Bonds are a defensive asset that can provide a portfolio with a measure of protection against volatile markets.
The face value of a bond is returned in full at maturity – the end of a bond’s life. This means capital is somewhat protected if the bond is held to maturity.
Investors who hold bonds also receive interest payments — known as a coupon — that provides regular, predictable income.
Capital preservation and predictable income means government and high grade investment bonds are generally lower risk and less volatile than shares.
In the event of a company going bankrupt, bond holders receive payment before equity holders.
Bonds also trade in what is known as the ‘secondary market’. The price of these bonds rise and fall in line with expectations of interest rates in the future. It means bonds also offer opportunities for capital appreciation (as well as capital loss) because they can be bought and sold before maturity.
The price of a bond moves inversely to the level of interest rates. If rates are rising, the coupon paid on future issuance is likely to be higher than paid on the current bond. Hence the current bonds price falls. So higher rates mean bond prices fall and lower rates mean bond prices rise.
Currently, as interest rates rise, bond prices fall providing a better yield. Given higher interest rates tend to dampen returns in many other asset classes, such as equities, bonds become relatively more attractive.
This feature means slowing economic growth often corresponds with the potential for a lift in the value of bonds, providing positive returns when other investments like shares can be delivering negative returns.