What Are Government Bond Funds?
Government bond funds are investment companies that hold a portfolio of government issued or backed debt securities. Government bonds are considered to be one of the safest investment options, and the bond funds holding these securities provide investors with access to diversified, professionally managed portfolios of these bonds. The safety and return of a specific government bond fund is based on the portfolio characteristics of the fund.
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Identification
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Government bonds are debt securities issued by the U.S. government or agencies of the federal government. Investment companies that exclusively hold government bonds are classified as government bond funds. According to the Securities and Exchange Commission (SEC) web page on bond funds, these investment companies can be mutual funds, closed end funds, unit investment trusts or exchange traded funds (ETFs).
Categories
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Government bond funds can be divided into different categories to provide investors with an indication of a fund's earnings potential and possible risk. Funds can be actively managed with a fund manager selecting bonds based on the investment objectives of the fund or index funds where the fund buys bonds to match the characteristics of a specific bond index. Government bond funds are usually categorized by the average term of the bonds in the portfolio. A specific fund can be focused on short, intermediate or long-term bonds.
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Considerations
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Government bonds are considered to be risk free regarding the payment of interest and principal. These bonds trade on the secondary bond markets, and the market value can fluctuate with changes in interest rates. Government bond funds can be evaluated based on the types and maturities of the bonds they own and the management expenses of the funds. For bond funds, the expense ratio directly reduces the dividend rate of the fund and a lower expense ratio will provide a higher net income to a fund's investors.
Effects
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Government bond prices are affected by changes in market interest rates. Rising rates will cause bond prices to decline and falling rates will result in an increase in bond values. The longer the term or time to maturity of a bond, the greater will be the price changes in response to interest rate changes. Long-term government bond funds will react most to changes in interest rates and are best in a falling-rate environment. Short-term bond funds have smaller price fluctuations and are the appropriate choice in a rising-rate environment. Intermediate-term government bond funds provide a balance of maturity and rate.
Potential
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A government bond fund pays out the interest earned from the fund's portfolio as a monthly dividend. EFT and closed-end fund dividends will be paid into an investor's brokerage account. Mutual fund and unit investment trust dividends can be taken as checks or reinvested into more shares of the fund. Bond funds holding longer maturity bonds will usually pay a higher rate of interest. Shorter-term bond funds will have a more stable share price.
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References
- Photo Credit Department of Treasury Building image by dwight9592 from Fotolia.com
