Investors may never recover ... losses from bond funds?

Question

Source: In a rising interest rate world, ... own bonds or bond funds?, by Gail Bebee, 2013 Jul 2

Managing a bond portfolio takes work and is not feasible for smaller accounts. Consequently, many investors buy bond mutual funds or bond exchange-traded funds. These funds pay regular distributions. [1] When interest rates rise, fund net asset values fall to reflect the current value of the bond holdings. [2] Investors may never recover these losses because there is no maturity date when the holder is paid the bond’s face value.

Question 1: [1] is true exactly due to the inverse between bond prices and interest rates, right?

Question 2: Please explain [2]? Does it refer to bonds? If so, how can a bond lack a maturity ?

Answer 1

The fund NAV is not guaranteed to recover. Suppose the following occurs:

1. An investor invests in a simple treasury bond fund holding bonds with a 2% yield and 2% coupon
2. Yields rise to 4%, fund NAV declines
3. The fund sells the 2% coupon bond for $90 and buys $90 of 5% bonds at $100
4. Yields stabilize at 5%

In this case, the fund's share price could remain lower than the purchase price. The coupon payments from the bond may be sent out as distributions, rather than reinvested into new bonds. In this case, the investor could have a positive return if the coupon income exceeds the losses from the share price decline.

The above is not investment advice or an offer to buy or sell securities. It is for educational purposes only.

Answer 2

The claim is not exactly true. Not true at all, in fact.

That is correct that the bond prices fall when the rates go up. But it is incorrect that the fund members will not be able to recover their losses. The changes in fund prices merely reflect the changes in the value if the assets the funds hold. These assets do have maturity date and will be paid face value at that date. So the fund NAV will recover, and the fund value will reflect that recovery.