Looking for a debt fund that offers you higher fixed returns at low risk? Have you considered corporate bond debt funds? Check out the benefits, features and other details of this profitable investment vehicle.
Savvy mutual fund investors would know that mutual funds do not just invest in equities but also in debt instruments. The reason for this is to – diversify the risks incurred by the investor. When it comes to debt instruments, there are plenty of choices and types.
Here, in this post, you can find all that you need to know about corporate bond funds – a subcategory of debt schemes.
Let’s start with the basics.
What are Corporate Bond Debt Funds?
Any company in India can issue a corporate bond, which is also known as NCD (Non-Convertible Debentures). Any organisation, be it a start-up or a multi-million dollar firm, requires money for daily operations as well as to fund future plans.
Companies usually resort to raising money for their firm using debt investments, because this doesn’t pose much risk to the shareholders. Compared to bank loans, debentures or bonds provide companies with an alternative, economical way to raise funds.
When you buy a corporate fund, it essentially means that the company is borrowing from you. The firm repays the principal after the maturity period specified in the bond. Meanwhile, you earn interest (fixed) for the amount. The interest payments are known as coupon and usually happen twice a year.
Who Should Consider Investing in Corporate Bond Funds?
Corporate bond funds are ideal for people who are looking to earn a higher fixed income without taking much risk. Its low-risk, compared to other debt funds. What more, corporate debt funds offer protection for your capital and can help you reach your financial goals faster.
Features of Corporate Bond Funds
- Bond Price: Every corporate bond has a price that keeps on varying. You may even have to shell out different prices for the bond, based on the time you purchase it. Analysing the price fluctuations of a corporate bond gives you a better idea of the market movement.
- Par Value: This is the price that the bond issuer (company) pays you at the time of maturity of the bond.
- Coupon: This is the interest the bond issuer pays you until bond maturity. The interest is usually a fixed percentage of the par value.
- Current Yield: This denotes the annual returns you make from the bond.
- Yield to Maturity (YTM): This is the sum of all cash flows generated by the bond. It includes the present bond price, total of coupon payments until maturity, and the principal. The general rule of thumb here is that higher the YTM, greater will be your returns and vice versa.
- Tax Efficiency: If you hold a corporate bond debt fund for less than three years, then you have to pay short-term capital gains. On the other hand, if you hold it for a longer investment horizon (more than three years), then according to Section 112 of the ITA, you have to pay 20% long-term capital gains tax.
Benefits of Corporate Bond Funds
Unlike long-term debt funds where the interest rates fluctuate, in a corporate bond debt fund, the interest rate is fixed. The average investment horizon for corporate bond funds in India ranges from one to four years. It’s also tax-efficient, helping you reduce your tax burdens, even if you belong to the highest income tax slab.
What are the Risk Factors and Average Returns of Corporate Bond Debt Funds?
If your debt fund manager invests only in high-rated companies, you can expect an average return of 8 to 10% with minimal risk.
On the other hand, by investing in lower-rated securities, you run the risk of the bond issuer defaulting on their obligations.
Corporate bond funds work better when you consider them as a long-term investment vehicle. Also, make sure that you choose a reputed fund manager, so that they don’t take unnecessary risks with your investments, by investing in the bonds of low-rated companies.