Just as equity mutual funds are divided into different categories based on its asset type and market capitalization, debt mutual funds are also divided into different categories, based on the risk type and portfolio asset.
Among those, Corporate Bond Funds are one of the most popular investment options in the debt mutual fund category.
In this article, we will find out more about corporate bond funds and some of the best corporate debt funds in India.
Corporate Bond Funds are broadly classified into two different types:
Type One: Funds sticking to invest only in debt papers of high-rated companies - PSU companies and Banks.
Type Two: Funds selecting to invest in slightly lower-rated companies, usually "AA-" and below.
Compared to Type One, the chances of default in Type Two category Corporate Bond Fund are higher, and in the event of such default, it affects the return as well as erodes capital.
For example, CRISIL "A" rated debt paper with 1-year residual maturity has a default chance of 0.56%, whereas a debt paper with the same rating and 3-year residual maturity has a default chance of 4.79%.
The following are some unique features of Corporate Bond Funds:
Corporate Bond Fund invest in various debt papers issued by companies including non-convertible debentures, commercial papers and structured obligation. Each debt paper has its own risk profile and maturity period which affects the overall value.
The prices of bonds change from time to time, depending on the residual maturity period and interest rate. The main element that affects the price of the bond is the interest rate scenario of the economy.
For example, bonds with residual maturity of less than 1 year will have minimal effect on its value due to a change in the interest rate. Whereas, longer the residual maturity period, greater would be the price variation observed during bank interest rate changes. If the central bank reduces the interest rate on deposits, then the prices of bonds with higher coupon rates will increase due to greater demand, and vice versa.
The company that issues the bond pays a fixed interest to the investors throughout its duration. The interest component of a bond is called coupon and is generally a specific percentage of the par value.
The annual return from the bond is called current yield and the total return from the bond held until maturity is called yield-to-maturity (YTM).
YTM is expressed as an annual percentage rate; the greater the rate, the higher the returns.
A Corporate Bond Fund generally maintains an exposure of up to 90% in corporate debt papers and the rest 10% is maintained in a safer options like government securities.
The portfolio of the Corporate Bond Fund is affected by movement in interest rates. The longer the residual maturity duration, greater will be the volatility.
The effect of volatility in debt funds is determined through the modified duration of the fund. The longer the duration of the fund, greater will be the effect of an interest rate change on the debt fund, and vice versa.
The returns of the fund are directly proportional to the risk rating of the fund's portfolio. Funds invested in the highest-rated bonds will have a stable return and will be less volatile to market risks.
Whereas, funds invested in slightly lower-rated bonds can be rewarding, but carry a higher default-risk. The volatility in such funds are higher during troubled economic scenarios and rating adjustments.
If the investment is redeemed within 3 years from the date of purchase, then you have to pay short term capital gains (STCG) tax on the gains, based on your income tax slab.
For an investment period of more than 3 years in debt funds, LTCG of 20% with the benefit of indexation is applicable to the investment.
Every debt paper issued by corporates are listed on exchanges and are trade-able, just like any equity shares. This allows the debt papers to get the fair value as per the evolving economic scenario and credit rating of the company.
Corporate Bond Fund buys corporate debt papers that are trade-able and prices move according to the demand of the particular rated debt paper.
For example, following a cut in interest rates by the central bank, long term debt funds with a higher coupon rate will witness a demand, which will subsequently push the price of the bond higher, and vice versa.
If the same corporate debt paper is in the portfolio of the Corporate Bond Fund, the NAV of the fund will also rise. This is an additional return over and above the fixed interest income from the bond.
Debt papers from slightly lower-rated companies tend to offer a higher coupon rate in order to attract lenders. However, the chances of default are slightly higher and if anything goes wrong like a default in interest payment or credit-rating downgrade, the investment will lose its value.
Corporate Bond Funds are suitable for investors seeking fixed and regular incomes at higher levels from a relatively safer avenue from their investments other than an equity option. The returns from such funds are usually predictable, but there is no guarantee of assured returns.
This is a low-risked type investment option and is best for capital appreciation over a long period of time. However, it is not a suitable investment options for aggressive investors or risk-takers who want an above-average rate of returns from their investment. Corporate Bond Funds are a good fit for conservative investors with a medium to long term investment horizon.
When investing in Corporate Bond Funds, it is always advised to invest in the offering of large AMCs, in order to better manage the risk. Large AMCs are known for sticking to the fund's investment objective, which ensures that the fund's assets are invested in high-rated corporate bond papers, thus reducing the overall risk of default.
Following are the Top 10 Ranked Corporate Bond Mutual Funds.
| Fund Name (Direct Plan) | AUM | Expense Ratio (%) | Modified Duration (yrs) | Returns (%) 1 yr | Returns (%) 2 yr | Returns (%) 3 yr |
|---|---|---|---|---|---|---|
| HDFC Corporate Bond Fund | Rs 13,112 cr | 0.30 | 3.10 | 11.47 | 7.83 | 8.73 |
| Franklin India Corporate Debt Fund | Rs 1,054 cr | 0.32 | 2.94 | 11.23 | 8.68 | 9.29 |
| Kotak Corporate Bond Fund - Standard Plan | Rs 2,757 cr | 0.32 | 1.32 | 10.50 | 8.30 | 9.45 |
| ICICI Prudential Corporate Bond Fund | Rs 9,146 cr | 0.25 | 1.74 | 10.49 | 7.77 | 8.60 |
| Nippon India Prime Debt Fund | Rs 1,120 cr | 0.31 | 1.59 | 8.64 | 7.53 | 8.32 |
| Sundaram Corporate Bond Fund | Rs 718 cr | 0.28 | 3.03 | 13.15 | 7.54 | 9.23 |
| Canara Robeco Corporate Bond Fund | Rs 183 cr | 0.28 | 2.07 | 11.22 | 7.38 | 8.32 |
| IDFC Corporate Bond Fund | Rs 15,835 cr | 0.26 | 0.50 | 9.79 | 7.36 | - |
| Invesco India Corporate Bond Fund | Rs 617 cr | 0.20 | 2.21 | 12.50 | 6.32 | 8.35 |
| L & T Triple Ace Bond Fund | Rs 1,616 cr | 0.34 | 5.71 | 14.31 | 6.90 | 8.44 |
Are corporate bond funds safe?
Compared to equity funds, corporate bond funds are safer due to a structure that allows for predictable returns and reduced risk ratios. However, corporate bonds are not completely safe and the risk of default remains, even in the highest-rated debt papers. Corporate Bond Funds are affected by interest rate risks and credit risks, which affect the total returns of the funds.
The interest rate risk in debt funds can be managed by reducing the duration of the fund. However, a downgrade in credit ratings can wreak havoc on such funds, not only affecting the scheduled interest payment but also eroding the value of the fund.
How do corporate bond funds work?
Corporate Bond Funds, also known as credit opportunity funds, invests significantly in debt papers of the highest rated companies that are tradeable.
The companies pay interest throughout the duration of the bond to the lenders, which comprises a part of returns of the fund. On the other hand, the prices of such bonds move according to the demand of the particular bond category, the current economic scenario (change in interest rate) and changes in the credit-risk rating of the debt paper.
For example, a cut in interest rates by the central bank will bring in a demand for higher coupon rate bonds, which eventually will increase the price of bonds. This results in an increase in the NAV of the fund and makes additional money over and above the interest income. However, it can move the other way round, if there is an increase in interest rates.
What is the best corporate bond fund?
Corporate Bond Funds fall under two categories:
Investing in Type Two fund can yield you higher returns over the long term, but the risk of default is higher (default on interest payment or principal repayment), which can drag the returns of the funds and also erode your capital.
On the other hand, Type One category funds can generate an average return of 8-10%, above which, risks are minimal.
Following are the best 5 corporate bond fund:
How much interest do corporate bonds pay?
Corporate Bonds are generally issued at a par value of Rs. 1,000 at a certain coupon rate, paid at a regular interval of time to the investors of the bond.
Case Scenario:
An issue of a Rs. 1000 bond with a coupon rate of 6% pays Rs. 60 annually as interest payment to the bondholder. However, if there is a cut in interest rates by the central bank, the price of the bond will increase to Rs. 1,080 due to an increased demand. However, the coupon payment still remains the same at Rs 60 per annum. Here, the rate of return from the bond comes out at 5.55%. The yearly coupon rate remains the same during the tenure of the bond, but the rate of return tends to vary with changes in the price of the bond.
Because corporate bonds are riskier when compared to government securities, the coupon payment is generally higher. In India, the coupon rate of corporate bond generally average between 8-10% of the highest rated companies.
