Everything You Need to Know About Corporate Bond Funds

Are you seeking a fixed income investment for the long term? Do you want a tax-efficient investment as compared to bank fixed deposits? You can invest in corporate bond funds. It is a debt fund that invests at least 80% of its assets in corporate bonds of high quality. Banks have offered lower interest rates on fixed deposits in recent years. It forces investors to look at alternative safe investment avenues and offer higher post-tax returns than bank FDs. Should you invest in corporate bond funds?

What are Corporate Bond Funds?

Corporate bond funds as debt mutual funds invest a minimum of 80% of their assets under management in corporate bonds with a credit rating of AA+ and above. However, they may have small holdings in government securities and money market instruments. 

Credit rating firms such as ICRA, CARE and CRISIL assign credit ratings to financial instruments or funds depending on the issuer’s financial strength. 

Corporate bond funds have a Macaulay duration between two to five years. However, corporate bond funds are impacted by the interest rate fluctuations in the economy called interest-rate risk. It is because they invest in corporate bonds of a longer duration. 

Should you invest in corporate bond funds?

You could invest in corporate bond funds to attain your medium-term financial goals. It is an ideal investment for a time horizon of two to three years. Moreover, investors who are conservative and prefer fixed income instruments can look at corporate bond funds. 

You could also consider corporate bond funds if you fall in the higher income tax brackets. It offers returns similar to bank fixed deposits. However, they have higher tax efficiency because these funds are taxed as debt mutual funds. 

Long-term capital gains above three years for debt funds are taxed at 20% with the indexation benefit. It adjusts the purchase price of the debt fund for inflation, thereby offering higher post-tax returns than bank FDs. 

Points to check before investing in corporate bond funds?

You must check the portfolio of corporate bond funds to gauge the quality of bonds in their portfolio. For instance, you must invest in corporate bond funds that have high credit quality bonds in their portfolio. 

Corporate bond funds invest at least 80% of their assets in high credit quality instruments. However, you must check the remaining 20% portfolio for the credit quality of financial instruments. 

You should also check the duration of bonds in the portfolio of corporate bond funds. It helps to understand that interest rate fluctuations in the economy impact corporate bond funds that have bonds of longer duration in their portfolio.

Check the expense ratio of corporate bond funds and opt for those with a lower expense ratio. It is the cost of managing your investment, and investing in funds with a lower expense ratio increases your overall returns with time. You can check the track record of the mutual fund house and the fund manager before investing in the corporate bond fund. 

You could invest in corporate bond funds to diversify your portfolio across fixed income securities. However, you must understand credit risk and interest rate risk before investing in these funds. You could opt for corporate bond funds from Asset Management Companies with huge Assets Under Management (AUM). Moreover, these AMCs can handle the high redemption pressure of big investors during periods of excess liquidity. In a nutshell, conservative investors who fall in the higher income tax slabs can opt for corporate bond funds. 

For any clarifications/feedback on the topic, please contact the writer at cleyon.dsouza@cleartax.in