The Fund Industry: How Your Money is Managed, 2nd Edition

CHAPTER 7

Portfolio Management of Bond Funds

In this chapter, we review the portfolio management of bond funds. These funds are also called fixed income funds, a name that refers to the relative predictability of the income stream of the bonds held in the funds. Because the issuers of bonds are contractually obligated to make specified payments to investors on fixed dates, bond returns are generally more stable than stock returns.

This chapter reviews:

• The principal types of securities held in bond fund portfolios.
• The main approaches to the portfolio management of bond funds.

Before you read on, please note that we assume throughout this discussion that you are familiar with how bonds work and are comfortable with fixed income terminology. If that's not the case, you might want to read the “Bond Basics” chapter, which is available on this book's website.

BOND FUND HOLDINGS

Bond funds are divided into two major segments: taxable and tax-exempt. Taxable funds invest in a variety of bonds that pay interest subject to federal income tax, while tax-exempt funds invest in bonds issued by states and municipalities that are exempt from federal income taxes and sometimes state income taxes. This section reviews the types of securities that are often found in the portfolios of each category of bond fund.

Holdings in Taxable Bond Funds

As we saw in Chapter 4, taxable bond funds have a wide variety of investment objectives. Some funds have a very broad mandate to invest in many kinds ...