Debt funds: Betting on corporate bond funds? | The Financial Express

Debt funds: Betting on corporate bond funds?

They appeal to investors seeking a higher yield within the fixed-income space, as these funds invest in better-yielding instruments compared to government securities

Debt funds: Betting on corporate bond funds?
These appeal to investors seeking a higher yield within the fixed-income space, as these funds invest into better-yielding instruments compared to G-Secs.

Risk-averse investors looking for returns higher than that from bank deposits can opt for corporate bond funds. These funds invest in highest quality instruments and the credit risk is lower than other debt funds and have a mandate to invest at least 80% of their corpus into AA+ and higher-rated corporate bonds.

Corporate bond funds offer an additional yield to investors to compensate them for the credit and liquidity risk that they entail, over and above the corresponding maturity G-Sec yields. These appeal to investors seeking a higher yield within the fixed-income space, as these funds invest into better-yielding instruments compared to G-Secs.

Akhil Mittal, senior fund manager, Tata Mutual Fund, says, the accruals in this category are decent and the volatility is also less as compared to long duration funds. “Hence this category makes a good investment case for individual investors,” he says.

What to evaluate before investing
Investors should note that fixed-income funds too are prone to the risk of capital loss, as has been evident from the recent market events over the past two-three years, which saw significant markdowns in several debt funds following downgrades and defaults of various issuers. Investors should look at the current spreads offered by corporate bonds over the corresponding maturity G-Secs, and long-term history spreads to get a sense of prevailing valuations.

Dhaval Kapadia, director, Investment Advisory, Morningstar Investment Adviser (India), says those considering investing in corporate bond funds should evaluate the credit quality of the portfolio of the prospective funds being considered. “Investors can check for the exposure of the debt instruments to AA and below-rated instruments to gauge the risk inherent in the prospective funds. Preferably, one should consider well-diversified portfolios in terms of issuers and instruments,” he says.

Investment duration
In any fixed income fund, one should stay invested for a period similar to the duration of the fund as this will help tide over rate cycle moves and smoothen the impact of changes in interest rates. Corporate debt fund is amongst the few categories on the mutual fund platform that have flexible duration criteria and the duration range in the industry spans from a little less than a year to five years. In these funds, one should look to stay invested for a period of two to three years to optimise investments.

Dwijendra Srivastava, chief investment officer, Fixed Income, Sundaram Mutual, says you need to look at your investment horizon and gumption for volatility (maximum drawdown on return) before selecting the duration of the corporate debt fund to invest in. “Assuming an investor has a three-year investment horizon we suggest a duration band of around three years. In this duration band, the yield curve relatively flattens out and the volatility in interest rates will reduce considerably on account of the investment horizon,” he says.

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Change in credit ratings
Changes in credit ratings is one of the important factors that determine the long-term performance of debt investment. There can be small changes (one notch) depending upon many macro / micro factors pertaining to any issuer, which might not be an immediate cause of fear. “Any sharp deterioration in credit rating (by two or more notches in one go, or continuous downgrades in smaller time intervals) should be carefully studied. In case there are material adverse developments, one could consider reducing exposure to such fund / issuer,” says Mittal.

Taxation
Income from the transfer of corporate bond funds is taxable under the heading “income from capital gains” and the rate of taxation depends on the holding period of the fund. Neeraj Agarwala, partner, Nangia Andersen India, says, if the holding period of the investment is more than 36 months, only then is investing in corporate bond funds more tax efficient. “In the case of corporate bond funds, if the holding period is more than 36 months, not only are you taxed at a lower tax rate of 20% as but also the benefit of indexation is available which could reduce your tax liability substantially,” he says.

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