Bonds can play an important role in an investor’s portfolio. While shares typically offer higher returns over time, bonds aren’t expected to experience such big price swings. This means they should help keep portfolios stable when the stock market is choppy. They can also provide a source of income.

There is no one-size-fits-all bond investment. So, if you’re building your own portfolio and have decided that bonds play a role, it’s important to understand the different types of bond funds and what they can offer.

What is a bond?

A bond is a type of investment where you lend money to a borrower, such as a government or company, for a set period. In return, the borrower pays you interest at a specified rate. When the loan period ends, which is called ‘reaching maturity’, the borrower should pay you back the full amount.

Although bonds are generally considered more stable and less risky than shares, their price can fluctuate over time due to various factors. These include interest rates, inflation and economic conditions. For example, when interest rates rise, bond prices typically fall. This is because new bonds issued at higher rates are more attractive to investors, making existing bonds with lower rates less valuable. When interest rates fall, bond prices typically rise.

Why invest in a bond fund?

Buying individual bonds can be tricky because there are tens of thousands to choose from. Additionally, many bonds are not easily accessible for investors to purchase. For this reason, many people prefer to invest in bond funds to access their benefits. A bond fund pools your money with other investors’ money and invests in lots of different bonds, sometimes hundreds or even thousands. This helps to spread the risk. 

Vanguard offers a range of bond funds. Some are index funds, which typically try to match the performance of a specific index (also known as a ‘benchmark’¹). Others are active funds, where a fund manager picks bonds to try to beat a benchmark. As well as offering these different management types, our funds also invest in different types of bonds in different regions of the world.

Types of bonds

There are many different types of bonds, but the main two categories are government bonds and corporate bonds.

Both types of bonds are assigned a credit rating by independent rating agencies like Moody’s, Standard & Poor’s and Fitch. This indicates the bond issuer’s ability to service and repay its debt. The highest credit rating is typically AAA, which indicates the lowest risk of default. Bonds with lower ratings, such as BB or below, come with higher risk but also higher potential returns.

Some of our funds hold bonds issued by both governments and companies, providing a low-cost and simple way to diversify your investments. For example, the Global Aggregate Bond UCITS ETF² invests in around 12,000 bonds issued by governments and companies around the world. 

Short-term versus long-term bond funds 

You might see some funds with ‘short-term’, ‘long-duration’ or a specific timespan like ‘1-3 year’ in the name. This is because some bond funds target groups of bonds with specific maturities. Short-term bonds typically mature in one to five years, medium-term or intermediate bonds will normally reach maturity in five to 10 years, and long-term bonds often mature in more than 10 years.

What’s the difference between these funds? Short-term bonds tend to be less risky because they aren’t as affected by changes in interest rates. If interest rates rise, the value of short-term bonds is less likely to drop significantly. This makes them more stable and predictable. Vanguard recently launched a short-term UK government bond fund and we also offer intermediate-term and long-term UK government bond funds. 

Long-term bonds usually offer higher income but are more sensitive to changes in interest rates. If interest rates rise, the value of these bonds can fall more significantly.

If you don’t want to focus on a specific maturity, you can choose a bond fund that holds bonds with a mix of different maturity periods. This can help to balance your risk and potential returns.

Investment grade versus high-yield bond funds

When you explore our bond funds, you might also come across the term ‘investment grade’. This means the fund invests in bonds that are considered to have a lower risk of default and receive higher ratings by credit rating agencies – typically BBB or above. The opposite to an investment-grade bond is a high-yield or ‘junk’ bond. These are considered to have a higher risk of default and are typically rated BB or below. 

In general, investment-grade bonds are less risky and provide lower income, whereas high-yield bonds are riskier and offer higher income. Given that the role of bonds is often to reduce or manage investment risk, it’s important to choose high-quality, investment-grade bonds. During times of market volatility, other types of bonds can act more like shares. This can increase risk at a time when you want bonds to act as a stabiliser in your portfolio. Planning ahead and selecting the right types of bonds can help ensure that your portfolio remains stable and aligned with your risk tolerance.

We do not offer high-yield bond funds at Vanguard.

Investing at Vanguard

We offer a range of solutions to help you get started with your investment journey. 

If want to build your own portfolio, you can choose from our full range of funds. Under the ‘Building my own portfolio’ tab you can select bonds and then filter the funds by region, risk level and management type.

Alternatively, you can keep it simple by picking one of our LifeStrategy funds or Target Retirement Funds. These combine shares and bonds in one ready-made portfolio, ranging from 100% shares and 0% bonds to 20% shares and 80% bonds. The key difference is the LifeStrategy funds maintain a fixed proportion of shares and bonds, whereas the Target Retirement Funds gradually shift your exposure from shares to bonds as you get closer to your target retirement date.

If you’re not confident choosing funds, we also offer a managed service where we select funds for you based on how you feel about risk and then manage your portfolio going forwards.

¹ A benchmark is a market index, or combination of indices, that investors use to measure investment performance. An index typically measures the performance of a group (or ‘basket’) of investments, such as a basket of shares or bonds, that are intended to represent a certain area of the market.

² An ETF, or exchange-traded fund, invests in potentially hundreds, sometimes thousands, of individual securities including shares and bonds. It trades on an exchange throughout the day like a stock and will typically track a specific market, like the FTSE 100.

Investment risk information

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Some funds invest in emerging markets which can be more volatile than more established markets. As a result the value of your investment may rise or fall .

Vanguard Target Retirement Funds and Vanguard LifeStrategy®Funds may invest in Exchange Traded Fund (ETF) shares.

ETF shares can be bought or sold only through a broker. Investing in ETFs entails stockbroker commission and a bid- offer spread which should be considered fully before investing.

Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.

The Funds may use derivatives in order to reduce risk or cost and/or generate extra income or growth. The use of derivatives could increase or reduce exposure to underlying assets and result in greater fluctuations of the Fund's net asset value. A derivative is a financial contract whose value is based on the value of a financial asset (such as a share, bond, or currency) or a market index.

For further information on risks please see the “Risk Factors” section of the prospectus on our website.

Important information

Vanguard only gives information on products and services and does not give investment advice based on individual circumstances. If you have any questions related to your investment decision or the suitability or appropriateness for you of the product[s] described, please contact your financial adviser.

For further information on the fund's investment policies and risks, please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions. The KIID for this fund is available, alongside the prospectus via Vanguard’s website.

This is designed for use by, and is directed only at persons resident in the UK.

The information contained herein is not to be regarded as an offer to buy or sell or the solicitation of any offer to buy or sell securities in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so. The information is general in nature and does not constitute legal, tax, or investment advice. Potential investors are urged to consult their professional advisers on the implications of making an investment in, holding or disposing of [units/shares], and the receipt of distribution from any investment.

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