- Date : 16/09/2021
- Read: 5 mins
A complete overview of everything you need to know about corporate debt funds. Here’s a must-read guide that will allow you to make an informed decision.
It is well-known that corporate houses and business organisations need a constant supply of funds. Did you think they always take bank loans for funding their operations? The short answer is no. For meeting working capital requirements, marketing costs, or other such small to medium expenses, a corporate bond fund is what most business firms opt for.
So, what is a corporate bond fund? Are all mutual funds equity funds? In this article, you can find the answers to all your queries related to corporate bond funds.
What is a corporate bond fund?
To understand what corporate bond funds are, you will need to understand corporate bonds in the first place. A corporate bond is a financial instrument issued by corporate houses to raise funds. This is a debt instrument against which the investor gets interest on the amount lent to the borrower. When the bond matures, the principal amount is returned.
A corporate bond fund is a fund that invests most of its assets in such corporate bonds. They are becoming popular due to regular income benefits and lower risk profiles. They can be segregated into two types:
- Top-rated corporate bond funds: These funds invest in corporate bonds of companies rated at the top by CRISIL. E.g. Navaratna companies, other public sector companies.
- Low-rated corporate bond funds: These funds invest in corporates having slightly lower rating. The risk factor here is higher. The risk lies in defaulting payments of interest and principal.
Features of corporate bond funds
- Components: The corporate bond funds predominantly invest in corporate bonds. It can also invest in other debt instruments issued by corporates like debentures, commercial papers, and other structured obligations. All these instruments are debt instruments paying a particular interest (fixed income) and carry a somewhat similar risk profile. All of them have maturity dates.
- Price: The price of the bond keeps changing as per the market interest rate. Interest rate and bond price have an inverse relationship. When the interest rate in the market is high, the bond price falls, and vice versa. Interest rate in the market refers to the interest rate on fixed deposits and other government schemes. As corporate bonds pay a fixed interest (decided when the bond is issued), if the market interest rate increases, generally the investors would dump the bonds and go for higher interest-paying instruments.
- Par value of bond: Every bond has a par value which is the face value of the bond. This is the amount the business house has promised to pay the bondholder on the maturity of the bond. The price of the bond and its par value are different. Price is what the bond is trading at the market while par value is the amount the company promises to pay on maturity of the bond. In simple words, it is the principal amount of loan provided by the lender to the corporate house.
- Interest or coupon: The corporate house has to pay a coupon to the bondholder at regular intervals till the bond matures or the bondholder sells the bond. The interest rate or coupon is fixed while buying the bond.
- Current yield: The coupon is paid at the current yield of the bond, also known as the interest or coupon rate. The current yield is the annual return from a bond. For instance, if it is fixed at 15% on a bond of par value Rs 1000, the yearly interest would be Rs 150.
- Yield to Maturity: YTM is the rate
of return of all the income generated by the bond. It includes all coupon payments till maturity, the current price of the bond, and the principal amount.
- Liquidity: Corporate bonds are used for meeting short-term fund requirements and thus the fund stays rolling. These funds are liquid and readily saleable in the market.
- Tax element: Returns from a corporate bond fund are taxable as per capital gains tax. Short-term capital gains tax would be applicable if the bond is held for less than three years, and long-term capital gains tax if it’s held for more than three years.
Who should invest in this fund?
If you are looking for a relatively safe investment option that can provide you with regular income, you can choose corporate bond funds. Though the risk factor is not zero, it is lower than that of equity funds. People with short-term investment goals can invest in these bond funds too. Investors in the high income tax bracket is another segment that can benefit from corporate bond funds.
Corporate bonds funds generally carry lower risk compared to equity funds and hybrid funds. However, they can be volatile due to interest rate fluctuation in the long term. Moreover, there is a risk of the company defaulting on payments of interest and principal too. So, investing in corporate bond funds can fetch you higher regular returns on a safe horizon. It can be a source of secondary income as well, which you can liquidate anytime.