Bond or Bond Fund: Which one is for you?

Investing has become so much more accessible over the last few years. Ordinary Filipinos can now easily invest their hard-earned savings with the click of a button or a swipe on their smartphones. While electronic channels for trading local stocks and investing in pooled funds have been around for a while, the ability to buy and sell bonds completely online is a more recent development.

Some financial institutions and investment platforms allow you to trade peso government securities. Gone are days when clients had to visit a physical branch just to order the latest peso treasury bill, fixed rate treasury note (FXTN), or retail treasury bond (RTB).

But this new ease in transacting peso bonds raises an important question: Is it better to buy individual bonds or invest in a bond fund?

Putting the “fixed” in fixed income

The main purpose of investing in bonds is to receive a stream of fixed income payments – a feature that is unique to this asset class.

Take the latest RTB 5-19, a retail treasury bond, for example. The bond features a coupon rate of 6.000% per annum gross (or 4.800% per annum net of 20% withholding tax), with a quarterly payment frequency. Assuming a face value of PHP 100,000, this is equivalent to payouts of PHP 1,200 every February 20, May 20, August 20, and November 20, until the bond’s maturity on August 20, 2030.

In contrast, another 5-year bond, FXTN 7-70, a fixed rate treasury note, has a slightly higher coupon rate of 6.375% per annum gross (or 5.100% per annum net of 20% withholding tax). But this bond has a semiannual payment frequency or payouts of PHP 2,550 every January 27 and July 27 until its maturity date on July 27, 2030.

Every bond is different – each with its own maturity date, coupon rate, payment frequency, price, and yield-to-maturity. If you’re the type of investor who invests with desired parameters in mind, then building your own portfolio of bonds will benefit you the most.

Choose specific bonds that fit your investment horizon and risk appetite. Arrange for the interest earnings and maturity proceeds to be automatically deposited to your nominated settlement account. And if you suddenly need cash for an emergency or a new investment opportunity, you can choose to sell some of your bonds back to the market. However, note that there is always a risk of selling a bond at a market price lower than its original purchase price.

Minimizing reinvestment risk, maximizing compound interest

For new investors who might find building your own portfolio too overwhelming, don’t worry. You can still gain exposure to the peso bond market through Unit Investment Trust Funds (UITFs). For example, there are medium-term bond funds that aim to grow your money by investing in diversified fixed income securities with a maximum weighted average duration of five years, which is not too long nor too short.

Many banks offer UITFs online, and some require only a minimal initial investment. Additional investments can be made at smaller increments, too. The portfolio managers pool these contributions and invest in a variety of peso government securities and corporate bonds, subject to an annual trust fee.

Unlike individual bonds, these funds may reinvest the interest earnings back into the fund instead of payouts to investors. This may seem counterproductive, since bonds are supposed to pay a stream of fixed income payments.

But what this does is minimize reinvestment risk or the risk that an investor will receive a lower rate of return when reinvesting cash flows from an outstanding investment. This in turn also maximizes compound interest – the concept that interest is also earning interest. When interest is reinvested and used to purchase new bonds, the earnings growth potential of the fund increases.

Clients who have been invested over a certain period may see a cumulative growth rate that is very attractive. Please be reminded, however, that past performance does not guarantee future results.

Also, unlike holding a single bond that pays regular coupons and returns principal at maturity, bond funds are marked-to-market daily, so their prices can fluctuate. UITFs may be ideal for passive investors who are okay with not receiving interest earnings now if it means potentially greater returns in the future.

Conclusion

We go back to the question, “Is it better to buy individual bonds or invest in a bond fund?”

It depends. Your investment objective matters. If you have funds to invest and want to select bonds according to specific parameters, then you can start building your own bond portfolio. However, if you’re just starting out and open to letting portfolio managers handle your money, then investing in UITFs can be your entry point into the peso bond market.

There are other options. For example, you can start by regularly contributing small amounts to a UITF in order to gain exposure to the peso bond market. Once your investment grows large enough, you can either stay invested or redeem the investment and use the proceeds to buy an individual bond.

Another idea is to maintain both individual bonds and bond funds to mitigate risks and preserve returns. This is a common strategy by our institutional investor clients. Instead of managing all your investments by yourself, it would be prudent to challenge your own biases and consider having a portion professionally managed by portfolio managers.

If you want to start your wealth journey with Metrobank and benefit from expert advice, you may go to any Metrobank branch. If you are already a client, you may reach out to your relationship manager or investment specialist or visit any branch for assistance.

Investing in peso government securities online is available via Metrobank Wealth Manager, while Metrobank’s UITF Online facilities allow for easy access to some of the best-performing bond funds in the country such as the Metro Max-5 Bond Fund.

For exclusive investment ideas and market analysis from Metrobank Wealth Insights, you can follow the steps here.

(Disclaimer: This is general investment information only and does not constitute an offer or guarantee, with all investment decisions made at your own risk. The bank takes no responsibility for any potential losses.)

EARL ANDREW “EA” AGUIRRE is the Head of the Investment Counselor Department under the Financial Markets Sector of Metrobank. He has more than a decade of experience in foreign exchange, fixed income securities, and derivatives sales. He has a Master’s in Business Administration from the Ateneo Graduate School of Business. His interests include regularly traveling to Japan and learning its language and culture.