Government Bond FundsBond Funds
Government bond funds use investor’s funds to purchase bonds issued by a specific sovereign government or group of governments. Government bonds can repay their issues using taxation, the printing of their own currency, or repayment using a stable foreign currency. The nation selected will be specified by the bond fund’s prospectus or investment objectives. Based on the selection, and your relation, a bond fund will be investing in your domestic nation or foreign nations. In either case, you should ensure that the person managing the government bond fund is both experienced and specializes in the target nation.
Government Bond Funds: Developmental Status
Based on the developmental status of the nation, a bond fund can be classified as investing in an emerging market or a developed market. An emerging market bond fund invests in countries still facing substantial economic development. This ongoing development makes these nations volatile, constantly encountering economic mistakes and growth pains. Developed markets will encounter significantly less risk and instability. They will also offer less return in exchange for their risks.
If you are investing in a bond fund specializing in emerging markets, research the fund’s management team. This team should have a background specializing in the economic development of the region. They need to be aware of potential problems and issues which may result in pitfalls for the investment.
Government Bond Funds: Nominal Bond Funds
Sovereign Bond funds come in two flavors. Nominal Sovereign bond funds purchase nominal bonds, which increase at a specified rate. These bonds do not adjust principal for inflation. If the stated rate is too low, or your nation’s inflation is too high, the fund’s return may be outpaced by your domestic country’s rate of inflation. You will suffer real losses, or reductions in purchasing power. If the rate of inflation is low, or the bond’s rate is high, your return from the fund will exceed inflation. You will incur real gains, or increases in purchasing power.
Government Bond Funds: Inflationary Bond Funds
Inflation Adjusted Bond Funds purchase bonds that adjust their principal for inflation, and then calculate yields from the adjusted principal. The result is a consistent return which guarantees the retention of purchasing power. Note that the bond fund will purchase bonds from the nation specified in their prospectus. That nation might not be your domestic nation. This poses a problem. Inflation adjusting bonds will attune to the inflation rate of the issuing country. If an issuing nation’s inflation rate is lower than your own nations, you can still lose purchasing power since the bonds adjust to a rate below your own.
Government Bond Funds: Sovereign Fund Risks
Sovereign Bond funds, like most bond funds, are susceptible to interest rate and reinvestment risk. If the nation’s central bank raises interest rates, bonds below the new rates will fall in desirability and price. Bonds maturing and coming due will be reinvested at higher yields than before. If the bank lowers interest rates, bonds above the new rates will rise in desirability and price. Bonds maturing and coming due will have profits reinvested at lower yields than before. The secondary market bonds traded by bond funds still function exactly the same way, and bond funds focused on a single nation are indirectly affected by their central bank’s interest rates.
Sovereign bond funds focused on a single nation are also susceptible to credit rating risks. If a nation’s credit rating is lowered, all bonds issued at the higher ratings will fall in price and desirability. The rate paid relative to the perceived risk has decreased and the trading ability of the fund will be hindered. If the nation’s credit rating is raised, all bonds issued at the lower ratings will rise in price and desirability. The rate paid relative to the perceived risk has increased.
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