The value of individual bond investments declines when the price drops as interest rates rise. However, bond fund managers sell low-value bonds and buy new ones with higher yields, offsetting the drop in value, reports Kiplinger. Interest rates on bank-loan or floating-rate funds adjust on a regular basis to short-term rates, and bank-loan investments benefit in rising rate environments, according to Morningstar.Continue Reading
If interest rates rise slowly, it may take time for a bond fund to show increased income that offsets capital losses. For this reason, the duration of the bond fund affects the impact of interest rate changes, states Kiplinger. If the fund has a duration of 4 1/2 years, the value falls by 4.5 percent with a 1 percent rise in interest rates. The inverse occurs with a 1 percent rate decrease whereby the fund's value increases by 4.5 percent.
The fixed interest rates of conventional bonds increase demand for higher yielding bonds when interest rates rise. Rates on bank and floating-rate loans adjust regularly with short-term rates. Respective funds achieve yields consistent with rates, but yields on bank loan investments are lower when interest rates decrease. Intermediate- and longer-term bonds typically perform better with interest rate declines, reports Morningstar.Learn more about Investing