Corporate Bond Funds: Basics, Benefits & More

Apart from equities, Mutual Funds invest in debt instruments. Debt instruments are classified as tools used by an individual, government, or business entity to obtain capital. Debt instruments provide capital, however, only to entities who can repay the same over time. Corporate Bonds are debt instruments issued by corporations who need funding for their business. 

A Corporate Bond Fund is defined as a fund that invests more than 80% of its corpus in high-rated Corporate Bonds, usually with a rating of AA and above.

What are Corporate Bond Debt Funds

Debt funds that invest in bonds issued by companies or corporations are defined as Corporate Bond Debt Funds. The premise of a Corporate Bond is that any company can issue them. They are also known as Non-Convertible Debentures or NCDs. Why would a company choose to issue a bond? 

For the functioning of a company, it needs funds. Funds are required not just for daily operations but also for expansion and growth. While some companies are cash-rich, some are not. These companies who need funds can borrow the required amount. 

There are two ways to achieve this. This is through debt and equity instruments. If the company chooses equity instruments, they will need to part ways with a portion of the shares of the company. A considerably safer option is to issue debt instruments. Bank loans are also an option. 

An alternative to raise funds is issuing bonds or debentures. 

When you ask what a Corporate Bond Fund is, the answer is simple. These are mutual funds that primarily invest in debt instruments such as bonds or NCDs issued by various corporations. 

Features of Corporate Bond Funds 

1. Components: Debt papers including bonds, debentures, structured obligations, and commercial papers are the components of Corporate Bonds. Each instrument has its maturity date and its own credit risk attached to them. 
2. Credit Rating: Corporate Bonds Funds usually invest in high rated securities, usually those with AA and above rating.
3. Bond Price: Corporate Bond Funds have dynamic pricing. There is always a possibility that you can buy the same bond at two different prices. This depends on the time you choose to buy. 
4. Par Value of the bond: The principal amount that the company pays when the bond matures is defined as the par value of the bond.  Corporates typically have a Par value of Rs 1000. 
5. Interest: The interest or the coupon value is a certain percentage of the par value. The company pays regular interest to you, till the Corporate Bond Fund matures or you choose to exit the bond. 
6. Current Yield: The returns that you gain annually from the bond are defined as current yield. It is the interest amount that you get from the par value. 
7. Yield to Maturity: The rate of returns on the cash flow, current bond price, and the interest payments until you exit the bond or its maturity is demarcated as yield to maturity. Your returns are higher when the yield to maturity is high and vice versa. 
8. Corporate Bond Fund Taxation: The gains received from investments in Corporate Bond Funds are liable for taxation. When a Corporate Bond Fund is exited before the end of 3 years from the date of issue, the gains are liable for short-term capital gain tax which are taxed as per the investors income tax slab. Profits or returns generated after exiting post 3 years of issue will attract long term capital gain tax of 20% with indexation benefits.
   

Benefits of Corporate Bond Funds

Before you invest in corporate bonds, there are certain benefits you should know about

1. Returns: When you try to do a comparison between Corporate Bond Funds and other bonds available, you will notice that the returns are significantly higher on Corporate Bond Funds. Investors can look for an average 6-8% returns on Corporate Bond Funds.
2. Liquidity: Businesses issue Corporate Bond Funds to fulfill short-term financial needs. This means the tenure of these bonds is also short-term. Corporate bonds can also be sold as per the investors’ wishes. He does not always need to wait for the maturity of the bond. This provides high liquidity, allowing investors to sell and convert the same into cash when the need arises. 
3. Security: As compared to equity instruments, Corporate Bond Funds have less risk associated with them. Equity instruments are risky as they are subject to the company’s performance and the profits and losses generated by them in a financial year. Corporate Bond Funds are an obligation to the company and are less risky than equity instruments particularly due to the high rating of paper quality which is included in the portfolio. 
4. Diversity: Corporate Bond Funds have tenures. You can invest in Corporate Bond Funds based on your financial goal. Apart from short-term, medium-term and long-term bonds you can also invest in perpetual bonds. 
5. Investing: Identifying top corporate bonds funds can be done based on credit ratings.  As an investor, if you are looking to invest in Corporate Bond Funds, consider the ratings and then choose the tenure.

Who Should Invest in Corporate Bonds

As an investment tool, Corporate Bond Funds are a relatively safe option for risk-averse investors. Investors can look for capital protection along with a fixed income source with Corporate Bond Funds. 

As Corporate Bond Funds carry high credit risk, they also tend to offer good returns. While investing, your fund manager would ideally look for funds with high credit ratings as there is a lesser chance of defaulting on them. 

Things to Remember Before Investing in Corporate Bond Funds

There are a few things you will need to keep in mind before investing: 

1. Think of Corporate Bond Funds as long-term investments as corporate bonds invest in debentures and bonds for their tenure. 
2. One thing you need to remember before investing is that you will need to have basic market knowledge. Not every investor would be able to understand how the corporate bond market works. As an investor, seek advice from a professional who understands how Corporate Bond Funds work.
3. Analyzing historical data is a good way to know how an investment works. However , there is no sure guarantee that the Corporate Bond Funds will be able to provide similar or high returns in the future. 
4. As an investor, try to invest in Corporate Bond Funds offered by top asset management companies. If you are new in this segment, try to choose Corporate Bond Funds that are high-rated with minimal credit risk 

Frequently Asked Questions (FAQs)

1. What is Meant by a Corporate Bond Fund?

To meet certain short-term financial needs, companies are known to issue debt papers. Debt funds that invest in these debt papers are known as Corporate Bond Funds.

2. Are Corporate Bonds Good Investments?

Corporate Bond Funds can be a good investment option for investors who wish to invest in instruments that are low-risk and can provide better returns.

3. Do Corporate Bond Funds have an Exit Load?

The percentage of the exit load on Corporate Bond Funds depends mainly on when the investor exits the fund. The exit load on some funds is 1% if redeemed in a year, however, this can vary from scheme to scheme.

4. Is there any Lock-in Period for Corporate Bond Funds?

There is no defined lock-in period when it comes to investing in Corporate Bond Funds. Your investment tenure would be as per your financial goal. Your interest payout also depends on your tenure of investment.

5. How do you Value a Corporate Bond?

To calculate the value of Corporate Bond Fund, you will need the sum of the bond’s future value along with the interest payout received annually, the bond’s principal which is returned at maturity, discounted at the market interest rate.