Corporate Bond Fund: Risks, Returns & Benefits

In India, investors have always preferred to invest in Bank Fixed Deposits. However, the declining interest rates of Fixed Deposits somewhat disappointed the investors. In such cases, corporate bond funds rose to popularity due to their low-risk features and assurance of stable and decent returns.

Want to know about a corporate bond fund? Read along!

Corporate bond funds are debt funds that invest more than 80% of their total financial resources in the bonds of  highest rating companies.

Corporate bond funds, also known as non-convertible debentures, are debt instruments companies issue to fund future expansion or growth.

As investors are aware of the definition of corporate bond funds, let’s proceed to the next sections.

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There are primarily two types of corporate bond funds. These are as follows,

Type One – Funds that only invest in the debt papers of highest rated companies (e.g. AAA companies - banks, and PSUs).

Type Two – Funds that only invest in the slightly lower rated company (companies having a rating of AA).

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Following are discussed the features and benefits of corporate bond funds,

Safe Investment

Corporate bond funds need to invest mostly in high-rated debt instruments. Hence, these types of investment instruments are highly safer than other debt fund categories. Here, investors can conduct a credit quality comparison to wholly assess the safety parameters of their investment.

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Low Default Rate

Another advantageous feature of a corporate debt fund is its low default rate. According to a 10-year analysis of high-rated CRISIL AAA papers, there is a lower percentage of default when invested in high-rated papers. However, the default rate certainly increased when investors chose to invest in comparatively low-rated bonds.

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Highly Liquid

As corporate bond funds invest in top-rate papers, it offers high liquidity. This feature helps fund managers rebalance portfolios as per requirement. As per an analysis of the liquidity aspect of corporate bond funds, 94% of the portfolio is in short-term liquid funds. This ranking is second to PSU and banking funds that have around ~97% liquidity. Also, in the case of the long-term liquidity aspect, corporate bond funds score impressively.

Stable Performance

Corporate bond funds have the capacity to ensure stable returns than other debt categories during adverse market conditions. As per a data of 5th January 2021, the average return from the corporate bond fund (9.86%) is much higher than other investment instruments such as Low duration funds (6.33%), Short duration funds (8.91%), Medium duration fund (7.35%), Dynamic duration fund (9.66%) and Banking and PSU funds (9.74%)

Tax Benefits

Investing in corporate bond funds allows investors to enjoy tax benefits. Here, investors have to hold their investment for at least 3 years to qualify for long-term capital gain with a tax rate of 20% with indexation. The tax rate is 10% without the benefit of indexation. This feature of corporate bond funds attracts investors with the highest tax bracket over bank fixed deposits. Wondering why? Bank fixed deposit returns are taxed as per the applicable income tax slabs. 

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When investors purchase bonds, companies actually borrow from them. It means the investors become lenders, and corporate bond fund issuers become borrowers.

Here, companies repay the principal amount as agreed upon. Throughout the tenure, these entities pay interest (referred to as coupons). The calculation of coupons occurs as a percentage of the face value of a bond. In India, investors usually get coupons twice a year.

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Similar to any mutual fund, a corporate bond fund operates in the debt market. When the value of a corporate bond fund increases in a portfolio, the NAV (net asset value) also increases which results in profit. Contrarily, a decline in NAV value has a negative effect on the total value of a mutual fund.

Here is a list of individuals who can invest in corporate bond funds,

• Individuals who wish to earn a stable return and avoid credit risks,
• Individuals who have an investment horizon of at least 2-3 years,
• Individuals who have a moderate risk appetite.

Investors willing to invest in top corporate bond funds can do so by purchasing them from the primary market, i.e. brokerage firms, bond traders, and banks.

Some corporate bond funds are available in the counter market, which offers increased liquidity.

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There are certain risk factors associated with corporate bond funds. These are as follows,

Interest Rate Risk

A corporate bond fund investment is a long term investment instrument. Therefore, changes in interest rate can affect coupon payments which in turn can impact returns.

Volatility

The long tenure of a corporate bond fund can make it subject to market volatility which can affect both coupon payment and returns.

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Below are discussed certain factors that investors must consider before investing in a corporate bond fund.

Investment Horizon

Corporate bond funds usually invest in corporate debentures and bonds having medium-to-long terms. Hence, investors must determine their investment horizon by prioritising their future goals. If investors have a long-term investment horizon, then this type of investment instrument can prove beneficial to them.

Knowledge of Market Condition

All kinds of investments come with a risk factor, so it makes the corporate bond fund investment. Corporate bonds have higher credit risk than other investments. Here, investors need to have some knowledge regarding market risks and challenges to make smart and profitable investment decisions.

Past Performance of Corporate Bond Funds

Evaluating the past performance of any investment is important before taking any decision. Past performance of investment helps investors get an idea about possible and usually similar returns given in a stable market condition. However, investors must note that past performance is only indicative. A large number of defaults in a portfolio can negatively impact returns. Hence, investors should not ideally depend only on past performance while investing in corporate bond funds.

Rating of Bonds

A corporate bond fund can acquire a crucial position in a core debt fund portfolio. The possibility of stable returns, indexation benefits in taxation, and restricted downgrade risk can benefit investors having a long term investment horizon. 

Therefore, consult with a financial advisor, determine your investment horizon, decide on investment goals, and assess risk appetite before investing in a Corporate bond fund to ensure assured returns.

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