Corporate bond funds: A mix of risks and returns.
Investors in debt funds have been worried in the past few years, considering the uncertainty in the market. Investors want to allocate their money in schemes which have less volatility and provides decent gains. Banking bond schemes and Public Sector Undertaking Bonds (PSU Bonds) schemes are the preferred sectors by the debt fund investors. Nonetheless, corporate bond funds can also be worth investing. As of April 2020, corporate bond funds approximately have ₹86,000 crore in assets under management.
Mistakes committed while investing:
For more than two decades, debt funds invested in bonds issued by corporations have been in existence. But in the long run while chasing for high returns, some debt funds are invested in the instruments which have low credit rating and did not perform well over a period of time. In fact, a small part of the portfolio invested in such securities which really has a good strategy. However, a credit risk overload in the portfolio will harm if the underlying bonds fail to repay interest or principal.
Corporate bond funds:
As part of its reclassification exercise, the Securities Exchange Board of India (SEBI) tightened the concept of debt fund categories. Thus, corporate bond funds have been separately developed as a group. They are a more secure group of debt funds. Most schemes are open-ended and invest primarily in highly rated corporate bonds like AA+ and contributes almost 80% in the portfolio of investors. Looking at Corporate bond funds as a category, these type of funds fetched 8.8% return in the timeline of one year.
Corporate bond funds vs Public Sector Undertaking Bonds (PSU Bonds) vs Banking bond schemes:
Corporate bond funds, Public Sector Undertaking Bonds (PSU Bonds) and bond schemes issued by banks, all three categories create a safe bunch of investments in debt funds. However, all the three categories are not similar and have their own characteristics. Banking & PSU Debt funds must be invested in the bonds issued by banks and bonds from public sector undertakings (PSUs). Banking & PSU Debt funds may also invest in bonds issued by the banks and public sector undertakings (PSUs) with a lower credit rating.
In case of corporate bond funds, the sector is not restricted but investment in bonds with ratings below AA+ has been strictly limited by the regulator to 20% of the scheme. Obviously, comparatively higher ratings do not mean that returns are guaranteed or credit incidents will not take place. But the probability is very less. In the wake of Covid-19, the country is under lock down and many corporates are suffering due to market failure and poor liquidity. Although, Indian government made various provisions for the revival of economy as well as banking sector.
Reserve bank of India (RBI) made provisions like providing money to banks which further they can lend to corporates. But the truth is, companies which have low credit ratings find it difficult as banks hesitate to lend money to them. Therefore, it is rational for investors to stick to funds invested in top-rated bonds. Corporate bond investments fetch almost more 100 basis points than government bonds compared to returns on top-rated corporate bonds with the same maturity period.
Precautions before investing:
Past returns and performance offer a sense of the scheme’s success. However, search the portfolios for the risks involved. Unless the fund has a paper exposure below AA+, there is an increased risk. The Nippon India Prime Debt Fund, for example, has 5.5% exposure to A rated bonds. On the credit side, some funds can take limited or no risks. However, they may be at risk by investing in long-term government bonds and corporate securities. The L&T triple ace bond fund, for instance, has been updated over a 5.36-year cycle.
While the UTI Corporate Bond Fund has changed over a 3.73-year period as of 31st April, 2020. These funds show strong numbers in the declining interest regime, such as the one we are in, as portfolio bond prices are growing. However, if the tide turns, such schemes may see silent returns unless fund managers properly churn out the portfolio.
Invest in a fairly short-term and high credit quality fund if investors wants to shrink the risk. Capital gains earned from assets held for more than 3 years in corporate bond funds are taxed at 20% after indexation benefits. Then the profits would be added to the income of the investors and taxed at a marginal rate. In a nutshell, it is always better to do your own research before investing into any schemes this will help an investor to get the clear idea about the scheme and also the expected future gains.