Understanding Corporate Bonds
In the investment hierarchy, corporate bonds are thought of as a relatively conservative and safe investment.
Investors often add bonds to their portfolios to offset riskier investments, such as shares and stocks. Adding more bonds over the years ensures their accumulated capital is protected.
However, compared to government bonds, corporate bonds are considered to carry a higher risk. Hence, the interest rates are always high, even with organisations with top-notch credit ratings.
Types of Corporate Bond Funds
- Type One: These bonds invest in public sector unit companies, banks, and other top-rated organisations.
- Type Two: These bonds invest in organisations with low ratings, such as ‘AA-‘ and below. They allocate at least half their portfolios to lower-rated firms. They are always at risk of lower returns.
- Convertible Bond: These can be exchanged for predefined stocks of the issuing enterprise at the investor’s disposal. These can be converted into stocks if they’re likely to yield better results than bonds.
- Non-convertible Bonds: These cannot be exchanged with the stocks of the issuer. They remain as purchased till their maturity date.
Corporate Bond Ratings
Corporate bonds are rated after analysing the organisation’s financials. Credit rating agencies carry out the assessment.
Rating agencies like CRISIL rate corporate bonds and these ratings range from AAA to Default, wherein AAA is the highest rating indicating a low risk of default. The bonds with an AAA rating are safer and less risky of default. Compared to the bonds with lesser ratings, these bonds are available at lower interest rates.
Features & Benefits of Corporate Bond Funds
- Components of Corporate Bonds: Corporate bond funds predominantly invest in debt papers. Firms issue debt papers, including debentures, bonds, structured obligations and commercial papers. These components carry a unique risk profile, and the maturity date varies.
- Price of the Bond: The price of a corporate bond is dynamic. Investors can purchase the same bond at different prices based on the time they choose to buy. Investors must check how it varies from the par value as this will provide information about the market movement.
- Par Value of the Bond: Par Value is the amount the company or bond issuer pays investors when the bond matures. It is the loan principle. A corporate bond’s par value is Rs. 1,000 in India.
- Coupon (interest): When investors purchase a bond, the firm makes regular interest payments until the investor exists the corporate bond or the bond matures. This interest is known as the coupon, a percentage of the par value.
- Current Yield: The current yield is the annual returns made from the bond. For instance, if the bond’s coupon rate with Rs. 1,000 par value is 20%, the issuer will pay Rs. 200 as interest per year.
- Liquidity: Most corporate bond funds trade on the secondary market. So, investors can buy and sell these debt instruments even after their issue.
In other words, an investor can sell if the bond prices increase or purchase when the prices fall.
- Yield to Maturity (YTM): Yield to maturity is the in-house rate of returns of all the cash flows in the bond, the coupon payments until maturity, the current bond price and the principal. Returns are higher when the YTM is greater and vice versa.
- Security: A corporate bond has a lower associated risk because it poses a financial obligation to the company.
- Tax-efficiency: If investors hold their corporate bond fund for less than 3 years, they must pay short-term capital gains tax (STCG) based on their tax slab.
Section 112 of the Indian Income Tax mandates a 20% tax on long-term capital gains, which applies to investors holding the bond for more than 3 years.
- Exposure & Allocation: Sometimes, corporate bond funds take small exposures to government securities. But this happens only when there are no suitable opportunities in the credit space.
On average, these bonds have approximately 5.22% allocation to sovereign fixed income.
Who Should Invest in Corporate Bonds?
Corporate bond funds are a debt instrument ensuring capital protection and have lower risk sensitivity. It is ideal for investors with a low-risk appetite looking for high returns on their investments.
The period of the top-rated bond funds typically ranges between one and four years, preserving the investor’s liquidity.
How Are Corporate Bonds Sold?
- Firms list their bonds with the help of an investment bank. The bank underwrites and sells the bonds to the investors.
- Organisations issue these bonds at face value or par value, following a standard coupon structure.
- Upon maturity, investors can redeem the bonds at face value.
- Investors purchasing these bonds receive regular interest payments until the maturity date. The interest payments might be floating or fixed rates.
- If the interest changes dramatically, these bonds have a call provision enabling early repayment. The firm would recall the old bonds and issue new ones when it is profitable.
- Investors can trade these bonds in the secondary market. But the bond price in the secondary market is decided by the number of interest instalments that are still due before the bond’s maturity date. In this case, the investor might receive less than the bond’s face value.
- Besides direct investment, investors may get exposed to these bonds via ETF investment and specially designed mutual funds.
What are Corporate Bond Debt Funds?
A corporate bond debt fund is a mutual fund that invests over 80% of its total financial resources in corporate bonds.
Organisations sell these to fund their short expenses, such as advertising, working capital needs, insurance premium payments, etc.
For businesses, corporate bond funds are increasingly becoming a preferred debt instrument to raise the needed finances because associated costs are lower than bank loans.
No, corporate bond investment is safe for investors and ideal for those expecting regular and higher returns on their investment. If you are a risk-averse investor, you must check the bond’s rating and invest in bonds with AA+ or higher ratings.
An example of a corporate bond is a convertible bond that can be exchanged for predefined stocks of the issuing company. There are also type one bond that invests in PSU companies or banks.
These bonds are a good investment because they are less risky than stocks and shares. It is a great choice for investors looking for a fixed but higher income from a safe option.
Some of the best Corporate Bond Mutual Funds to invest in 2022 are Axis Corporate Debt Fund, ICICI Prudential Corporate Bond Fund, Aditya Birla Sun Life Corporate Bond, Kotak Corporate Bond Fund, SBI Corporate Bond Fund, HDFC Corporate Bond Fund, etc.
Corporate bond funds ensure significantly higher returns than other debt instruments. Investors can expect average yields of 8-10% for corporate debt instruments.