Don’t be shy, ask ii...why do some bond funds have such high yields?

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Andrew Quayle asks:I have been puzzling over the article by Helen Pridham for ii, which includes Royal London Global Bond Opportunities fund in a high-income portfolio.

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I had understood that investing in bonds was low risk compared with equities, which resulted in relatively low yields. However, the figures presented in the article mention Royal London Global Bond Opportunities with a 5.33% yield, which compares with much lower yields for equity funds. 

If this is so, why invest in equity funds with more risk?

I feel I am missing something.

Hope you can clear my confusion.

Kyle Caldwell (pictured above), Collectives Editor, interactive investor, says: That’s a good point you have raised. You would expect a bond fund to have a much lower yield than a UK equity income fund, given bond yields are currently at historically low levels. But this is not always the case. Some bond funds invest in what are called non-investment grade bonds, sometimes referred to as junk bonds. These are low-quality bonds which offer high yields to compensate for the greater risk that whoever issued the bond may default.

In the case of Royal London Global Bond Opportunities - which is included in the ii Super 60 list of rated funds - the fund favours high yield and unrated bonds (the latter accounts for 30% of the fund). Funds focused on high-quality bonds issued by safe and secure companies typically offer lower yields because there is less risk involved. This is especially true for government bonds, or gilts, where the yield is often much lower because the bond comes with a government guarantee.

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Many equity funds are struggling to generate the same level of income they did in the past because of the pandemic. Many companies cut dividend payments to preserve their balance sheets to survive lockdowns and the global economic downturn.

Historically, equity funds generate much stronger growth than bond funds and offer exposure to different parts of the economy. Different factors influence bonds and equities, which is why diversified portfolios typically own both asset classes.