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Bond Fund Credit Risk

Credit risk is the risk that the issuer of the bond will not be able to pay the interest or principal payments and you will lose some, or all of the money you have invested. Just as with interest rate risk the more credit risk you are willing to take the higher your potential returns can be, and the more volatile you can expect those returns to be.  Bond funds with the least credit risk are those that invest only in US Treasuries and other debt which is backed by the US Government.  In fact, US Government bonds are free of default risk all together.

What you trade for the safety of US Government bond funds is a lower yield than other types of investment grade bond funds, like a fund that invests in Investment Grade Corporate bonds.  To help demonstrate this point have a look at the chart below which shows the performance of Vanguard Intermediate Treasury Fund (Ticker: VFIUX) which invests only in US Government Debt to Vanguard’s Investment Grade Intermediate Bond Fund (Ticker: VFIDX) which invests in a wide variety of Investment Grade bonds.  As you can see the performance of the Treasury Fund is significantly less volatile, especially during times of economic uncertainty, like during the recent financial crisis.

The below example is true even though the Vanguard Intermediate Treasury Fund and the Vanguard Investment Grade Intermediate Bond Fund are both investment grade bond funds.  This is true because within the investment grade and non investment grade bond universes, there are multiple levels of ratings and credit risk.  For a full list of the various credit ratings see our table here.

 

For more information on bond mutual funds and bond ETFs visit the bond funds section here at Learn Bonds.

All trading carries risk. Views expressed are those of the writers only. Past performance is no guarantee of future results. The opinions expressed in this Site do not constitute investment advice and independent financial advice should be sought where appropriate. This website is free for you to use but we may receive commission from the companies we feature on this site.
David Waring

David Waring

David Waring was the founder of LearnBonds.com and has been a major contributor to the extensive library of investing news and information available on the site. Until the launch of Learnbonds.com in late 2011 there was no single site on the internet catering exclusively to the individual bond investor. This was true even though more individuals own stocks than bonds. Learn Bonds was launched to fill that gap.
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