Corporate bonds are debt securities that companies issue to raise money. Bonds are subject to interest-rate risk or market risk. They tend to rise in value with the fall of interest rates and vice versa.
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Corporate bond funds are open ended debt funds that invest at least 80% of their assets in the highest rated corporate bonds. Corporate bond funds use credit opportunities of the corporate debt papers to earn returns. These funds are subject to interest rate risk due to their long durations. Hence making them exposed to market volatility. The underlying securities of corporate bond funds can be both high rated and low rated securities. Therefore, the credit quality for these funds can be low, and they can have significant credit risk.
Fund Name | Return Since Inception | Epense Ratio |
SBI Corporate Bond Fund (G) | 6.70% | 0.79% |
HDFC Corporate Bond fund (G) | 8.20% | 0.61% |
Aditya Birla Sun Life Corporate Bond Fund (G) | 9.00% | 0.46% |
ICICI Prudential Corporate Bond Fund (G) | 6.90% | 0.58% |
Kotak Corporate Bond Standard Plan (G) | 7.70% | 0.66% |
Corporate bond schemes are a type of debt securityies. These are the types of bonds that companies’ issue. Corporate bonds are also known as Non-Convertible Debentures (NCDs). Firms or companies raise capital for their operations, growth opportunities and future expansion. They either raise capital through debt or equity. A debt issue will not dilute any shareholding pattern and hence is most preferred by companies. Both public and private companies issue corporate bonds.
Bank loans are not always cheap and can become an expensive affair. Therefore, companies issue debentures or bonds to raise funds which is an economical alternative. Also, sometimes the company pledges its physical assets as collateral.
When one buys corporate bond security, it means that the company is borrowing money from them. Therefore, the company will repay the principal upon maturity. Also, the company pays interest on the borrowing; this is known as the coupon. Mostly, the coupon payments are made twice in a year.
Corporate bond fund category is one of the largest categories within the debt segment (9% of total debt fund’s assets). Corporate bonds are mandated to invest at least 80% of their total assets in the highest rated securities.
Also, corporate bond funds have a significant credit risk. Companies can default their payments, resulting in a loss for an investor. Often the potential incremental return may not justify the higher credit risk and higher interest rate risk.
The taxation of corporate bond funds is similar to other debt funds. Short term capital gains (investments redeemed within three years) are taxable as per the individual’s income tax slab rate. At the same time, long term capital gains (investments redeemed after three years) are taxable at 20% with indexation benefit.
For example, there are two bonds with different maturities. Bond X is a one-year residual maturity bond with a CRISIL ‘A’ rating and 0.60% chance of default. Bond Y is a three-year residual maturity bond with a CRISIL ‘A’ rating and 5.00% chance of default. Corporate bond funds’ portfolio manager invests the majority of the assets in the highest rated securities. However, there is a significant default risk with the other low rated securities. Therefore, this results in lower portfolio returns.
This category is one of the largest categories within the Debt Segment (9% of total debt fund assets). Though the funds have predictable returns, they do not guarantee returns. These funds tend to have higher duration exposing them to interest rate movements and market volatility. Since the funds tend to have higher duration, their returns are highly dependent on interest rates. Also, the credit quality of funds in this category is relatively poor.
“Scripbox does not recommend funds in this category. We believe that the potential incremental return is not justified by the higher credit risk and higher interest rate risk.”
Corporate bond funds are suitable for investors seeking fixed and regular income from their investments. The returns from these funds are predictable. However, there is no guarantee of the same. Corporate bond funds do not guarantee returns. Though they are low-risk investments, the returns from them do not justify the risk. The corporate bond funds that do not invest in high rated securities are exposed to credit risk. Additionally, these funds are subject to interest rate fluctuations as they have long modified durations.
Investors seeking low risk investments for low returns can look at investing in corporate bond funds. However, these funds do not guarantee returns. If an investor is willing to invest in these funds, the ideal investment horizon for these funds is 3-5 years.
Corporate bond funds invest in corporate bonds or debt securities issued by different organisations. Companies raise money either through equity or debentures. Corporate bond funds earn a return through interest income and capital gains. Similar to equity securities, debt securities also trade in the debt market. When a mutual fund buys a bond, and the price of the bond goes up, the fund gains through capital appreciation.
Corporate bond funds usually invest in AAA and AA-rated bonds. And the returns from these funds are quite predictable. However, they are exposed to interest rate risk and default risk. If the fund’s portfolio is majorly invested in AAA-rated securities, then the default risk is minimum. Hence investors who expect stable returns at low risk can invest in corporate bond funds.