Corporate Bond Funds : Risks, returns and suitability
It is essential to be aware that mutual funds don’t invest solely in equity, additionally, they invest in bonds. The investors should select mutual funds that fit with their risk profiles. This article provides details about corporate bond funds – a kind of debt fund scheme.
Corporate Bond Debt Funds
Every company is able to issue corporate bonds, which are also called non-convertible debt (NCDs). Organisations or firms need money to finance their daily operation as well for future expansions and opportunities for growth. For this, they can use two methods – the equity and debt instruments. It is safer to use debt because it does not affect the shareholders directly. Hence, most companies prefer the issue of debt instruments to raise funds to run their business. Depending on their needs, banks can be costly for companies. This is where bonds or debt instruments provide businesses with an economical alternative to raise funds. Corporate bond securities form the base portfolios of credit opportunities for debt funds. When you buy a bond, the firm has borrowed money from your. The company will pay back the principal upon the expiration of the time specified on the contract. While you wait, you will receive the dividend (fixed income) called the coupon. In general, coupon payments in India occur twice per year.
Who is the right person to invest in corporate bonds?
Corporate bonds are a fantastic choice for investors looking to earn more stable income with a risk-free option. Corporate bonds are a risk-free investment vehicle when compared to debt funds since they provide capital protection. However, these bonds aren’t 100% secure. If you decide to invest in corporations bond funds, which are invested in high-quality debt instruments, then it can serve your financial goals better. Long-term debt funds typically tend to be more risky as interest rates fluctuate above expectations. Therefore, corporate bond funds make investments in scrips in order to limit the risk of volatility. They typically follow an investment horizon of one two to three years. This could be an added benefit if you remain invested for up to three years. It may also better tax-efficient if belong to the highest tax bracket for income.
Go to: Online mutual fund investment portal
Benefits and features of Corporate Bond Funds
The components of bonds issued by corporations
The corporate bond fund invests predominantly in debt paper. The companies issue debt securities including bonds commercial papers and structured commitments. Each component has specific risk profiles, and the date of maturity differs.
Price of the bond
Every bond comes with a cost, and it is dynamic. You can buy the same bond at different prices according to the time that you choose to buy. Investors should be aware of how it differs from the par value – it will give information about the market movement.
Par Valuation of bond
That is the sum that the organization (bond issuer) pays you when the bond matures. It’s the principal. In India, a corporate bond’s par value is typically at least Rs. 1,000.
Coupon (interest)
When you buy bond, the business will pay out interest in a regular manner until you are out of the corporation bond or when the bond is mature. This interest is called the coupon that is a specific percentage in the value.
Today Yield
The annual amount you earn from the bond are referred to”current yield.. In this case, for instance, if the coupon rate of the bond that has a Rs. 1,000 amount is 20% the issuer is paying Rs 200 as interest per year.
Yield to maturity (YTM)
The in-house rate is the sum of returns of all the cash flows in the bond that is the current price of the bond, the coupon payments until maturity , and the principal. Greater the YTM, higher will be your returns , and vice versa.
Tax-efficiency
If you’ve held the corporate bond funds for less than three years, you will need to pay short-term capital gains tax (STCG) in accordance with your tax bracket. In contrast, Section 112 of the Indian Income Tax mandates 20% tax on long-term capital gains. This applies to people who hold the bonds for more than three years.
Exposure & allocation
Corporate bond funds, occasionally may take small risks to securities issued by government agencies as well. But they do so only when opportunities that are suitable for the credit market are available. In the average corporate bond funds have approximately 5.22 percent allotted to fixed income sovereigns.
Risk factors & returns
There’s always a chance that bond issuers will default on their obligations. This is a greater risk when securities are not rated well and can go in a spiral upwards with the maturities of increasing. If your fund manager only invests in high-rated companies, anticipate an average yield in the range of 8%-10 percent. In this case, the risk is also minimal. However If you invest in a fund that is not rated highly but a well-managed fund, you could reap the rewards. In particular, firms tend to offer somewhat higher coupon rates to attract investors. But, there’s a chance it is the funds manager’s choice on a company going wrong. Hence, if a company falls behind on its interest payments, principal repayments or gets further downgraded, it’s a loss for investors.
How do corporate bonds make returns?
There is a market called a debt market where a range of bonds are traded. It is a market where the prices of bonds may increase or decrease, just as they do on market for stocks. For example the mutual fund purchases bonds, and their price then rises. It then makes more money than the amount it earned from the interest earnings by itself. However, it could take the opposite route.
Funds for corporate bonds of various types
Broadlyspeaking, there are two types of corporate bond funds.
- Type one:Type one bonds for corporate purposes can be used to invest in high-rated firms – private sector (PSU) banks and companies.
- Type two:Type Two corporate bonds invest in slightly lower rated businesses like ‘AA- or below. Let’s look at a straightforward example for understanding this. If we consider an CRISIL “A” rated bond with a 1 year residual maturity has a 0.56 percent chance of default and the CRISIL “A” rating bond with a residual of 3 years maturity has an 4.79 percent chance of defaulting. Most corporate bond funds will allocate most of their portfolios to bonds with an AA rank or lower. There is always the possibility of one or other bond in the portfolio going into default that could lead to a decline of the return on investment.
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