Corporate Bond Mutual Funds

What Are Corporate Bond Mutual Funds?

Corporate bonds are debt instruments issued to raise capital by corporates. Also known as Non-Convertible Debentures (NCDs), corporate bonds fund the growth and expansion of corporates. Both public and private companies raise them as an alternative to bank loans.

However, choosing the right bond can be daunting for retail investors who lack sufficient skill and knowledge of the market. In such cases, they can opt for corporate bond funds.

Corporate bond funds are debt fund schemes that invest predominantly in corporate bonds or NCDs. SEBI mandates these funds to invest at least 80% of their corpus in high-rated corporate bonds. Investment in high-quality instruments relatively lowers their credit risk compared to other debt funds schemes.

Types Of Corporate Bond Funds

Corporate bond funds are typically categorized into two types:

● Type one: Funds that only prefer investing in debt papers of top-tier companies such as banks and other PSU companies.

● Type two: Funds that prefer investing in a bit low-rated companies, typically AA- or less.

Who Should Invest In Corporate Bond Mutual Funds?

Top corporate bond funds are ideal for investors who want regular, fixed revenue at higher levels from avenues with less risk.

You can usually predict the returns from these types of funds. However, assured returns aren’t guaranteed by such funds.

This type of investment involves minimal risk and is an ideal choice for individuals seeking capital appreciation over the long haul.

Nevertheless, if you’re a risk-taker or an aggressive investor looking after an above-average return rate from investments, you should avoid investing in these funds.

Conservative investors who intend to invest for a medium to long term can always choose to invest in corporate bond funds.

Features of Corporate Bond Mutual Funds

Below are some of the features of corporate bond funds.

Corpus Allocation

A Corporate Bond Fund allocates 80% of its corpus for high-rated corporate bonds. The remaining 20 % is invested in other debts and money market instruments, including REITs. However, managers can also invest in safer government securities to maintain an optimum risk profile.

Bond Price

Bond prices are dynamic and affected by interest rates movements in the market. The prices fall as the interest rate rises and rise as the interest rates fall. This is because of the negative correlation between bond price and interest rates. Comparing the bond’s market price with its par value will give one an understanding of market movements.

Maturity

There is no fixed portfolio duration for corporate bond funds. The optimal duration depends on the future outlook of the market. For example, longer maturity can be beneficial when interest rates are falling. On the other hand, it’s best to keep a lower duration when interest rates are expected to rise.

Taxability of Corporate Bond Funds

The corporate bond funds returns are taxed at the time of receipt of dividends or redemption of the scheme. Dividend income is taxed at the regular slab rate applicable to the investor. Additionally, the mutual fund will deduct a TDS of 10% on dividend income if the total dividend paid to the investor in a year exceeds Rs 5000.

On redemption of the scheme, the investor is taxed as follows:

For Units Sold Within 3 Years

Investors need to pay short-term capital gain tax as per their applicable slab rate.

For Units Sold After 3 Years

Investors can enjoy the benefit of long-term capital gain at 20%. In addition, they also get the indexation benefit which considerably reduces their tax obligation. This makes the best corporate bond funds an excellent alternative to FD and other small saving schemes. FD returns are taxed as per the income tax slab. 

Risk Involved With Corporate Bond Funds

Though the high-rated papers keep corporate bonds comparatively safe on default risk, they are exposed to interest rate and market risks similar to other debt funds. Below is a brief account of the risks corporate bonds are subject to.

Default Risk

Although credit risk is lower in corporate bond funds, there is no guarantee that a company won’t default on its payment. Credit defaults can permanently reduce the fund’s Net Asset Value (NAV). A certain degree of default risk always exists in corporate bond funds. The risk can be mitigated to some extent by investing in high-rated debt funds.

Interest Rate Risk

Corporate bond funds are long-term investment instruments. They are susceptible to interest rate changes in the market. Adverse interest rate movement in the market can reduce their NAV. The interest rate risk is higher in schemes with longer maturities. To compensate for the higher risk, long-duration bond funds also offer higher returns to investors.

Market Risk

All mutual fund schemes are subject to market risk. There is no assurance of capital safety or a guaranteed return. The wrong estimate of fund managers can lead to a loss in investment. It is essential to seek experienced and trusted managers.

Advantage of Corporate Bond Funds

High on Safety

As 80% of the exposure of corporate bond funds is in top rated debt securities, mostly AAA and AA rated. Hence they carry inherently lower credit risk.

Higher Liquidity

Being high on AAA-rated securities boosts the liquidity of corporate bond funds. Moreover, they are highly traded in the secondary market. Thus a person can easily convert the corporate bond mutual fund into cash when needed. Besides, a considerably large portion of their portfolio is short-term liquid securities. This appropriately insulates the investors from liquidity risks.

Steady Returns

Even during market upheavals, corporate bond funds have proved themselves with steady returns. The performance of corporate bond funds in most periods has topped the performance of banking and PSU debt funds. Their average yield is 7% to 10%, nearly double that government bonds provide.

Tax Benefits

Debt mutual fund schemes offer a considerable tax advantage over traditional investment schemes such as FDs. After allowing indexation benefits, long-term investors (3 years and more) are taxed at only 20%.

How Do Corporate Bonds Make Returns?

Corporate bond funds usually function similarly to any other mutual fund in the stock market.

A boost or surge in the corporate bond value in the mutual fund portfolio results in a growth in the NAV of the fund, hence releasing profits.

Meanwhile, a decline in the value of NAV has a contrasting impact on the mutual fund’s aggregate value.

How To Invest In A Corporate Bond Mutual Fund Using The 5paisa App?

Investing in corporate bond funds via the 5paisa app is simple and convenient. Here are the steps on how to proceed:

● Register yourself on the 5paisa app. If you’re already a user, simply log in.
● Search for the Mutual Funds section via the search bar.
● Select the Corporate Bond Fund option and tap on the invest button.
● Select the mode of investment: lump sum or SIP.
● Fill in the KYC details, and you’re done!

 

Invest Now