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What are Corporate Bond Funds & How to Invest?
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!
Table of Contents
What is a Corporate Bond Fund?
Corporate bond funds are debt funds that invest more than 80% of their total financial resources in the bonds of the 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.
How Do Corporate Bond Funds Work?
When investors purchase bonds, companies 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.
What are the Types of Corporate Bond Funds?
There are primarily two types of corporate bond funds. These are as follows,
- Type One – Funds that only invest in the debt papers of the 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).
Benefits of Corporate Bond Funds
The following are the features and benefits of corporate bond funds.
1. Safe Investment
Corporate bond funds need to invest mostly in high-rated debt instruments. Hence, these types of investment instruments are much safer than other debt fund categories. Here, investors can conduct a credit quality comparison to wholly assess the safety parameters of their investment.
2. 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.
3. Highly Liquid
As corporate bond funds invest in top-rated papers, they offer 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.
4. Stable Performance
Corporate bond funds can ensure more stable returns than other debt categories during adverse market conditions. As per 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 funds (7.35%), Dynamic duration fund (9.66%) and Banking and PSU funds (9.74%).
5. Tax Benefits
Investing in corporate bond funds allows investors to enjoy tax benefits. Here, investors have to hold their investments 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.
How Does Corporate Bond Fund Make Returns?
Who Should Invest in Corporate Bond Funds?
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.
How to Invest in Corporate Bond Funds?
- 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.
What are the Risks Involved in Corporate Bond Funds?
1. Interest Rate Risk
A corporate bond fund investment is a long-term investment instrument. Therefore, changes in interest rates can affect coupon payments, which in turn can impact returns.2. Volatility
The long tenure of a corporate bond fund can make it subject to market volatility, which can affect both coupon payment and returns.Factors to Consider Before Investing in a Corporate Bond Funds
Below are discussed certain factors that investors must consider before investing in a corporate bond fund.
1. 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 prioritizing their future goals. If investors have a long-term investment horizon, then this type of investment instrument can prove beneficial to them.
2. 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.
3. Past Performance of Corporate Bond Funds
Evaluating the past performance of any investment is important before making 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.
4. 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 with a long-term investment horizon.
Disclaimer: The information provided on this website is for general informational purposes only and should not be construed as financial, investment, or legal advice. While we strive to provide accurate and up-to-date content, we do not guarantee the completeness, reliability, or suitability of the information for your specific needs.
We do not promote or endorse any financial product or service mentioned in these articles. Readers are advised to conduct their own research, consult with financial experts, and make informed decisions based on their unique financial circumstances. Any reliance you place on the information provided here is strictly at your own risk.
FAQs about Corporate Bond Funds
What is the par value of a corporate bond fund?
What is the taxation rule for corporate bond fund withholding periods of fewer than 3 years?
What is the current yield of a corporate bond?
What is a corporate bond fund?
Who should invest in corporate bond funds?
Other Important Articles about Mutual Funds
Disclaimer
- This is an informative article provided on 'as is' basis for awareness purpose only and not intended as a professional advice. The content of the article is derived from various open sources across the Internet. Digit Life Insurance is not promoting or recommending any aspect in the article or its correctness. Please verify the information and your requirement before taking any decisions.
- All the figures reflected in the article are for illustrative purposes. The premium for Coverage that one buys depends on various factors including customer requirements, eligibility, age, demography, insurance provider, product, coverage amount, term and other factors
- Tax Benefits, if applicable depend on the Tax Regime opted by the individual and the applicable tax provision. Please consult your Tax consultant before making any decision.
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