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What Are Strategic Bonds?

Jim B.
Jim B.

Strategic bonds are bonds found in mutual funds that are devoted to fixed income instruments but are meant to replicate the yield of equity mutual funds. These strategic bond funds accomplish these higher returns by investing in bonds that come from all over the market. Some of the strategic bonds that comprise these funds may come from international markets or from companies that are offering high yield to compensate for their low credit ratings. As a result, investors might get higher returns than if they had invested in safer bonds, but they could be exposed to a great deal more risk in the process.

Investors often flock to bonds, which are issued by institutions and offer regular interest payments to those who buy them, as a way of keeping their money safe and gaining a little fixed income along the way. In recent years, however, some bond investors have been lured to mutual funds which are managed a bit more aggressively and touch on a broader spectrum of bonds than typical bond funds. The strategic bonds that make up these funds can conceivably offer investors returns more in line with stock funds.

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To manage this, bond funds must invest in strategic bonds that offer a little more yield than so-called investment grade bonds. Investment grade bonds usually are issued by institutions, like governments or banks, that have impeccable credit ratings. These institutions can usually offer interest rates on their bonds that are relatively low compared to other securities.

By contrast, the strategic bonds found in strategic bond funds can offer higher interest rates than investment grade bonds. Some of these bonds may come from corporations that are looking to fund some sort of business initiative with the capital raised from the issuing. Strategic bond funds may also choose to look internationally for its bonds. As a result, these funds can offer investors a bit more diversity in their portfolio than a typical bond fund.

What many investors might fail to realize are the risks associated with the strategic bonds found in these funds. Such investors may associate bonds with safety, ignorant of the fact that the types of bonds included in these funds might be less than a sure thing. The institutions that offer high returns on their bonds generally must do so to compensate for the fact that they have poor credit ratings and run the risk of defaulting on their obligations. If such defaults occur on a widespread basis during times of economic turmoil, funds filled with these bonds could fall far short of investors' expectations.

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