Page 129 - Profile's Unit Trusts & Collective Investments - September 2025

Understanding asset allocation Chapter 7

Why do bond prices fluctuate?
Think of the relationship between bond prices and interest rates as opposite ends of a pulley.
When interest rates fall, bond prices rise. When interest rates rise, bond prices fall.
Let’s say that you buy a bond worth R10 000 paying 10% interest (R1 000 per annum) until
it matures in 20 years time. The bond would have been bought in the expectation that interest rates
would go down.
Now suppose you want to sell the bond after only five years. And suppose that the interest rate has
gone up to around 15%. Why should investors buy a bond with an interest rate of 10%, when they
can buy a new bond at an interest rate of 15%? You will have to drop the price of the bond below the
price you paid for it – to around R7 000 (R1 000/R7 000 means the buyer gets an effective interest rate
of 14.3%).
Suppose, on the other hand, you needed to sell when the prevailing interest rate had gone down
to 5%. You could charge a premium price – around R20 000 – for your bond, which is paying R1 000
(R1 000/R20 000 means the buyer gets an effective interest rate of 5%). Either way, the buyer will
receive R10 000 when the bond matures, because that is the face value of the bond.
The corporate bond market (where the private sector can raise money) has also become a lot
more active in recent years. This is partly due to the government’s privatisation initiatives. Telkom,
for example, used to be a “parastatal” bond: it is now listed under the corporate sector.

Classification of bonds
Bonds are typically classified in three ways:
R By the issuing company/organisation
R By maturity
R By quality
Issuing company/organisation
The South African government sells bonds through the Treasury to finance the national debt.
Semi-government institutions (such as Eskom and Transnet) issue bonds to finance long term
equipment development. Corporations sell bonds (often called debentures) to finance their long
term capital projects, such as building new factories or investing in information technology.
Maturity
Maturity refers to the duration of the loan – the length of time until the principal is repaid. Short term
bonds mature in less than three years, long term bonds mature in more than 10 years. A medium
term bond typically matures in about seven years. In general, the longer the maturity, the greater the
interest rate risk.
Quality
Bond quality refers to the creditworthiness of the issuing organisation and the likelihood that it
will repay its debt. Independent overseas rating services, such as Fitch Ratings, Moody’s Investors
Service and Standard & Poor’s in the US, conduct in-depth research across a wide range of
political, economic and business criteria, based on which, they publish a “rating” of the dependability
of the issuer.
Costs and minimums for bond funds
The Bond Funds sector in the ASISA unit trust fund classification became the Variable Term
sector in 2013. Many of the funds in the sector, however, still use “bond fund” in their names.
The initial fees of domestic bond funds are usually zero (broker commission excepted) and annual
fees range from 0.15% to 2.62%. Bond funds in the global and regional categories have no initial
fees and annual fees ranging from 0.1% to 0.92%. Only two funds (across all categories) charge
performance fees.

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