What are Corporate Bond Funds
Public and private companies both issue corporate bonds.
The bond prices are affected by a change in interest rates and the maturity period
Corporate bond funds, also known as Non-Convertible Debentures (NCDs), are increasingly becoming a popular debt instrument for businesses to raise finances required for their operations, growth and future expansion. Business organizations issue these bonds to fund working capital requirements, advertising expenses, insurance premium payments as bank loans can become expensive. Public and private companies both issue corporate bonds.
What are Corporate Bond Funds?
A corporate bond is debt mutual funds issued by a company or firm to raise capital and sell to investors. Corporate bond funds are mandated to lend at least 80% of their total assets to companies with the highest possible credit rating issuing these corporate bonds. This rating is given to financially strong companies with a high probability of paying lenders on time.
Types of Corporate Bond Funds
A mutual fund typically invests in two types of corporate bonds:
- Top-rated companies with debt papers having incredibly high CRISIL credit ratings. These are generally top public sector companies (PSU) and banks.
- Companies having a slightly lower credit rating, debt papers with ‘AA-‘ and below ratings.
How do Corporate Bonds make Returns?
When investors buy corporate bond security, the company is borrowing money from them and repaying the principal upon maturity. The company also pays interest on the borrowing, which is known as the coupon. It is a percentage of the par value, usually made twice a year.
YTM is the annual return on the bond. The total return from the bond until maturity is called yield to maturity. Higher the YTM, the higher the returns. These operate in the share market, similar to any standard mutual fund. The NAV of the fund increases with the increase in the value of a corporate bond in the portfolio and vice versa, thereby realizing profits.
The bond prices are affected by a change in interest rates and the maturity period. Bond prices fall if the interest rates rise, and vice versa. Bonds are issued below par value, and the issuer pays back the par value upon maturity.
Corporate bonds offer higher interest rates as they carry higher credit risk depending on the respective portfolio managers’ investment patterns. Companies with high credit ratings have low defaulting chances, while relatively lower ratings have a higher chance.
Who Should Invest in Corporate Bonds?
The ideal investment horizon for corporate bonds is 3-5 years. Investors seeking fixed and regular income and low-risk investments for low returns can look at investing in corporate bond funds. However, these funds do not guarantee returns.
Features and Benefits of Corporate Bond Funds
Corporate bond funds ensure significantly higher returns compared to other debt instruments in the market. Average yields of 8-10 percent can be expected from corporate debt instruments, while government-held bonds only provide approximately half of it.
It provides high liquidity as investors can obtain and sell corporate bond mutual funds as and when the need arises.
Like debt mutual funds, corporate bond funds are taxable at the individual’s income tax slab rates for the investments held for less than three years. Otherwise, they are taxable at 20% with indexation benefits.
Things to Remember before Investing
Risk factors and returns
Corporate bond funds put money in corporate debt papers and have a significant credit risk. They usually have higher maturity and hence are subject to interest rate risks. Companies can fail to make their payments, resulting in a loss for investors. If the fund manager invests in all high rated securities, the risk is considerably less.
The corporate bond funds have a higher default risk since the probability of the company defaulting the payments is relatively high. Even if the ratings are high, there is no guarantee that a company wouldn’t default its payments.
Interest rate risk
These funds are long term investment options. Therefore, interest rates are subject to change, which will impact coupon payments and returns.
These long-duration investments are subject to market volatility due to fluctuations in the interest rates. In other words, bond prices and coupon payments can be affected by dynamic interest rates.
However, investing in these funds requires some knowledge of corporate bonds. A typical investor might find it challenging to understand the bond market and the potential risks. Therefore talk to your advisor.
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