has a positive return for the investor due to its higher yield to maturity. But if you take a closer look, this picture is still there embellished because the TER only includes a good half of the costs actually incurred. Issuing commissions, trading fees, taxes and levies are added on top of that, so that even Fund C probably only produces a return of almost zero.

With such bond funds, investors bet on further falling interest rates, because only then can positive returns be generated again in the short and medium term. However, it is realistic to assume that sooner or later we will face a sustained phase of rising interest rates. Of course, the bond managers don't just stand by and watch. In the short term, however, there is little they can do to counter the negative trend, particularly in the case of investment grade funds, which are limited to high debtor quality. The investor has to accept the loss in value. Over time, higher yields to maturity will only arise in the managed bond portfolios once the market interest rate has risen significantly.

The fund managers therefore try to keep the portfolio in positive territory by accepting higher risks. This can be done either by buying debtors with a significantly lower rating (lower credit rating), investing in foreign currencies or investing in longer terms that yield higher coupons. However, many investors do not want to bear such risks with bond investments, because for them secure bond funds are a substitute for the interest on the savings book, but not a risk investment. Even with the currently measly savings book interest rates, one earns more in the medium term than with bond funds in the interest and cost trap.

Ways out of the cost trap

One attempt to escape the cost trap is to keep it as low as possible, i.e. to switch to funds with the lowest management fees. You quickly end up with the topic of bond ETFs, which operate on average with TERs between 0.10% and 0.20%. But replicating bond indices is more difficult and technically demanding than it is for stocks. Many bond ETFs rely on fictitious bonds (synthetic replication) and reproduce their development. This is associated with less transparency and higher risks for the investor (e.g. counterparty risks for derivatives). Bond ETFs are therefore not a real solution either. They only alleviate the cost problem somewhat, but without being able to offer fundamentally better prospects.

The traditional method of only holding single bonds in the portfolio should still be examined. In contrast to bond funds, individual bonds that you buy and place in your custody account until they expire have a fixed expiry date. So if you add a single bond from a company or a state to your portfolio, you can forget about the price development of your bonds. You wait until it expires, then the bond is repaid at face value. A regular market valuation of the bonds, as the bond fund manager has to carry out, is not necessary. A lower value in the meantime is irrelevant and not visible. It only becomes relevant if you have to sell before maturity. With single bonds you are less well diversified and you have to pay more attention to the creditworthiness of the debtor. However, if one carefully examines the costs and tax consequences on interest income when buying, individual bonds may be a better alternative in the low interest rate environment than many bond funds are today.

Technical terms in connection with bond investments

Bond fund: Bond funds are investment funds that invest in bonds and other fixed- or variable-interest securities. As a rule, they are geared towards a specific reference and investment currency.

ETF: Exchange Traded Funds (ETF) for bonds map the development of government, corporate and high-yield bonds and invest in bond indices for different regions and maturities. Compared to actively managed bond funds, they cost significantly less, which is very important in the context of lower interest rates.

Yield to maturity: The yield to maturity indicates the yield an investor will achieve if he buys a bond - or, in the case of bond funds, a whole basket full of bonds - at the current market price, collects all interest payments and receives 100% repayment at maturity.

Debtor creditworthiness: Describes the quality of an issuer of a bond (debtor), i.e. the ability to repay the bond at the end of its term. The more secure the repayment, the higher the debtor's creditworthiness.

Investment grade: Debtors with a high credit rating, so that investors who have to invest their money securely (e.g. pension funds) are also allowed to invest.