An evaluation of a bond fund requires all the information noted above, plus some unique, bond-specific statistics.
First, maturity is a determinant of both return and risk. Usually, the greater the maturity, the greater the return, and the greater the volatility of return as interest rate levels change in the bond market. Return includes both yield, the income received on the bond, and capital gains, changes in the price of the bond in response to bond market interest rate changes.
Duration is another measure of bond fund return volatility that not only includes maturity, but also mathematically incorporates the impact of the income produced by the bonds in the fund. The higher the duration number, the greater the exposure of the bond fund to interest rate risk—bonds drop in price when interest rates rise, and rise in price when rates fall, and the response is magnified at greater average maturities and lower average bond interest income levels.
A second type of risk for bonds is credit risk, either bonds defaulting or dropping down the credit rating scale and the resulting drops in bond price. The average credit rating will give an indication of credit risk; the closer the average is to AAA, the less the risk for corporate and municipal bonds. U.S. government bonds have no credit risk, and therefore no credit rating. But average credit rating might hide a significant problem: low-rated bonds that are offset by bonds with higher ratings but that still pose substantial risk.
A distribution of credit ratings will give you a quick overview of the credit risk of the bond portfolio. Bonds rated below BBB, the lowest investment-quality grade, are more susceptible to default risk. A junk bond fund would have a low average credit rating for its bonds and a distribution bulging below BBB.
Finally, yield—the income received on the portfolio relative to the value of the portfolio—is the reason most investors seek bonds funds. But if you find a bond fund with significantly greater yield than its competitors, you can bet it has either a lower average credit rating, more bonds below investment grade, a longer maturity, a longer duration, or some combination of these higher risk factors.
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