Understanding investment risk

All investments involve risk. The value of investments, and any income they produce, may fall as well as rise, which means you could get back less than you originally invested.

That sentence appears on everything, and it is easy to read past. What follows is the detail underneath it: the specific, named risks a bond fund sets out in its own documentation. They are worth knowing because they explain why a fund can fall, rather than simply warning you that it might.

The risks a bond fund names

Interest rate risk. A fund can hold assets whose value is sensitive to changes in interest rates, so their value may move significantly as rates move. The value of a bond tends to fall when interest rates rise.

Credit risk. The issuer of a bond, or of a similar investment held in the fund, may fail to pay income or repay capital when it is due.

Pricing risk. Prices move. The value of assets can fall as well as rise, and that is typically amplified in more volatile market conditions.

Liquidity risk. In difficult markets there may not be enough buyers and sellers for certain investments, which can affect the value of the fund.

Derivative risk. A fund may use derivatives to reduce costs or reduce its overall risk, which is known as efficient portfolio management. Derivatives carry a level of risk of their own, though used this way they should not increase the overall riskiness of the fund.

Counterparty default risk. The risk of loss if the other side of a derivatives contract fails, or if a custodian safeguarding the fund's assets fails.

Charges taken from capital. Some or all of a fund's charges may be taken from capital rather than from income. If there is not sufficient capital growth to cover them, that can erode the capital itself.

Share class hedging risk. Where a share class is hedged, that process can cause the value of investments to fall, through market movements, rebalancing, and in extreme circumstances the failure of the counterparty providing the hedging contract.

Reading this alongside the fund's own documents

This is a plain English summary and it is not the full picture. Any fund you are considering must publish its own regulatory information, and the prospectus sets out its risk factors in full.

Risk is also not a single dial. A fund can be low risk in one sense and high in another: a short dated government bond fund carries little credit risk and still moves with interest rates. The risk tool shows how the general level of risk changes what you should expect, and our guide to fixed income explains where bonds sit against cash and shares.