• What does benchmark freedom mean in the bond sector and why is it important?
• What are the weaknesses of passive bond ETFs?
• What are income strategies in bond funds?
• What do coupon, credit rating, maturity, duration and SRI mean?
   

Benchmark freedom means that a fund manager does not have to replicate a rigid benchmark index, but instead has the freedom to adjust the portfolio proactively. This is a decisive advantage for active risk management, particularly in the bond sector. Why? A typical bond index gives the highest weighting to those issuers (debtors) with the greatest debt burden. What may still seem plausible for equities, where the largest companies receive the highest index weighting, appears paradoxical for bonds: The higher the debt of a country or company, the more strongly it is represented in the index. A bond ETF must follow this pattern and therefore invests the most money in the largest borrowers. An active fund manager, on the other hand, can avoid this obsessive proximity to the index: They are free from benchmark requirements and can deliberately reduce exposure to highly indebted issuers or avoid them altogether. This reduces cluster risks and protects against potential defaults by individual debtors. Benchmark freedom also makes it possible to exploit opportunities outside the index. Large issuers often issue dozens of different bonds. For example, a company like Apple has dozens of different bonds with different coupons, maturities and terms. An index-oriented ETF would include almost all of these securities in the portfolio according to their issue volumes. An active bond fund, on the other hand, can take a selective approach: The manager selects the most attractive bonds of an issuer - for example, those with the best risk/return profile - and leaves out less advantageous bonds. This flexibility at issuer level allows for a targets improvement of overall portfolio quality. Last but not least, diversification plays a special role in bond management. Broad diversification is important in every asset class, but particularly in the case of bonds: As a creditor, the maximum amount of interest and the nominal value you can receive back until a bond matures. The profit side is therefore limited, while in extreme cases there is a risk of total loss in the event of default. For this reason, a bond portfolio should not concentrate on just a few debtors. A benchmark-free fund can control the distribution of risks itself, for example by ensuring that no single issuer accounts for more than a certain proportion of the fund assets. This makes active risk management possible: The managers are guided by absolute risk targets (such as a maximum loss threshold or volatility) instead of index deviations. Overall, benchmark freedom gives active bond funds great scope to flexibly manage market risks and exploit opportunities. Even if they are measured by whether they outperform a benchmark index (if available) in the medium term, capital preservation and controlled risk are often the top priority. 

Passive bond ETFs are very popular for their broad market access and low cost. However, investors should be aware of the weaknesses of these index products:

• Issuer weighting by debt load: As mentioned above, bond ETFs track indices that are weighted by market size. This means that the largest debtors have the greatest weighting in the portfolio. Put simply: A country bond index lends the most money to highly indebted countries, and a corporate bond ETF is heavily invested in companies that have a lot of bonds outstanding. This principle is not a quality selection, but volume based. This can be unfavorable for investors, as a high level of debt often goes hand in hand with a higher default risk. A passive ETF cannot reduce exposure to problematic debtors as long as they remain in the index. An extreme example from the past: When Greece was facing a sovereign debt crisis, it was nevertheless highly weighted in many euro government bond indices. Active managers had reduced the country's weighting early on in some cases, while index funds had to wait until Greece dropped out of the index. 

• Trading margins in times of stress: ETFs are traded on the stock exchange, which benefits liquidity-seeking investors. But in market crises, this can become a problem. When bond markets are under stress (e.g. in a financial crash or panic selling), the buying and selling spreads on bond ETFs often widen significantly. The prices of the ETF units can then deviate significantly from the intrinsic value (NAV) of the fund. In concrete terms, this means that anyone selling a bond ETF in such phases may receive a price that is significantly below the fair value of the underlying bonds. The bid-ask spread widens. Particularly specialized bond ETFs in niches (such as emerging market corporate bonds or the high-yield sector) show considerable discounts and widening spreads in turbulent times. This makes buying and selling more expensive and makes it more difficult to liquidate large positions just when you might urgently need them. An actively managed fund is not immune to market stress (here too, share redemptions can provoke suspensions or discounts), but the fund manager can position more cautiously in advance, hold liquidity buffers or trade off-exchange. An ETF, on the other hand, is fully exposed to the market's liquidity conditions. The liquidity of the underlying bonds determines the tradability of the ETF.

With interest rates becoming attractive again, so-called income strategies are gaining importance. These are approaches that generate regular distributions - i.e. ongoing income that is paid out to investors. Private investors often first think of dividend funds that invest in shares with high dividends. However, a modern income strategy draws on a wider range of assets and does not rely solely on equity dividends.

Stable current income: The core goal of an income strategy is to achieve predictable cash flows - particularly attractive for investors who rely on withdrawals or a supplementary income. Bond funds play a central role here, as bonds provide regular interest payments through their coupons. After years of zero interest rates, good quality bonds now offer coupons of 3-4% per year, for example - comparable to many equity dividends, but often with significantly lower price risk. A balanced strategy with a diversified corporate bond portfolio has a medium-term volatility of around 3-6%. This corresponds to around a quarter of the fluctuations of an equity fund. It is also important to note that bonds bought below par - e.g. in a market downturn - are repaid at full face value, provided the company does not become insolvent before repayment. If a bond with a 3 percent coupon is purchased at 90 percent of the nominal value and still has three years to maturity, the yield to maturity is 9 percent (coupons) plus 10 percent (price gain due to purchase below par) - i.e. 19 percent over three years.

Bonds can also rise above 100 percent of their nominal value because the price on the market is determined by supply and demand and is not limited to the nominal value (100 percent). Two examples:

• Improving creditworthiness: If the risk premium falls, prices rise - even above 100 percent .

• Falling market interest rates: If ECB key interest rates are lowered, for example, older bonds with higher coupons are more attractive. The longer the remaining term, the greater the cash value advantage. Prices can climb well above 100 percent.

Assuming a reliable credit rating analysis and good maturity management, bond investors can selectively sell bonds that are trading above 100 percent and shift the profits into securities that are trading below par. This allows repeated price gains to be made in addition to coupons.

In addition to bond coupons and price gains, additional income can be achieved through strategic maturity positioning. Fund managers can use a roll-down strategy, for example: They buy bonds with slightly longer remaining maturities and sell them as soon as they have shorter maturities. This results in price gains if the yield curve rises normally. Targeted exploitation of interest rate differences between short and long maturities can also generate additional income.

Structured bonds also expand the spectrum, e.g. subordinated bonds or hybrid bonds. These generally offer higher coupons because investors accept additional risks - such as subordination in the event of insolvency. Such securities can increase the income yield of the fund.

An income strategy is therefore not limited to a single type of income such as dividends on the stock market. Those who integrate flexible bond funds into their income strategy can combine coupons, price gains, maturity gains and income from targeted bond selection. The advantage of this diversity is that the income streams have several legs to stand on. If one source is temporarily lower, others cushion it. In addition, the risk is spread: bond funds with an income focus often invest globally and across different credit ratings in order to achieve an attractive distribution at all times. Of course, an income strategy is not entirely without fluctuations in value. High-yield bonds in particular can cause temporary losses. All in all, income strategies today are much more than just dividend hunters: they use the entire range of capital market instruments, especially bonds, to generate a robust income for investors.

Finally, we take a look at some key terms that are often used in connection with bond funds. Investors should be familiar with these in order to better understand fund profiles and risks:

• Coupon: This refers to the interest rate of a bond. The coupon is usually paid out annually (or semi-annually) as a percentage of the nominal value. For example, a bond with a nominal value of € 1,000 and a 5% coupon has an annual interest rate of € 50. A high coupon initially means high current income. However, the coupon rate depends on the interest rate level at the time of issue and the issuer's credit rating. Old bonds often have lower coupons (if they were issued during periods of low interest rates), while newer bonds currently have higher coupons. Important: The coupon is not the same as the yield, as the latter also depends on the current price of the bond. If the price is above 100 %, the effective interest rate is lower than the coupon. If it is lower, it is correspondingly higher. In the context of bond funds, coupons often, but not always, contribute the majority of current income. An active manager can, for example, generate additional income by buying bonds below par until maturity. 

• Credit rating: The credit rating refers to the creditworthiness of the borrower of a bond, i.e. how high the default risk is estimated to be. It is often indicated by ratings from agencies such as Standard & Poor's, Moody's or Fitch. High-class debtors such as Germany or Switzerland receive a rating of AAA, which indicates excellent creditworthiness. Weaker borrowers receive BBB, BB, B down to CCC or lower. Anything below BBB- is considered non-investment grade or high yield with a correspondingly higher risk. For bond funds, the creditworthiness of their portfolio assets is key, as it influences both security and yield: better creditworthiness means lower default risk, but also lower interest rates. Poorer creditworthiness requires higher interest rates (risk premiums) as compensation. A fund with a focus on high creditworthiness (investment grade) will typically be more stable but less profitable than a high-yield fund, which is more volatile. Investors should therefore pay attention to the credit rating structure in the fund. It gives an indication of risk and possible fluctuations in value. Due to the separation between investment grade and high yield and the increased volume in passive investments, active managers have additional outperformance opportunities at the interface between the two bond segments.

• Term: The term of a bond is the period until maturity, i.e. until repayment of the nominal value. It is usually expressed in years. Bonds can be short-term (e.g. 1-3 years to maturity), medium-term (5-7 years) or long-term (10 years or more, up to 30+ years or perpetuals with no final maturity). The term is important because it is closely linked to the susceptibility to interest rate changes: long-term bonds generally react more strongly to interest rate changes than short-term bonds. In addition, longer maturities usually attract somewhat higher coupons/yields to compensate for the uncertainty over the long period. In funds, the average maturity or - even more meaningful - the duration is often stated instead of the individual maturities (see next point). As a general rule, a bond fund with a longer average duration will react more sensitively to interest rate changes, while a fund with short durations is more stable in terms of interest rates, but has less yield potential as long as there are no interest rate cuts. An active manager can control the duration and thus the risk. 

• Duration: Duration is a key figure that expresses the fixed-interest period and sensitivity to interest rate risk of a bond or a bond portfolio. More precisely, it is the average weighted capital commitment period in years. In practical terms, the modified duration can be interpreted as follows: It indicates the percentage by which the value of a bond falls if the market interest rate level rises by 1 percentage point (and vice versa). Example: If a fund has a duration of 5, then a 1% rise in interest rates would mathematically lead to around 5% price loss in the portfolio. A higher duration therefore means a higher interest rate risk, but also greater price opportunities if interest rates fall. Duration and maturity are related, but not identical. Duration also takes into account when interest payments are made. A high-coupon bond has a slightly shorter duration than a zero-coupon bond of the same maturity because part of the principal is returned earlier in the form of interest payments. For investors, duration is one of the most important key figures for assessing how strongly their bond fund is affected by interest rate changes. In phases of expected interest rate rises, many managers tend to keep duration short in order to limit losses. If interest rates are expected to fall, a longer duration can be advantageous in order to capture price gains. 

• SRI: The abbreviation stands for Summary Risk Indicator and is part of the "key information documents" (PRIIPs-KIDs) for funds, structured products and insurance investments in the EU. The SRI summarizes the overall risk of a product on a scale from 1 (very low) to 7 (very high). In contrast to the previous SRRI (Synthetic Risk and Reward Indicator), the SRI is not only based on historical volatility, but combines it: Market risk (calculated using a value-at-risk model) and credit risk (issuer default probability). This extended methodology is intended to give investors a more comprehensive picture of the overall risk. UK exception: In the UK, UCITS funds continue to use the SRRI (1-7, volatility) in the KIID. However, the SRI is also shown for other investment products that fall under the UK PRIIPs rules. The planned Consumer Composite Investments (CCI) regime is to replace the UK PRIIPs regime. The final CCI rules are to be published by the end of 2025 and implemented by the end of 2026 at the latest. 

Today, bond funds are far more than just "interest rate products". Active, benchmark-free bond funds can offer considerable advantages thanks to flexible management, targeted security selection and broad diversification - particularly in terms of risk management - while passive bond ETFs score points with low costs and ease of use, but at the same time have structural weaknesses such as rigid issuer weighting and possible liquidity bottlenecks in times of crisis. Which strategy is the right one depends on the investor's objectives and expertise. Institutional and private investors alike should consider the aspects presented - from benchmark freedom and income strategies to costs and technical terms - in order to make well-founded decisions for their 2025 bond portfolio. This will allow them to make the most of the interest rate renaissance without losing sight of the risks.