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Essential Features and Benefits of Corporate Bond Funds

Non-payment of dues and delayed payments have impacted the mutual fund scheme severely. Due to this, categories such as credit risk funds have seen major outflows in the last one year. Another debt mutual funds category, i.e., corporate bond funds’ assets rose by over 75%. In this article, we shall discuss it in detail.

What is the Corporate Bond Fund?

A Corporate Bond Fund is essentially a mutual fund that invests at least 80 % of its assets in the highest-rated instruments. These funds are less risky than the credit risk funds as they invest in high rated papers. However, it doesn’t mean the elimination of risks entirely. Companies like RCom, Zee, DHFL are examples where the highest rated companies defaulted.

Who should invest in Corporate Bonds?

It is a perfect choice for investors that are looking for a fixed and higher income from a safe option. They are low-risk investment vehicle in comparison to debt funds as it provides capital protection. In the case of corporate bond funds that invest in high-quality debt instruments, then it will help you meet your financial goals.

Long term debt funds are riskier when interest rates go up and down beyond expectations. As a result, the corporate bond fund invests in scrips to combat volatility. More often, they go for an investment of one to four years. It can be beneficial in a way if you remain invested for three years. 

What are the types of corporate bond funds?

There are broadly two types of it:

1. The first type of corporate bond is the ones that invest in high rated companies- public sector unit companies and banks.
2. The second type of corporate bond invests in slightly lower credit rating companies.

What are the essential features and benefits of Corporate Bond funds?

The following are the essential features and benefits of the Corporate Bond fund:

• Corporate bonds Components

They usually invest in debt papers. Companies issue debt papers, which include bonds, debentures, and structured obligations. All of these carry a unique risk profile and maturity date.

• Bond price

Each bond has a price, and it is dynamic. One can buy the same bond at different prices depending upon the time you choose to buy. Investors are required to check how it varies from the par value.

• Par value of the bond

The Par value of the bond is the amount the company gives you when the bond matures. It is the loan principal. A corporate bonds‘ par value is usually 1000 rupees in India.

• Higher returns

Corporate bonds fund usually ensures higher returns than other debt instruments in the market. Average yields of 8 to 10 percent can be expected from corporate debt instruments.

• Security

Corporate debt funds have a less associated risk than shares as the former poses a financial obligation on the company. On the flip side, equity investments are subject to the profits and losses generated by the company in one financial year; therefore, they are riskier.

• Liquidity

As you would know, corporate debt funds are generated to satisfy the short term financing needs of a business, they are also the short term in nature, and corporate bond mutual funds can be obtained and sold according to the investor. It provides high liquidity of financial resources, thus allowing a person to convert it to cash when required.

• Tax efficiency

If a person holds a corporate bond fund for less than three years, then they are required to pay short term capital gains tax based on your tax slab. Section 112 of the Income Tax Act^[1] mandates a 20% tax on long term capital gains. It applies to those who hold a bond for over three years.

• Exposure and allocation

It sometimes takes small exposures to government securities. They do this only when there is no suitable opportunity in the credit space.

Risk Factors and Returns

There are chances where bond issuers may default on their obligations. The default risk is higher for low rated securities. If the fund manager invests only in high rated companies, the risk factor of the company defaulting is considerably less.

In case if the investment is made in a slightly low rated but a well-managed fund, then it can be beneficial. Organizations with a lower credit rating offer higher coupon value to attract investors and several mutual funds. Trained portfolio managers decide to invest a portion of the total resource in such funds during favorable market conditions and withdraw the funds in case of potential fluctuations.

Things to know before you invest in Corporate Bond Funds

Here are a few points to remember:

• Corporate bond funds invest in corporate debenture and bonds of medium to long term tenure. Therefore consider it a long term investment vehicle.
• Having market knowledge is indispensable here. In case a person is not a seasoned debt fund investor, then it would be challenging to know potential risks and markets.
• It may be noted that a large number of defaults in a fund’s portfolio can lead to a severe drag in returns. In case you decide to invest, then never allow past year returns to influence your decision making.
• It is advised to stick to the offerings of large AMCs. Else the new investors would be doing well by sticking with high rated short term debt funds with lower credit risk.

Conclusion

Compared to equity funds, corporate bond funds are safer due to the structure that allows for predictable returns and reduced risks. However, they are not entirely safe as well, and the risk of default remains.

Read our article:How Does a Mutual Fund Operate?