The main reasons why the net asset value of bond funds falls (or the likelihood of a fall increases) are due to a combination of three factors: rising market interest rates, exchange rate fluctuations, and changes in issuer creditworthiness.
The specific reasons to be cautious, especially in the current financial environment, are as follows.
1. Decline in bond prices due to rising interest rates (the most important factor)
Bond prices and market interest rates have a “seesaw” (inverse correlation) relationship.
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Mechanism: When market interest rates rise, the interest rates on newly issued bonds increase. As a result, existing bonds issued in the past with lower yields become less attractive, are sold off, and their market prices fall.
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Future Context:
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Domestic Bond Funds: In a phase where the Bank of Japan (BOJ) proceeds with the normalization of monetary policy or additional interest rate hikes, domestic interest rates will rise, pushing down the valuation of held bonds.
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Developed Country Bond Funds: If interest rates in the U.S. or Europe remain high, or if the pace of rate cuts slows down or rate hikes resume due to factors like reignited inflation, it becomes a factor for falling bond prices.
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2. Progress of “yen appreciation” (in the case of foreign bond funds)
If you hold foreign bond funds (without currency hedging) denominated in U.S. dollars or euros, investment performance is heavily influenced by exchange rates.
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Mechanism: Even if the price of the foreign bonds themselves does not change, if the yen appreciates against the dollar, the yen-denominated net asset value will fall.
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Future Context: In a phase where the yen strengthens against the dollar due to factors like the narrowing interest rate gap between Japan and the U.S., exchange losses are more likely to occur.
3. Credit risk (widening of credit spreads)
This is a risk that occurs in funds that primarily incorporate corporate bonds and high-yield bonds.
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Mechanism: When concerns about economic recession or deteriorating corporate performance increase, leading to a sense of caution that “they might not be repaid,” the prices of corporate bonds fall.
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Future Context: If a global economic slowdown or an increase in corporate default rates occurs, corporate bond funds will suffer greater damage to their net asset value than government bond funds.
4. Impact of remaining duration
The longer the average remaining duration (time until maturity) of the bonds incorporated, the greater the price decline when interest rates rise.
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Example: In the case of a fund with a duration of “7 years,” if market interest rates rise by 1%, the net asset value will theoretically fall by approximately 7%.
💡 Supplementary note on long-term holding (reasons why it doesn’t just end in a decline)
While the net asset value falls in the short term due to rising interest rates, bond funds reinvest by purchasing new, higher-yield bonds each time the bonds they hold reach maturity.
Therefore, from a medium- to long-term perspective, there is also the aspect that interest income (income gain) for the entire fund increases due to rising interest rates, contributing to the recovery and growth of future net asset value as well.
While rising interest rates have the effect of curbing economic overheating, they also have various impacts on many areas, including individuals, companies, governments, and financial markets. The main dangers (risks) are listed by area of impact.
1. Risks to individuals and households
* Increased burden of mortgage repayments
If you have a variable-rate mortgage, rising interest rates will increase your monthly and total repayment amounts, putting pressure on your household’s disposable income.
* Reduced use of new loans and credit (cooling of personal consumption)
Since interest rates for auto loans, education loans, and credit card cash advances also rise, people will refrain from making large purchases or spending.
* Decline in the valuation of assets held (bonds, housing, etc.)
The market price of fixed-rate bonds (government and corporate bonds) falls when interest rates rise. Additionally, downward pressure is placed on real estate prices due to reduced demand for mortgages.
2. Risks to corporate activities
* Increased cost of capital (interest payments)
The cost of raising funds through bank loans or issuing corporate bonds increases, which reduces the cash (profits) available to companies.
* Suppression of capital investment and business expansion
Due to the rise in borrowing costs, yield calculations become stricter, leading to a stronger tendency to refrain from growth investments such as new factories, systems, and M&A.
* Increased risk of bankruptcy for zombie companies and over-indebted companies
There is an increased possibility that underperforming or over-indebted companies that were kept alive by a low-interest-rate environment (such as zero-interest-rate policies) will be forced into bankruptcy as they become unable to bear the burden of interest payments.
3. Risks to financial markets and asset prices
* Downward pressure on the stock market
In addition to concerns about deteriorating corporate performance, the yields on safe assets like deposits and bonds rise, making it easier for capital to flee from risk assets like stocks (this particularly hits high-valuation growth stocks).
* Credit rating downgrades and default risk in the bond market
The default rate for high-yield bonds issued by companies with low creditworthiness increases, causing instability in the bond market as a whole.
4. Risks to the government and government bonds
* Fiscal pressure due to a sharp increase in government bond interest payments
As the yields on government bonds issued by the government rise, the country’s interest payment costs increase. This creates a risk that other budgets, such as social security and education, may be cut, or that it may lead to tax increases.
* Concerns about the soundness of central banks and financial institutions due to valuation losses
Unrealized losses may occur on the bonds held by central banks and private banks (especially regional banks, etc.) that hold large amounts of government bonds, which may raise concerns about the stability of the financial system.
5. Risks to exchange rates and the macroeconomy
* Deterioration in the performance of export companies due to a rapid currency appreciation (such as a stronger yen)
If interest rates are raised rapidly against other countries, the domestic currency may surge, creating a risk that the price competitiveness and earnings of export companies will decline.
* Induction of a rapid economic downturn (recession)
If a central bank carries out rapid interest rate hikes for purposes such as curbing inflation, there is a risk (hard landing) that it will cool the economy too much and trigger a recession.