Why We Prefer Individual Bonds

Bond Series 4

To continue our series about the fixed income market, we’d like to discuss how NPF manages bond portfolios to navigate these difficult markets.

Many investors get their bond exposure through mutual funds, which has seen tremendous price weakness during the rising interest rate environment during 2022. Essentially, the investors in bond funds were forced to ride the waves as the portfolio of bonds got repriced in the market on a daily basis (the “Net Asset Value”). And unfortunately, if you needed to take money out of a fund during those weak times, you would have taken a haircut (possibly substantial) on the value of your interest in the fund – as you would sell at your pro-rata share of the current value of the holdings.

Unfortunately for the bond fund investor, it is typically the better quality holdings that are sold to help provide cash for those redeeming their interest in the fund (as those holdings are easier to sell at a lower discount to fair value), but the value you get per each share of the bond fund you redeem is still at that discounted, Net Asset Value. This problem is exacerbated in markets  there is a wave if investors that are redeeming their bond fund interests – forcing the manager of the funds to sell the good, liquid bond holdings, and leaving the remaining investors in the funds with less-liquid, often lower-quality holdings.

The experience many owners of bond mutual funds had in 2022 is why NPF has always preferred to purchase individual bonds for our clients.  By owning individual bonds, the portfolio is aligned with the investor’s known circumstances. For example, if an investor knows they need $50,000 for a new car in the next couple of years – a bond can be purchased which aligns roughly with the known expenditure. No need to sell the bond fund down 15% , we just let the bond mature and buy the car with the proceeds. If the investor no longer needs that cash flow, we would then be able to invest where we see the best interest rates for the new desired timeframe .

Cash flow timing is not the only way to customize a bond portfolio for a client. Taxes, credit quality, and many other factors can be utilized to build a portfolio that meets your individual circumstances.  For example, by knowing your tax situation, we know when it is appropriate to buy tax-free bonds in a taxable account. For some people, they are better off buying taxable bonds and paying some tax on it (i.e. when in a lower tax-bracket, or when tax-free bonds are selling at a premium relative to taxable bonds). We also help determine when it is appropriate to take calculated risks on certain bonds to improve the total potential return. However, if your primary goal is minimize the risk of losing principal, then we would want to minimize credit risk.

Ultimately, it’s like a tailored suit that we want to have fit exactly to your specifications. A bond fund can provide easy access to the fixed-income asset class, but it is a “mass market” vehicle – not managed for you, but managed for a pool of investors. You’ve worked hard for your wealth, and we believe that you deserve a portfolio designed to work the best way for you.

To learn more about how NPF can assist you with bond portfolio, please feel free to contact us with any questions or comments.

Click here to go back to Part 1 of our Bond Series: You’ve Got Questions. We’ve Got Answers.

Go back to Part 3: How to Lose Money in Bonds