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As you know mutual fund invests not only in equities but also debt. This is to diversify the risks of the investor. Again, this debt part is divided into different categories. In this article, we will discuss corporate bond funds – a category of debt fund schemes.

  1. What are corporate bond funds?
  2. Who should invest in corporate bonds?
  3. Features & benefits of corporate bond debt funds
  4. How to assess risk factors and return prospects
  5. How a corporate bond fund works
  6. What are the types of corporate bond funds?
  7. Top corporate bond funds in India
  8. Things to keep in mind while investing

 

1. Corporate Bond Debt Funds

Any company can issue a corporate bond, also called as Non Convertible Debentures (NCDs). Any organization or firm requires capital for daily operations as well as future expansion. There are two ways for a company to raise money – debt or equity investment. Debt is the safer option as it doesn’t affect the shareholders directly. So most companies prefer to go for debt. Bank loans can be quite expensive, so bonds or debentures give companies a economical alternative to raise funds.

Corporate bond securities, basically, form the underlying portfolios of credit opportunities debt funds. When you buy one, the company is actually borrowing money from you. The firm will repay the principal to you after the maturity period you agreed on. In the mean time, you will receive the interest (fixed income) to your account – known as coupon. Coupon payments in India are generally made twice a year.

2. Who should invest in corporate bonds?

Corporate bonds are a good choice for investors who are looking for a fixed but higher income from a safe avenue. It is a low-risk investment vehicle, compared to debt funds as it ensures capital protection. If you opt for corporate bond funds that put majorly put money in high quality debt instruments, it can serve your financial goal.

Long-term debt funds often tend to become riskier when the interest rates fluctuates beyond expectations. Therefore, corporate bond funds invests in scrips to reduce this volatility. They usually go for an investment horizon of 1-4 years. This can be an extra benefit, if you remain invested up to 3 years. It can also prove to be more tax-efficient if you belong to the highest income tax slab.

3. Features & benefits of corporate bond funds

a. Components of corporate bonds

Corporate bond funds invest significantly in debt paper. Companies issue the debt papers, which include bonds, debentures, commercial papers and structured obligations. Each of the component carries a unique risk profile and maturity date.

b. Price of the bond

Every bond has a price and it is never static. You can buy the same bond at different prices, based on the time you choose to buy. Check how it varies from par value – it will tell you about the market movement.

c. Par Value of the bond

This is the amount the company (bond issuer) gives you when the bond matures. Basically, it is the loan principal. In our country, a corporate bond’s par value is normally Rs. 1000.

d. Coupon (interest)

When you buy a bond, the company will pay you interest regularly until you exit the corporate bond. This interest is called coupon, which is a specific percentage of the par value.

e. Current Yield

The annual returns you make from the bond is called current yield. For example, if coupon rate of a bond with Rs. 1000 par value is 20%, then the firm must pay you Rs. 200 as interest per year.

f. Yield to Maturity (YTM)

This is the in-house rate of returns of all the cash-flows in the bond, the present bond price, the coupon payments till maturity and the principal. Greater the YTM, higher will be your returns and vice versa.

g. Tax-efficiency

If you are holding your corporate bond fund for less than 3 years, you must pay short-term capital gains tax based on your tax slab. On the other hand, Section 112 of the Indian Income Tax mandates 20% long-term capital gains tax for larger investment horizon. This is applicable to those who hold the bond for more than 3 years.

h. Exposure & allocation

Corporate Bond Funds sometimes do take very small exposures to government securities as well. But usually they do so only when no suitable opportunities in the credit space are available. On an average, Corporate Bond Funds will have approximately 5.22% allocation to sovereign fixed income.

4. Risk factors & returns

There’s always the possibility of bond issuer defaulting on its obligations. This default risk is higher for lower rated securities, and goes up exponentially with increasing maturities. If your fund manager invests only in highly-rated companies, expect an average returns of 8-10%. Here, the risk is also minimal.  

On the other hand, if you invest in a slightly low-rated but a well-managed, fund, it can be rewarding. For instance, the companies tend to give slightly higher coupon rates to attract more investors. However, there is also a chance that the fund manager’s call on the company goes wrong. Example, if it defaults on interest payments or principal repayment or the company gets downgraded further), it can cause a setback for investors.

5. How do corporate bonds make returns?

Like the Fixed Deposits (FDs) that individuals invest in, mutual funds invest in bonds that are tradable.  Just like shares are traded in stock market! Similarly, there is also a debt market where you can trade various bonds. In this market, the prices of different bonds can rise or fall, just like they do on the stock markets. For instance, a mutual fund buys a bond and its price subsequently rises. Then it can make additional money over and above what it would have made out of the interest income alone. However, it could also go the other way round.

6. Types of corporate bond funds

Broadly, there are two types of corporate bond funds.

Type One: Type One Corporate Bond sticks to high-rated companies – public sector unit (PSU) companies and banks.

Type Two: Second type invests in slightly lower rated companies such as ‘AA-‘ and below.

Let’s take a simple example to understand this. Suppose,  a CRISIL “A” rated bond with 1-year residual maturity has a 0.56% chance of defaulting, whereas a CRISIL “A” rated bond with a 3-year residual maturity has a 4.79% chance of defaulting. Considering that Corporate Bond Funds typically allocate at least half their portfolios to bonds that are ranked AA or lower, there’s always the risk of some of its portfolio bonds defaulting, resulting in a drag on portfolio returns.

7. Top Corporate Bond Funds in India

 

Bond Fund

YTD

1 year

3 year

5 year

Franklin India Corporate Bond Opportunities Fund Direct-Growth 0.95% 8.38% 9.43% 10.2%
Baroda Pioneer Credit Opportunities Fund Plan B Direct-Growth 0.64% 8.70% 10.82%
DSP BlackRock Income Opportunities Direct Plan-Growth 0.55% 6.54% 9.11% 9.60%

 

8. Things to remember before investing in Corporate Bond Funds

  • You must always review Corporate Bond Funds as a long term investment vehicle. This is because these funds invest in corporate debenture and bonds of medium to long term tenure.
  • If you are not a seasoned debt fund investor, it will be difficult for you to understand potential risks and market.
  • Remember that a  large number of defaults within a fund’s portfolio can lead to a serious drag in returns. If you decide to invest into them, don’t be swayed by past returns.
  • In case of corporate bond funds, it is better to stick to the offerings of large AMCs, preferably, the top 5 funds. New investors are advised to stick to highly rated, short term debt funds with lower credit risk instead.

 

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