As businesses grow and take on new projects, they often need more funds than they currently have. To get these funds, they can either borrow money or sell shares.
Most companies choose to borrow money because it doesn't dilute their shareholders' ownership percentage. One way they can do this is by issuing bonds, which create something calledCorporate Bond Funds.
These funds are a popular choice for investors because they offer both stability and the potential for good returns.
But what exactly are they? How do they work? And are they a wise investment for you? This article will answer all your questions and give you a solid understanding of Corporate Bond Funds.
What are Corporate Bond Funds?
Corporate Bond Funds are mutual funds primarily investing in high-quality corporate bonds (at least 80 per cent of their total fund value).
These bonds are debt instruments issued by companies to raise capital from the public. When a company issues a corporate bond, it's essentially borrowing money from the investors with a promise to pay it back later, known as the maturity date.
Now, there are two types of corporate bonds: secured and unsecured. The company's assets-backed bonds are secured, so if the company can't repay the bond, the fund house has to sell assets to pay back the investors.
On the other hand, unsecured bonds don't have any assets backing them up, so they're riskier. But, to make up for the risk, they offer higher interest rates.
Credit rating agencies give bond ratings to help investors decide which bonds are safe to invest in. These ratings indicate the risk level associated with the bond and give investors an idea of whether or not they should invest, i.e. the higher the rating, the lower the risk, and vice versa.
How do Corporate Bond Funds work?
When you invest in a Corporate Bond Fund, your money is pooled with that of other investors and used to purchase a diversified portfolio of corporate bonds. The fund manager, a professional with expertise in bond markets, selects the bonds based on their credit ratings, interest rates, and maturity profiles.
The returns from a Corporate Bond Fund come from two primary sources. The first is the interest income from the bonds in the fund's portfolio. This income is distributed to the fund's investors as dividends.
The second source of returns is capital appreciation. If the market price of a bond in the fund's portfolio increases, the fund can sell the bond for a profit. This profit is reflected in the fund's net asset value (NAV), which increases the value of your investment.
Types of Corporate Bond Funds
Corporate Bond Funds can be broadly categorized into two types based on the credit quality of the bonds they invest in:
Low-Yield Corporate Bond Funds (Type 1):
These funds invest primarily in bonds issued by debt papers of high-rated companies - PSU companies and Banks. These companies are considered to have a low risk of defaulting on their debt payments. As a result, the bonds they issue offer lower interest rates. However, they provide more stability and are less likely to be affected by economic downturns.
High-Yield Corporate Bond Funds (Type 2):
These funds invest in bonds issued by companies with slightly lower-rated companies, usually "AA-" and below. These companies have a higher risk of defaulting on their debt payments. The bonds they issue offer higher interest rates to compensate for this risk. While these funds have the potential for higher returns, they also carry a higher risk.
Who should invest in Corporate Bond Funds?
Corporate Bond Funds can be a suitable investment for individuals looking for higher returns than government securities but are willing to take on a bit more risk. They can be a good fit for a variety of investors like:
1.Investors looking for a regular income from their investments can consider Corporate Bond Funds. These funds pay out regular interest income (coupons) to the investors, providing a steady income stream.
2.Corporate Bond Funds are ideal for investors with low to moderate risk tolerance. While these funds carry some risk (primarily credit and interest rate risk), they are generally considered less risky thanequity funds.
3.Apart from regular income, Corporate Bond Funds also have the potential for capital appreciation. If the market interest rates fall, the price of the existing bonds (with a higher coupon rate) can increase, leading to capital appreciation, which is different and an add-on on the interest investors get on fixed periods.
Factors to consider before investing in Corporate Bond Funds in India
Before you decide to invest in Corporate Bond Funds, it's crucial to consider several factors to ensure that the investment aligns with your financial goals and risk tolerance. Here are some key factors to consider:
Risks
Investing in Corporate Bond Funds comes with risks like credit, interest rate, and liquidity risks. Credit risk means the company may be unable to pay you back. Interest rate risk happens when changes in interest rates affect the bond's value. Liquidity risk is when you have trouble selling your bond quickly, which can hurt its price.
Returns
Corporate Bond Funds typically offer higher returns than government bonds due to the higher risk associated with corporate bonds. However, the returns can vary based on the creditworthiness of the issuing company and the current interest rate environment.
Yield to Maturity (YTM) & Current Yield
The Yield to Maturity (YTM) of a bond refers to the total return you receive when you hold onto it until it reaches maturity. This amount includes interest payments and any capital gain or loss that might occur over time. YTM is expressed as an annual percentage rate; the higher the rate, the greater the returns you can expect. On the other hand, the current yield of a bond is the annual income in the form of interest that you receive, divided by the bond's current market price.
Exposure & Allocation
When managing your investment risk, it's a good idea to look at the different sectors and companies your fund is putting money into. A diverse portfolio can help minimize risk. It's also essential to check out the mix of bonds in the fund – things like the credit rating and how long they'll be held. Most of the fund's value (80 per cent or more) is invested in bonds from reliable companies, while the rest (around 20 per cent) is in government securities that are pretty much a sure thing.
Volatility
Changes in interest rates impact the Corporate Bond Fund's portfolio. This impact is more significant for longer residual maturity durations, and increasing volatility. The modified duration of the fund determines the extent of this volatility. The longer the time, the more significant the effect of an interest rate change on thedebt fund, and vice versa.
Bond Price
The value of a bond can vary depending on various factors, such as interest rate changes, the issuer's creditworthiness, and market conditions like supply and demand. If interest rates decrease, bond prices increase because they become more attractive to investors compared to other securities with lower interest rates set by the central bank.
Taxation of Corporate Bond Funds
Corporate Bond Funds in India are taxed just like any other debt instrument. This means that all gains are taxed based on your income slab, and you will be taxed accordingly.
Conclusion
Adding Corporate Bond Funds to your investment portfolio can be beneficial as they offer the potential for higher returns compared to government bonds and still provide a regular income stream.
However, it's crucial to understand the risks involved and consider various factors before investing, just like with any other investment. Ensure that your investments align with your financial goals, risk tolerance, and investment horizon.
Corporate Bond Funds: Frequently Asked Questions (FAQs)
1.What are Corporate Bond Funds?
Mutual funds that mainly invest in corporate bonds are called Corporate Bond Funds. Companies issue these bonds to raise capital for funding operations or financing growth strategies.
2.Who should invest in Corporate Bond Funds?
Investors willing to take on a moderate level of risk and seek higher returns than government bonds may find Corporate Bond Funds a suitable option. Additionally, these funds can provide regular income, making them a good choice for investors seeking such benefits.
3.What are the risks associated with Corporate Bond Funds?
Corporate Bond Funds carry three main risks: credit, interest rate, and liquidity. Credit risk is the possibility that the bond issuer may default on its payment obligations. Interest rate risk refers to the risk that changes in interest rates will harm the bond price. Liquidity risk refers to the possibility that you may only be able to sell your bond quickly without affecting its price.
4.How long should I remain invested in Corporate Bond Funds?
Corporate Bond Funds are best suited for medium to long-term investment horizons, but the specific duration should be determined based on your financial goals and risk tolerance.
5.What does a Corporate Bond Mutual Fund invest in?
A Corporate Bond Mutual Fund mainly invests in corporate bonds, essentially debt instruments companies issue to obtain funds. This fund may also allocate a smaller portion of its assets to other bond or money market instruments.
6.Are Corporate Bond Funds safe?
Compared to equity funds, Corporate Bond Funds are typically perceived as less risky because of their structure. Nonetheless, they come with credit, interest rate, and liquidity risks. It's crucial to have a good comprehension of these risks before investing any money.
(This article is part of IndiaDotCom Pvt Ltd’s Consumer Connect Initiative, a paid publication programme. IDPL claims no editorial involvement and assumes no responsibility, liability or claims for any errors or omissions in the content of the article. The IDPL Editorial team is not responsible for this content.)
