Bonds are described as the safe part of a portfolio, and they can still lose value when interest rates move. The mechanism is arithmetic rather than sentiment.
The payments are fixed at issue
A conventional bond promises defined payments on defined dates and a repayment of principal at maturity. Those amounts do not change once the bond is issued.
What can change is the price at which the bond trades, which is the only variable available to adjust its attractiveness against alternatives.
The yield an investor receives is therefore a function of what they paid rather than of the coupon printed on the bond.
Two investors holding identical bonds bought at different times can consequently earn quite different returns, despite receiving exactly the same payments on the same dates.
New issues reset the competition
When prevailing rates rise, newly issued bonds of similar quality and maturity pay more. An investor choosing between them has no reason to accept the older, lower payments.
The older bond can only compete by costing less, so its price falls until the return from buying it at that price matches the new alternative.
Nothing about the issuer's ability to pay has changed. The fall reflects the opportunity cost of holding a fixed stream when better streams are available.
Maturity determines the size of the move
A bond maturing shortly returns its principal soon, so the period during which the holder is stuck with below-market payments is brief.
A bond maturing decades away locks in those payments far longer, so a given change in rates moves its price much more.
This sensitivity is measured as duration, and it is the reason two bonds from the same issuer can behave very differently as rates move.
Holding to maturity changes what is experienced
An investor holding an individual bond to maturity receives the promised payments and principal, so the interim price fall is not realised.
The loss is real in opportunity terms, since the money could have been earning the higher prevailing rate, but it does not appear as a cash shortfall.
Funds do not offer this, because they hold a rolling range of maturities and report a market value that reflects current prices continuously.
Falling rates run the same mechanism backwards
When prevailing rates fall, existing bonds paying more than new issues become more attractive, and their prices rise until the returns align.
This is why bonds can post substantial gains in periods of monetary easing, and why long-dated bonds gain most.
The same sensitivity works in both directions, so the instruments offering the largest gains as rates fall are those exposed to the largest losses when rates rise.