Investors commonly think that if they own a bond fund, they own a financial instrument that performs like a bond. They treat bonds and bond funds as interchangeable, and that is not the case.

Bonds

Bonds are not like stocks. Individual bonds have a maturity date and a coupon rate. If you buy a bond that matures in 2031 (a “2031 bond”) with a 5% coupon (5% interest rate) for $1,000 today, you will receive $50 a year between now and when the bond matures, at which point you will get back your original $1,000 plus the last coupon payment.

A predictable aspect of owning bonds is that if interest rates go up, compared to when you bought the bond, the value of your bond will go down. A year from now, if interest rates have gone up by 1%, your 5-year bond with 4 years left will be worth about $965 rather than $1,000. If interest rates spike massively, up 5% over the first year, the value of your bond will drop to about $842. This change in value of the bond is called rate sensitivity and the effects of rates on prices are predictable.

How much does this matter to you and your $1,000 bond with the 5% coupon? If you don’t sell the bond, it doesn’t really matter at all. You can keep collecting your $50 each year plus the original $1,000 when the bond matures. Plus, the closer your bond gets to maturity, the less sensitive it will be to changes in rates. If interest rates spike massively at the end of Year 4 rather than Year 1, your bond’s price will drop to about $954 rather than $842.

Traditional bond funds

Unlike the example above, traditional bond funds do not usually hold bonds to maturity. Most traditional funds maintain a constant horizon of 3 years to maturity, 5 years to maturity, 10 years to maturity, and so on. As one reference example, Vanguard’s total bond market fund (BND) maintains a constant horizon of about 8 years to maturity.

As bonds age out of the fund’s constant-horizon window, traditional funds continually replace them with bonds that are in the constant-horizon window.

In the individual bond example earlier, an investor who holds a bond that has declined significantly in value because of increased interest rates has the option to hold the bond to maturity and realize its par value of $1,000. The investor who holds a constant-horizon bond fund has no such option. When the values of the bonds in the fund decline due to a rate increase, the bonds inside the fund and the fund itself never pull to par because the bonds are not held to maturity. They are sold and new bonds are purchased so that the constant horizon of 3 years, 5 years, 10 years, etc. is always maintained.

This attribute of traditional bond funds is a big deal, and, in my experience, most investors are completely unaware of what it means:

• There’s no known end-point for the fund
• Bonds are not held until they reach maturity and don’t pay off their original price of $1,000 (called pull to par)
• There is no pull to par for the constant-horizon fund as a whole
• There is no way for an investor in a constant-horizon fund to avoid fluctuations due to rate sensitivity

Why this matters

Bonds are supposed to provide more stability than stocks, including less fluctuation and more future availability of capital.

Whether constant-horizon bond funds provide this is highly questionable. Post-pandemic, Vanguard’s total bond market fund (BND) lost 18.6% of its value from late 2021 through late 2023. Vanguard’s long-term corporate bond fund (VCLT) lost 34.3% of its value, and its long-term government bond fund (VGLT) lost 46.2% of its value. As of October 1, 2026, VGLT has still not fully regained the value it had at the end of 2021.

If a bond portfolio comprised of constant-horizon bond funds is supposed to provide stability and future availability of capital, and it isn’t doing that, would some other type of fund be better for those jobs?

Target-maturity bond funds

Over the past 15 years, companies have begun offering a different kind of bond fund: a target maturity bond fund or bullet fund. These funds do not maintain a constant horizon; they are constructed with bonds that mature in a target year. For example, a 2031 fund would hold bonds that mostly or completely mature in 2031.

Bullet funds perform more similarly to bonds than constant-horizon bond funds do. They reach maturity, the underlying bonds pull to par at maturity, and there is a point in time at which the terminal value of an investment in bonds can largely be known.

Kinds of returns from bonds

For traditional, constant-horizon bond funds, total returns consist of both income (the interest paid by the coupons) and price return (the change in the bond’s prices over time). When interest rates rise, and the bonds’ prices fall, the negative price returns can dwarf the income.

Constant-horizon funds keep investors continually exposed to the price component, which means investors are also continually exposed to the possibility of negative total returns, with no ability to control the timing of when the total returns will again become positive. These funds do not perform the functions typically attributed to bonds, which are to provide stability and future availability of capital.

Bullet funds reduce exposure to the price component in two ways. First, the maturity date is known, and if bond prices fall significantly, the investor has the option of holding the fund until its maturity date, with the underlying bonds pulling toward par as they approach maturity. Second, price sensitivity declines as maturity approaches, which means the investor doesn’t necessarily need to hold the fund all the way to maturity because the fund may reach a point, before maturity, at which the price sensitivity becomes immaterial.

Rain Dog’s Bullet Portfolio strategy

Bullet funds allow investors to design bond portfolios with maturities that match their need for liquidity, their tolerance for interim price fluctuations, and their need to support future switching decisions at low transition cost. Constant-horizon funds provide none of these options. At the same time, a bullet fund portfolio can be designed to produce a steady-state rate of return comparable to a diversified constant-horizon bond portfolio.

Rain Dog has developed a bond portfolio strategy that centers on the use of bullet funds, which we call the Bullet Portfolio strategy. For an in-depth analysis, see our Investment Thesis: Replacing Constant-Horizon Bond Funds with Target-Maturity Bond Funds [link to white paper].

Data sources

Bond performance data is from YCharts and Yahoo! Finance.