What Are Corporate Bond Funds?
Corporate Bond Funds are debt mutual funds that invest at least 80% of their assets in corporate bonds. These funds invest in bonds issued by companies to raise capital, offering higher returns than government securities but with higher credit risk. Corporate bonds are debt instruments where companies borrow money from investors and promise to pay interest and return the principal. Corporate Bond Funds are suitable for investors seeking higher returns than government bonds while accepting moderate credit risk. They provide diversification across different companies and sectors, helping spread credit risk.
Key Features of Corporate Bond Funds
80% Corporate Bonds
Invest at least 80% of assets in corporate bonds, as per SEBI regulations for corporate bond funds.
Higher Returns
Typically provide 6-8% returns, higher than government bond funds due to credit risk premium.
Diversification
Provide diversification across different companies and sectors, helping spread credit risk.
Credit Risk
Carry moderate to high credit risk, as corporate bonds can default, unlike government bonds.
Types of Corporate Bonds
| Type | Credit Rating | Risk Level | Returns |
|---|---|---|---|
| AAA Rated | Highest Credit Quality | Low Risk | 6-7% |
| AA Rated | High Credit Quality | Moderate Risk | 7-8% |
| A Rated | Good Credit Quality | Moderate-High Risk | 8-9% |
| BBB Rated | Adequate Credit Quality | High Risk | 9-10% |
Benefits of Corporate Bond Funds
Higher Returns
Provide 6-8% returns, higher than government bond funds (5-7%) due to the credit risk premium, offering better returns for moderate risk.
Diversification
Provide diversification across different companies and sectors, helping spread credit risk and reduce concentration risk.
Professional Management
Fund managers actively manage the portfolio, selecting high-quality corporate bonds and managing credit risk effectively.
Tax Efficiency
Long-term capital gains (3+ years) taxed at 20% with indexation benefit, which can significantly reduce tax liability.
Risks and Considerations
Credit Risk
Corporate bonds carry default risk. If a company defaults, investors may lose part or all of their investment. Credit risk is higher for lower-rated bonds.
Interest Rate Risk
NAV fluctuates with interest rate changes. When rates rise, bond prices fall, and vice versa. Longer duration bonds are more sensitive to rate changes.
Liquidity Risk
Some corporate bonds may have lower liquidity, making it difficult to sell at fair prices during market stress or redemption pressure.
Concentration Risk
If the fund is concentrated in a few companies or sectors, adverse events can significantly impact returns. Diversification helps mitigate this risk.
Who Should Invest in Corporate Bond Funds?
Higher Return Seekers
Ideal for investors seeking higher returns (6-8%) than government bonds while accepting moderate credit risk.
Moderate Risk Tolerance
Suitable for investors with moderate risk tolerance who can accept credit risk for higher returns.
Medium to Long-term
Best for investors with medium to long-term investment horizons (3-5 years) to benefit from compounding and tax efficiency.
Portfolio Diversification
Suitable for investors looking to diversify their debt portfolio beyond government securities for better risk-adjusted returns.
Final Thoughts
Corporate Bond Funds offer higher returns (6-8%) than government bond funds due to the credit risk premium. They invest at least 80% in corporate bonds, which carry default risk but offer better returns. The funds provide diversification across companies and sectors, helping spread credit risk. They are suitable for investors seeking higher returns than government bonds while accepting moderate credit risk. However, investors should assess the credit quality of underlying bonds and be prepared for potential defaults. The funds also carry interest rate risk, which affects NAV when interest rates change. For risk-averse investors, government bond funds (gilt funds) may be more suitable, while for those seeking higher returns, corporate bond funds offer a good balance.