Corporate Bond Funds: Know the Important Aspects!

A mutual fund that invests more than 80% of its corporate bonds assets is known as a Corporate Bond fund. Businesses sell them to fund short-term expenses such as working capital, advertising, and insurance premium payments. Since the associated costs are lower than bank loans, corporate bond funds are becoming more popular as a debt instrument for businesses to raise required funds.

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This rating is given to companies with a strong financial position and a high probability of paying creditors on time.

This article is all about corporate Bond Funds and their important aspects. Let’s begin with the features and benefits here.

 Corporate Bond Funds and Salient Features

These bonds come with interesting features, some of them are:

  • Ideal for the money you won't use for at least two years.
  • Funds in this group have a higher rate of return than Bank Fixed Deposits of the same name.
  • Holding them for three years or longer would result in tax-efficient returns due to indexation benefits.

How does Corporate Bond Fund Benefit?

Corporate Bonds are better options as compared to bank FDs. Funds exceeding 3 years term qualify for long-term capital gains tax at the rate of 20%. This makes it a better option as FD returns are taxed at prevailing income tax slabs. Another benefit of these funds are they have higher growth potential than govt. owned bonds. They are less exposed to the inflation and rate of interest increases due to short-term redemption. They are the best options for low-medium, medium and medium-high risk profiles.

Types of Corporate Bond Fund

 Corporate Bonds can be found as

  • Type 1: Funds that only invest in debt securities issued by high-rated companies.
  • Type 2: Funds that want to invest in businesses with a significantly lower credit rating.

Important Components of Corporate Bonds

Corporate bond funds primarily invest in debt securities. Bonds, debentures, commercial papers, and formal obligations are examples of debt papers issued by companies. Each of these components has its own risk profile, as well as the different maturity date. They are:

  • Price of the Bond: Every bond has a price and that price changes over time. You can purchase the same bond at different rates depending on from where you buy it. Investors should look at how it differs from the par value since this will expose market movement.
  • Security: Since the former imposes a contractual obligation (liability) on the corporation, corporate debt funds have a lower risk than bonds. On the other hand, equity investments are subject to a company's gains and losses for a single fiscal year, and therefore are riskier.
  • Volatility: Interest rate movements affect the Corporate Bond Fund's portfolio. The greater the uncertainty, the longer is the residual maturity period. The impact of volatility on debt funds is calculated by the fund's adjusted period. The influence of an interest rate adjustment on the debt fund would be more significant as the fund's period rises and vice versa.

Who Should Invest in Corporate Bonds?

 Corporate Bond Funds are appropriate for investors seeking higher-yielding fixed and daily incomes from a less-risky investment alternative than an equity option. The returns from these funds are typically predictable, but no promises can be made. This is a low-risk investment option that is best for long-term capital appreciation. However, it is not a good investment choice for aggressive investors or risk-takers looking for a higher-than-average rate of return on their money. Corporate Bond Funds are an excellent option for cautious investors with a medium to the long investment horizon.

 How Corporate Bond Fund Works?

 Any corporate debt paper is listed on exchanges and can be traded, just like any equity share. This helps the debt papers be valued fairly in light of the changing economic climate and its credit rating. Corporate Bond Fund purchases tradeable corporate debt papers, with rates fluctuating according to demand for each classified debt paper. Following a Central Bank rate cut, long-term debt funds with a higher coupon rate, for example, would see increased demand, pushing the bond price higher and vice versa. If the Corporate Bond Fund's portfolio contains the same corporate debt document, the fund's NAV will grow as well. It is a premium return in addition to the fixed-interest income from the bond.

*All savings are provided by the insurer as per the IRDAI approved insurance plan. Standard T&C Apply

Risk Factors & Returns under Corporate Bond Fund

 It's always possible that bond issuers would default on their obligations. Low-rated securities have a higher default risk, which increases exponentially with maturities. Expect an average return in the range of 8% to 10% if your investment manager only invests in highly-rated businesses. The risk is also small in this case. Investment in a slightly lower-rated but well-managed fund, on the other hand, maybe rewarding. For example, in order to attract investors, businesses also offer higher coupon rates. However, there is a risk that the fund manager's prediction about a business would be incorrect. Consequently, if a company fails to make interest or principal payments, or if it is downgraded further, it is a loss for investors.

 Things to Keep in Mind While Investing in Corporate Bonds

 Below are certain things to remember if you are looking for investing in corporate bond funds:

  • It's important to remember that all three variables are usually active at the same time. This is especially true for a corporate bond mutual fund or ETF, where it can be difficult to distinguish the effect of shifts in a single company's underlying financial power.
  • Nonetheless, knowing these three issues will help you gain a greater understanding of the factors that influence success.
  • Bear in mind that a large number of defaults in a fund's portfolio will cause a substantial drop in returns. If you plan to invest in them, don't be swayed by the previous year's results.
  • Stick to the offerings of large AMCs, ideally the top five funds, when it comes to best corporate bond funds. Otherwise, new investors should stick to high-rated short-term investments.

Bottom Line

 The corporate bond investor is worried about possible interest rates and the credit spread if the extra yield is risk-adequate. They hope that interest rates remain stable or, better yet, decrease. They also hope that the credit spread stays the same or narrows slightly, but not too much. Since the credit spread's width affects the price of your bond, make sure you check if it's too narrow—but also make sure you check the credit risk of companies with broad credit spreads.

 

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