August 15, 2022

Corporate Bond Funds : Risks, Returns and Suitability

It is important to know that mutual funds don’t invest only in equities as well as debt-related instruments. Investors must select only mutual funds that match with their risk-response profile. This article gives information about corporate bond funds, a category of debt fund schemes Williams RIO Mortgages.

Corporate Bond Fund Debt

Any company can issue corporate bonds. They are known as Non-Convertible Debentures (NCDs). Firms and organizations need funds to fund their business operations as well as potential expansions and opportunities for growth. To do this, businesses have two options: either through equity or debt instruments. The debt option is more secure because it doesn’t directly affect shareholders of the company directly. Therefore, the majority of companies opt for making loans to raise capital for their operations. According to their needs, banks can be costly for businesses. This is the reason why bonds or debentures offer companies an economical alternative to raise funds. Corporate bonds are the primary portfolios of credit opportunities for debt funds. When you purchase bonds, the business is borrowing money from you. The company will pay back the principal after the maturity time specified on the agreement. While you wait you’ll be receiving interest (fixed income) – known as the coupon. In general, coupon payments in India are paid twice per year.

Who can invest for corporate bonds?

Corporate bonds are a good choice for investors looking to earn an income that is fixed, but with a risk-free option. Corporate bonds are considered to be a lower risk investment choice when compared with loans as they offer capital protection. However, these bonds are not entirely safe. If you choose to use Corporate bond funds which invest in top-quality debt instruments, it could help meet your financial objectives better. The long-term debt funds tend to be more risky in the event that interest rates increase beyond expectations. In the end, corporate bond funds invest in scrips to counter volatility. They typically follow an investment period of one year to four years. This can be an added benefit if you are invested for up to three years. It might also better tax-efficient if have the highest income tax slab.

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Features & benefits in corporate bond fund


Bonds issued by corporate entities

Corporate bond funds are predominantly in debt securities. They issue debt instruments comprising bonds commercial papers, and structured obligations. All of these components carry distinct risk profiles, and the time of maturity differs.


The bond’s price

Every bond has a price and is a dynamic. It is possible to purchase the same bond at different rates, based on the time you’re looking to purchase. Investors should look into how it varies in comparison to the par value. it will provide information on the price movement.


Par Valuation of bond

It is what the business (bond issuer) will pay you once the bond matures. It’s the principal of the loan. In India corporate bonds, the par value is usually $1,000.


Coupon (interest)

When you purchase an obligation, the firm will pay you interest every month until the time you decide to end the corporate bond or the bond matures. This is referred to as the coupon and is a particular percent that is the amount of par.


The Current Yield

The annual yield you get by selling the bond is called”current yield”. As an example, if coupon rate for a bond with Rs 1,000 par value is 20%, the issuer is paying Rs 200 as annual interest.


Yield to Maturity (YTM)

This is the rate in-house of return for all cash-flows from the bond including the current bond rate and the coupon payments up to maturity , and the principal. More the YTM more, greater your returns , and vice versa.


Tax-efficiency

If you have held the corporate bond funds for less than three years, you are required to contribute short-term capital gains tax (STCG) depending on the tax slab you are in. However, Section 112 of the Indian Income Tax mandates 20% tax on long-term capital gains. This is applicable to those who hold the bonds for more than three years.


Exposure & allocation

Corporate bond funds, at times, do take small exposures to government securities too. But they do so only whenever suitable opportunities in the credit space are in. In the average, corporate bond funds will have approximately 5.22 percentage of allocation to fixed income of sovereigns.

Risk factors & returns

There’s always the possibility of bond issuers defaulting on their obligations. This risk of default is more pronounced for low-rated securities and goes up exponentially with increasing maturities. If your fund manager only invests in highly-rated companies, expect an average return of range of 8 to 10 percent. The risk here is very low. On the other hand, if you invest in a slightly low-rated but managed well, then it can be rewarding. In particular, firms tend to provide slightly higher coupon rates to attract investors. However, there’s an opportunity an investment manager’s call on a company going wrong. If a company fails to pay interest or principal repayment , or gets further downgraded, it’s a setback for investors.

How do corporate bonds make returns?

There’s a market for bonds where bonds of various types are traded. On this marketplace, the prices of bonds vary and can either rise or fall, as they do in the stock market. For example when a mutual fund purchases bonds, and their value then increases. In the end, it could earn more money over and above the amount it earned through interest income on its own. However, it could also go the other way.

Funds for corporate bonds of various types

Broadly, there are two types of corporate bond funds.

  • Type OneType one bonds for corporate purposes invest in highly rated companies – private sector (PSU) banks and companies.
  • Type 2:Type two bonds for corporate purposes have a lower rating and are used to invest in companies like ‘AA- or below. Let’s go through a quick example to help us understand this. Consider the CRISIL “A” rated bond with a 1-year residual maturity is a 0.56 percent chance of default and an CRISIL “A” graded bond that has a 3-year residual maturity has an 4.79 percent chance of defaulting. Typically, corporate bond funds are able to allocate at least half their portfolios to bonds with an AA rank or lower. So, there’s always the chance of one or the other bond in the portfolio going into default that could lead to a decline of the return on investment.

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