Why Can Bond Mutual Funds and Government Bonds Fall When Interest Rates Rise?

A lot of people buy fixed income mutual funds or SBN (Indonesian government bonds) because they want something calmer than stocks.

Then the BI Rate goes up, bond prices fall, and their investment app suddenly turns red.

The reaction is understandable: “I thought bonds were safe. How can I lose money?”

The answer is that bonds are different from stocks, but that does not mean their value goes up every single day. Especially when interest rates move quickly.

Fixed income does not mean fixed prices

The phrase “fixed income” often misleads beginners.

What is relatively fixed is the coupon or interest paid by the bond, not its market price. If the bond can be traded, its price can move up and down before maturity.

This applies to:

• fixed income mutual funds;
• bond mutual funds;
• ORI and SR sold on the secondary market;
• government and corporate bonds that are traded.

SBR and ST are different because they are not freely traded on the secondary market. But for ORI, SR, and bond mutual funds, market prices still move.

If you are still sorting out the different types of SBN, start with the retail government bond guide and the differences between ORI, SR, ST, and SBR. Small details like whether something can be sold or not can completely change your experience when rates rise.

The relationship between interest rates and bond prices

Here is the basic rule:

When interest rates rise, older bond prices tend to fall.

Imagine you own an older bond with a 6% annual coupon. Then the government issues a new bond with a 7% annual coupon because interest rates have gone up.

Which one looks more attractive to a new buyer? Clearly the 7% one.

For the older 6% bond to stay attractive, its price has to fall. At a cheaper price, the effective yield for a new buyer can get closer to the new bond.

That is the mechanism. It is not because the old bond suddenly became bad. It is not because the government automatically became riskier. The price is simply adjusting to the new rate environment.

A simple example

Say there is a bond with a principal value of Rp 100 million and an annual coupon of Rp 6 million.

If market interest rates are still around 6%, that bond may trade close to Rp 100 million.

But if market rates rise to 7%, new buyers will not want to pay Rp 100 million for a bond that only pays Rp 6 million. They can look for newer bonds with higher coupons.

So the price of the older bond falls. Maybe to Rp 95 million or Rp 96 million, depending on the tenor, coupon, and market conditions.

The coupon stays Rp 6 million. But the market price changes.

Duration: a small word that can cost a lot

If you remember only one term from this article, remember this: duration.

Duration is a measure of how sensitive a bond’s price is to interest rate changes. The longer the duration, the bigger the effect of rising or falling rates on the price.

A rough example:

• a bond with a 2-year duration: if rates rise 1%, the price may fall around 2%;
• a bond with a 5-year duration: if rates rise 1%, the price may fall around 5%;
• a bond with an 8-year duration: if rates rise 1%, the price may fall around 8%.

These numbers are simplified, not exact formulas. But they are enough to capture the point: long-term bonds are more sensitive to rate changes.

That is why two fixed income mutual funds can perform very differently. One may hold shorter-duration bonds. Another may hold long-tenor government bonds. When rates rise sharply, the one with the longer duration usually feels more pain.

Why can bond mutual funds fall faster than expected?

Bond mutual funds value their portfolios using market prices. If the prices of the bonds inside the portfolio fall, the fund’s NAV falls too.

The investment manager does not have to sell every bond for the NAV to drop. As soon as market prices move, the portfolio value is adjusted.

That is why you can see a fixed income mutual fund in the red even though the bonds inside it are still paying coupons.

Coupons come in. Market prices move. Both affect the NAV.

What about ORI and SR?

ORI and SR create two very different experiences, depending on what you do.

If you hold them until maturity, the government pays the coupon on schedule and returns 100% of the principal at maturity. In a normal scenario, market price fluctuations do not matter much because you are not selling.

But if you sell before maturity in the secondary market, the selling price can be below 100. That is where you can realize a capital loss.

So the phrase “SBN is safe” needs the full version:

SBN is safe from default risk in the sense that the risk is very low if you hold until maturity. But tradable SBN still carries price risk if you sell before maturity.

For the part about selling before maturity, read the retail SBN secondary market too. A lot of panic happens because people buy ORI or SR like a deposit, then get surprised when they see the market price move.

What about SBR and ST?

SBR and ST cannot be freely sold on the secondary market. Their coupons are floating with a floor, so they are more protected when interest rates rise compared with older fixed-rate bonds.

But their liquidity is more limited. You can only use the early redemption facility under the rules for that series, usually for part of the investment and only after a holding period.

That means SBR/ST is better suited to people who are ready to lock in their money until maturity, not for emergency funds.

What should investors do now?

First, do not panic just because the NAV is down.

Ask yourself first:

When will this money be needed?

If the money is for something 3 months from now, a bond mutual fund may be too risky. For very short-term money, money market funds, deposits, or savings are more reasonable.

If the money is for a goal 3-5 years away, a temporary drop may be a normal part of the journey. Especially if bond coupons are still coming in and new yields are starting to look more attractive.

If the goal is only to park short-term cash, compare it first with deposits, SBN, and money market funds. Do not use longer-duration products for money you will need soon.

Second, check what kind of product you actually own.

• Money market fund: short duration, usually the most stable.
• Short-duration fixed income fund: it can still fall, but usually less.
• Long-tenor bond fund: more sensitive to interest rates.
• ORI/SR: safe if held to maturity, but the market price can fall if sold early.
• SBR/ST: not traded, floating coupon, limited liquidity.

Third, read the fund fact sheet. Look for information about bond composition, duration, average maturity, and risk.

If that document feels confusing, that is a sign you need a simpler product, not a more sophisticated one.

Are rising rates always bad?

No.

For holders of older bonds, rising rates can push prices down. But for new investors, higher rates can mean a chance to get more attractive yields.

Bond mutual funds can also gradually replace older bonds with newer ones that have higher coupons. The process is not instant, but the portfolio yield can improve over time.

The bond market is not as comfortable as a deposit. But it is also not as simple as “down means bad.”

Mistakes to avoid

Selling just because the screen is red.

If your goal is still far away and the product still fits, selling when bond prices are down can lock in what was actually only a temporary loss.

Using bond mutual funds for your emergency fund.

An emergency fund needs to be stable and quick to access. Money market funds or savings are usually a better fit.

Chasing the highest return without looking at duration.

A bond fund with very strong returns during a falling-rate period can look amazing. But if its duration is long, that same product can fall harder when rates rise.

Assuming all SBN is the same.

ORI, SR, SBR, and ST all work differently. Do not buy just because they are all labeled SBN.

Summary

If the BI Rate rises and your bond mutual fund falls, the main reason is usually that bond prices are adjusting to the new interest rate environment.

What you need to check:

• whether your product is fixed rate or floating;
• whether the bond can be traded;
• how long the duration is;
• when you need the money;
• whether you are ready to hold until maturity or until the bond market improves.

Bonds can still be an important part of a portfolio. But do not buy them with savings-account expectations.

Fixed income does not mean zero fluctuation.

Disclaimer: This article is for education only, not investment advice. Bond prices, coupons, and interest rate policy can change. Read the prospectus, information memorandum, and fund fact sheet before buying any product.