Bond Funds and Unit Trusts

BECAUSE prices of individual bonds are so unsteady, investors are looking for less risky ways to get into the bond market. You can spread the risk of default by buying bond mutual funds and unit trusts, which give you a small share in a large number of bonds. Professional managers relieve you of worries about which bonds to buy and sell, and when to purchase or unload them, by performing those tasks for you.

A bond mutual fund will always redeem your shares at the present worth of the underlying bonds. If the prices of bonds in the mutual fund's portfolio go up, then your shares immediately go up. Of course, it works the other way around, too. Brokers sell bond funds and collect commissions of up to 81/2% from you, but you easily can buy commission free, no load bond funds by mail.

As an alternative, of course, you can buy individual bonds. And you can sell them back in the market at any time. But whether you are buying or selling, you will usually take a beating on the price because commissions are high unless you are dealing with very large amounts. So you stand to get a better deal on commissions with no load bond funds than with individual bonds.

Individual bonds do have some advantage over funds. If interest rates rise and a bond's price drops, you know that your bond eventually will be paid off at its face value when it matures, or comes due. But bond funds never mature. So, if interest rates surge and stay high, your bond fund shares may never again be worth what you paid for them.

Unit trusts are usually huge bond portfolios assembled and sold by brokerage houses in small slices of $ 1,000 to $5,000. They give you the combined benefits of diversification and fairly good prices. After you have paid commissions, you generally get about $950 to $960 worth of securities for each $ 1,000 you invest. The yields are slightly bigger than those of bond funds because there is no management fee.

The trust's sponsor almost always will buy units back from you at a price equal to their net asset value. The advantages of liquidity and diversification, however, come at some cost; you run a risk that interest rates will rise, and the price of your units will decline. Also, the sponsors usually buy long term bonds maturing in 30 years and do not sell any of them unless the issuer is revealed to be in imminent danger of default. By then, of course, it is usually too late.

True, you will not be too badly clobbered because the trust owns many different bonds, and it is highly unlikely that more than a few bond issuers would default at any one time. Still, the way to safe guard yourself against turkeys in your trust before you send in your money is to read the trust's prospectus. It lists each bond in the portfolio along with its credit rating and tells you about any provisions that the bonds may be called in early by the issuer if interest rates fall.

You also can buy tax exempt unit trusts. In mid 1989, they were paying interest of about 6.9% tax free. Investors who are especially safety minded can put some money into an insured tax exempt trust. The bonds are backed by an insurance company guarantee that interest and principal will be paid on schedule, but the cost of the insurance reduces the yield to a shade less than you would get on an unsecured trust.

Taking all these factors together, the easiest and safest way for most persons of moderate means to buy a diversity of bonds is to invest in a no load bond mutual fund. The interest income is reasonably steady, there are no commissions when you buy or sell and the annual fees are modest. Unlike unit trusts, bond fund portfolios are actively managed. The issues in them are constantly being traded, and presumably the managers know enough to escape from a troubled situation and sell out well before a bond encounters the danger of default.