What is a bond?

A bond represents a loan that you as an investor make to a corporation, a government entity, municipality, or other institution, otherwise known as the bond’s issuer...

Learn more

Why invest in bonds?

There are three main reasons to invest in bonds: income, diversification, and stability. With a bond, you may receive a steady stream of interest payments—typically annually...

Learn more

What are the risks?

No investment is entirely risk-free—even bonds. In fact, some bonds are riskier than many stocks, especially those rated in the “non-investment grade” category...

Learn more

Best performing bond categories

Similar to stocks, diversification is extremely important in bond investing. The best performing bond categories vary from year to year...

Learn more

 

FIXED INCOME INVESTING

 

Strike a balance with bonds

When people think of investing, often the first thing that comes to mind is buying stocks. That makes sense because most investors need the growth potential of stocks to achieve their long-term goals.

But a strategy that includes only stocks may be too risky for most investors. Adding fixed income investments, generally in the form of bonds, can help reduce the overall risk of your portfolio. As a source of income, diversification, and stability, bonds provide a strong complement to stocks in a well-diversified portfolio. This guide will help you make decisions on how to use bonds to balance risk in your investment strategy.

  • What is a bond?

    +

    A bond represents a loan that you as an investor make to a corporation, a government entity, municipality, or other institution, otherwise known as the bond’s issuer. Bonds are used to raise money to build roads, finance factories, launch new products, construct hospitals, and much more. A bond is a form of fixed interest investment because it periodically pays a fixed amount of interest to investors. Bonds repay principal on a specific date, called the maturity date. The price paid to an issuer of a bond is known as its face value or par value, and the fixed rate of interest you receive from the bond is the coupon rate. The coupon rate is based on many factors, including the prevailing interest-rate environment, the length of time to maturity, and the creditworthiness of the issuer. For example, the coupon paid by a low-risk Treasury bill will be much lower than the rate paid by a long-term bond issued by a less secure corporation, which stands a much greater risk of not meeting interest and principal payments.

    The three types of bonds

    Bonds come in three broad categories: government, municipal, and corporate.

    Government bonds

    U.S. government securities, known as Treasurys, come in three varieties based on maturities:

    Billsmature in less than one year
    Notesmature in 1 to 10 years
    Bondsmature in more than 10 years

    Domestic government bonds are considered very safe because they are backed by the full faith and credit of the U.S. government. But the debt of foreign countries, especially developing countries, may carry a substantial risk of defaulting on interest or principal payments.

    Municipal bonds

    Municipalities issue bonds to fund infrastructure expenses like roads, bridges, schools, and special projects. Municipal bonds are slightly riskier than U.S. government bonds, but less risky than corporate bonds since they are backed by the taxing authority of the municipality or underlying project. Municipal bonds offer the advantage of being exempt from federal income taxes. Some are also exempt from state and local taxes. But, certain municipal bonds are subject to alternative minimum tax (AMT).

    Corporate bonds

    Corporations issue bonds just as they issue stock to raise money. The coupon rate paid on a corporate bond depends on the interest-rate environment, the financial strength of the company, and the bond’s maturity. The bond’s credit rating is very important since it relates to risk of default and the bond’s interest rate. A higher quality bond will generally have a lower risk of default as well as a lower interest rate paid to investors.

  • Why invest in bonds?

    +

    There are three main reasons to invest in bonds: income, diversification, and stability.

    Income

    With a bond, you may receive a steady stream of interest payments—typically annually, semiannually, or quarterly—that you can spend or reinvest to help increase your earnings. Reinvesting your interest can result in compounding, which is earning interest on your interest, since you are increasing your investment each time you reinvest earnings.

    Diversification

    Diversification, a powerful risk-management strategy, involves spreading your money across different types of investments to lessen the impact of poor performance in one investment category.

    Adding bonds to a stock portfolio is a good diversification strategy since market factors that are likely to affect stock market performance may not always have the same effect on bond market performance. Sometimes when the stock market is down, the bond market may be up. A mix of stocks and bonds in your portfolio can help reduce the overall risk of your investment strategy. Diversification does not ensure a profit or protect against loss in declining markets.

    Portfolio AllocationStandard Deviation*Average Return
    100% stocks15%11.6%
    80% stocks/20% bonds12%11%

     

    Source: Calculated by Prudential Investments LLC using data presented in Morningstar software products. All rights reserved. Used with permission. Performance period 1976–2014. This information is hypothetical, does not represent an actual investment, and is not intended to imply the future performance of any of the investments mentioned.
     

    *Standard deviation indicates the volatility of an investment and is often used as a measurement of risk. The higher the standard deviation, the riskier the investment. In this example, the portfolio diversified with fixed income investments has a slightly lower return but significantly lower risk. All rights reserved. Stock returns are based on the S&P 500 Index, a market-weighted, unmanaged index of 500 of the largest U.S. stocks in a variety of industry sectors. Bond returns are measured by the Barclays US Aggregate Bond Index, which is an unmanaged index composed of securities from the Barclays Government/Corporate Bond Index, Mortgage-Backed Securities Index, and Asset-Backed Securities Index. The Barclays Government/Corporate Bond Index includes securities in the Government and Credit indices; the Government Index includes Treasurys (i.e., public obligations of the U.S. Treasury that have remaining maturities of more than one year) and agencies (i.e., publicly issued debt of U.S. government agencies, quasi-federal corporations, and corporate or foreign debt guaranteed by the U.S. government); the Credit Index includes publicly issued U.S. corporate and foreign debentures and secured notes that meet specified maturity, liquidity, and quality requirements. The Barclays Mortgage-Backed Securities Index covers the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The Barclays Asset Backed Securities Index includes pass-through, bullet, and controlled amortization structures. The ABS Index includes only the senior class of each ABS issue and ERISA-eligible B and C tranches. Return figures for the Indexes do not reflect any fees or expenses. An investment cannot be made directly in an index. It is important to note that U.S. government bonds and U.S. Treasury bills are backed by the full faith and credit of the U.S. government, are less volatile than equity investments, and provide a guaranteed return of principal at maturity. Like any mutual fund, an investment in a bond mutual fund is not guaranteed and could lose value.

    Stability

    Few investments can match stocks for growth potential, but that growth comes at the cost of volatility. Stock markets are prone to large up-and-down movements. On the other hand, bonds are less volatile and can help provide a “smoother ride” for portfolios. Also, down periods for bonds have historically been shorter and less severe than for stocks. Over the past 40 years, the bond market has only been down two times, and the largest drop was –2.92%. In short, having an allocation in bonds can help most investors lower volatility in their portfolios.

    Source: Morningstar Direct as of 9/20/2015; Bond returns are measured by the Barclays US Aggregate Bond Index, which is an unmanaged index composed of securities from the Barclays Us Government/Corporate Bond Index, Mortgage-Backed Securities Index. Return figures for the indexes do not reflect any fees or expenses. An investment cannot be made directly in an index.

  • What are the risks?

    +

    No investment is entirely risk-free—even bonds. In fact, some bonds are riskier than many stocks, especially those rated in the “non-investment grade” category in the table below. Bonds are primarily subject to the following risks:

    Interest-rate risk the risk that interest rates will increase and thus reduce the price of bonds that were issued when rates were lower. Generally, the longer the time to maturity, the higher the bond’s interest rate since a bond that matures in one year is much more predictable and is considered less risky than a bond that matures in 20 years.

    Credit risk the possibility that the borrower may not be able to repay interest and principal. One way to assess an issuer’s creditworthiness is to refer to its credit rating assigned by an independent agency like Moody’s or Standard & Poor’s (see table). A low credit rating indicates that the issuer may have difficulty meeting the financial commitments of the bond, while a highly rated bond means the issuer has a strong capacity to meet interest and principal payments. Low-rated “junk” bonds generally have to pay higher interest rates to attract investors willing to take on greater risk. Since U.S. Treasurys are fully backed by the federal government, they are not subject to credit risk.

    Inflation risk the risk that returns will not sufficiently outpace inflation to meet an investor’s financial goals. A portfolio that includes both stocks and bonds can help reduce that risk.

    Market risk the bond market in general could decline due to economic conditions, especially during periods of rising interest rates.

     

     

     

     

     

    Bond RatingTypeRisk
    Moody’sStandard & Poor’s
    AaaAAAInvestment GradeHighest Rated
    AaAAInvestment GradeHigh Rated
    AAInvestment GradeStrong Rated
    BaaBBBInvestment GradeMedium Rated
    Ba/BBB/BNon-Investment GradeSpeculative
    Caa/Ca/CCCC/CC/CNon-Investment GradeHighly Speculative
    CDNon-Investment GradeIn Default
  • Which bond categories are the best performing?

    +

    Similar to stocks, diversification is extremely important in bond investing. As the table shows, the best-performing bond categories vary from year to year, and the differences between the best- and worst-performing bonds can be substantial. By including all types of bonds in your portfolio, you help ensure yourself of always having exposure to the strongest-performing categories.

    chart

    To view indices and definitions click here.

    Source: Barclays, JP Morgan and Credit Suisse, as of 12/31/2014. Past performance is not a guarantee of future results. Investors cannot invest directly in an index.

 

Consider PGIM Investments bond mutual funds

You can purchase individual bonds through your broker, but the cost of building a diversified bond portfolio with an appropriate mix of sectors, industries, and maturities can be expensive and time consuming. After all, bonds are often sold in $25,000 lots, making it hard for most investors to diversify on their own. Bond mutual funds are an easy and affordable way to invest because they offer:

Professional management Most investors don’t have the time or expertise to keep pace with the bond market. The size and scope of this market is larger and more complex than the stock market. Since there is so much bond information investors need to know, security selection and portfolio construction should be left to investment professionals.

Diversification A mutual fund contains a large pool of securities, which can help reduce the overall risk of your investments.

Efficiency For most investors, mutual funds provide professional management and diversification at a fraction of the cost of making such investments independently.

Liquidity Shares of bond funds may be bought or sold on any typical business day.

Choice Bond mutual funds are available in a wide variety of styles and maturities. Bond funds can cover one part of the market (e.g., short-term corporate bonds) or the entire bond market (e.g., a total return bond fund).

Broad access Many bonds are not offered to individual investors. Mutual funds have access to a wider range of bonds and often at a lower cost because they make large purchases.

Convenience Mutual funds offer access to a range of investment services, such as automatic investing and withdrawal programs, reinvestment of income, and fund exchanges

PGIM Investments is part of Prudential Financial, which is recognized by millions for its heritage of helping people grow and protect their wealth for over 135 years. PGIM Investments offers a broad spectrum of mutual funds that can be used to build diversified portfolios that help address a wide range of investor needs. The managers of our funds manage money for major corporations, foundations, and pension funds around the world. That means when you invest with us, you benefit from the same process, research, risk management, and competitive performance demanded by some of today’s largest and most sophisticated investors.


 

Fixed Income investments are subject to interest rate risk, and their value will decline as interest rates rise. The investment return and principal value will fluctuate, and shares, when sold, may be worth more or less than the original cost. Sales charges, fees, and expenses may also reduce your overall investment returns. Keep in mind that diversification does not ensure a profit or protect against loss in declining markets. Prudential Financial, its affiliates, and their financial professionals do not render tax or legal advice. Please consult with your tax and legal advisors regarding your personal circumstances.

 

FundMaturityObjective
Prudential Absolute Return Bond FundShortSeeks positive returns over the long term, regardless of market conditions.
Prudential Floating Rate Income FundShortSeeks high current income consistent with the preservation of principal.
Prudential Short-Term Corporate Bond Fund, Inc.ShortSeeks high current income consistent with the preservation of principal.
Prudential Emerging Markets Debt Local Currency FundIntermediateSeeks total return through a combination of current income and capital appreciation.
Prudential Global Total Return Fund, Inc.IntermediateSeeks total return—current income and capital appreciation.
Prudential Government Income FundIntermediateSeeks high current income.
Prudential High Yield Fund, Inc.IntermediateSeeks to maximize current income, with capital appreciation as a secondary objective.
Prudential Total Return Bond Fund, Inc.IntermediateSeeks total return—both interest and capital gains.
Prudential California Muni Income FundLongSeeks maximum amount of income that is exempt from federal income taxes, consistent with the preservation of capital
Prudential Muni High Income FundLongSeeks maximum amount of income that is exempt from federal income taxes, consistent with the preservation of capital.
Prudential National Muni Fund, Inc.LongSeeks high current income exempt from federal income taxes.

There is no guarantee the Funds’ objectives will be achieved. Some mutual funds have more risk than others. The risks associated with each fund are explained more fully in each fund’s respective prospectus.

 

Managed by Prudential Fixed Income

A leader in bond investing

The global bond markets are huge, diverse, and sophisticated. Prudential Fixed Income, manager of PGIM Investments’ bond mutual funds, applies its deep research expertise and vast resources in trying to find and take advantage of the investment opportunities that markets have to offer.

As one of the nation’s largest and most experienced fixed income managers, Prudential Fixed Income covers the bond market using a disciplined investment process, a deep understanding of every major sector, and one of the most sophisticated research organizations in the industry.

 

A distinctive approach to portfolio construction

The bond markets are extremely sensitive to interest-rate changes, inflation trends, and other broad economic factors. Prudential Fixed Income uses extensive research on these issues to develop quarterly market outlooks. Portfolio managers make “top-down” macro-level strategy decisions to fit within the framework of these outlooks.

Buy and sell decisions are based on an in-depth, “bottom-up” analysis of each security by sector specialists in consultation with research analysts. In some firms, portfolio managers make decisions across all sectors, even those in which they may not be experts.

 

Among the industry’s largest research teams

Prudential Fixed Income blankets the market with more than 44 analysts dedicated to credit research.

With expertise across many bond sectors, from corporate to emerging markets, Prudential Fixed Income can quickly and effectively seize infrequent or unexpected opportunities that others may miss.

 

Size and experience matter

Prudential Fixed Income has managed fixed income investments since 1875 and has served large corporate clients for over 135 years.

Portfolio managers average 27 years of experience. PGIM Investments has $550 billion in assets under management (as of 6/30/2015). Prudential Fixed Income’s size results in trading advantages when negotiating deals for clients.

 

Seek professional guidance

While mutual funds can generally be purchased directly, we believe every investor can benefit from the expertise and services of a financial professional who knows you and understands your goals, reasons for investing, and the amount of risk you’re comfortable assuming.

 

CONTACT US

 

 

 

0169951-00015-00 Ed.10/2016