What are Corporate Bond
Funds?
Companies need to raise funds to carry out their
operations. While many of us aware of the stock markets, corporate bond market
is another way to raise funds. Corporate bonds are securities
issued by corporates that have a maturity period of over one year.
The various rating agencies grade corporate bonds
based on the creditworthiness of the issuer. AAA rating is the highest rating
assigned to any paper. These high quality papers carry the lowest risk to the
investor.
Corporate Bond fund is a type of debt fund that
invests in highest quality or AAA rated corporate bonds.As per the regulator
SEBI’s guidelines, a corporate bond fund has to invest at least 80% of its
corpus in AAA-rated papers.
How do corporate bond funds work?
As stated earlier, companies issue corporate bonds
to raise funds. Institutional players like mutual funds invest in these papers.
The companies pay interest (coupon) to investors over the tenure. After the
investment tenure is over, the company return the principal invested by the
fund house.
As corporate bond funds invest in many corporate
bonds, the increase in the value of a corporate bond may lead to a proportional
increase in the fund`s value.On the other hand, a fall in the value of a bond
may cause loss.
The value of the corporate bond will depend on
various factors like capital appreciation of the bonds, interest rates and
downgrades of bonds by credit rating agencies, etc.
Things to keep in mind before investing in corporate
bond funds
Investment horizon: Corporate
bond funds invest in corporate bonds that have medium to long-term maturity
period. Hence, it is suitable for investors with an investment horizon of
around one to four years.
Rating: The
risk of the fund depends on the papers selected by the fund manager. Typically,
AAA rated papers are safer than other papers. Corporate Bond Funds have to
invest at least 80% of its portfolio in AAA-rated papers. Hence, it is
considered as a safer investment option than other types of funds that invest
in AA-rated papers.
Returns: Mutual Fund
houses can’t give a fixed rate of return on your investment in corporate bond
funds. It will depend on the market conditions and the quality of the bonds
held in the fund.
Diversity:A corporate bond
fund invests in several corporate bonds. Funds with less exposure to a single
company or group entities are relatively safer than funds with higher
allocation to a single group entity.
Default: Although these
funds invest in top quality corporate bonds, under certain situations, issuers
may not be able to make interest or principal payment on the bonds in due time.
This can cause bond default. A large number of defaults can have adverse impact
on the fund’s performance and your returns.
Size of the fund: Sticking
to a fund with a substantial corpus is less risky than funds with a low corpus.
It is because a higher corpus allows for adequate diversification that can
lower risk.
Who can invest in corporate bond funds?
Investors with an investment horizon of over 1 year
to up to 4 years can invest in corporate bond funds. People looking for an
income source can also invest in these funds.
Corporate bond funds are tax efficient than fixed
deposits. Investors looking to park their money for over three years in a
tax-efficient investment option can also invest in corporate bond funds.
Taxation of the corporate bond funds
Corporate bond fund is a category of debt fund. The
taxation of corporate bond funds is akin to other debt funds.
Depending on the investment period, the realised
gains are taxed as Short Term Capital Gains(STCG) or Long Term Capital
Gains(LTCG). Tax on Short Term Capital Gains applies if you redeem your
mutual funds within three years of investment. The gains are taxed as per your
income tax slab. Long Term Capital Gains applies if the units stayed invested
for more than three years. For debt funds, LTGC is taxed at 20% along with
indexation benefits. Indexation takes into account the increase in inflation
from the time of the investment.
Conclusion:
Corporate bond funds invest in high quality
AAA-rated corporate bonds. It is a safer debt mutual fund option as it invests
80% of its portfolio in top-rated papers. It is suitable for investors with an
investment horizon of nearly three years. It is also a tax-efficient investment
option. Consult your mutual fund distributor or financial advisor before
investing.
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