Investing in Retail Bond Funds allows you to Pick 'n' Mix your bond investments by crowd purchasing from a basket of bonds which are offered and managed by Fund managers.
A fund manager purchases a number of retail bonds and then breaks them up into smaller 'bite-size' chunks suitable for smaller investors to digest, who may not have the time or money to participate directly in bond issues.
A buyer with say £1,000 to invest can therefore spread that sum among a number of bonds by investing in a bond fund, rather than just investing the whole £1,000 in one bond. This also spreads the risk to the purchaser, for if one of the bond issuers to the fund defaults, the loss is limited to just one issuer which does not affect the whole fund.
Let's use an example:
Issuer A issues a £1,000 bond paying 5% interest which is bought by Mr Bellybutton from Bognor.
Issuer A goes 'belly up' ie., into liquidation shortly after, leaving Mr Bellybutton nursing a loss of £1,000 (plus the potential wrath of Mrs Bellybutton).
Investing in a Bonds Fund
Issuer A issues a £1,000 bond paying 5% interest which is bought by a Bond Fund Manager Mr Hampton from Henley.
Mr Hampton divides up this £1,000 bond into 20 x £50 bite-size chunks paying 3% interest to the investors (keeping 2% for himself plus management fees), one of whom is our Mr Bellybutton, who gobbles up one of the £50 chunks.
Issuer A goes 'belly up' ie., into liquidation shortly after, leaving Mr Hampton with a loss of £1,000, but Mr Bellybutton's loss is only £50. Mr Hampton may also be a big enough Bond Fund Manager to act as an insurer by guaranteeing certain bonds, in which case Mr Bellybutton might not lose anything if Issuer A defaults.
The advantage of not putting all one's eggs into one basket is clear, as most of Mr Bellybutton's investment is still intact and continues to produce income from the rest of the basket of bonds even if Issuer A defaults.