Corporate Bond Funds: Features, Advantages, Taxation & More

Corporate bond funds are the type of debt funds that invest in bonds issued by companies. 

These funds can be of two types. 

  • Funds investing in bonds with the highest possible credit rating, so the default risk is negligible. 
  • Funds investing in bonds with a slightly lower credit rating that may deliver superior returns. 

Ideal for 1 to 4 years of investment horizon, here’s everything you need to know about corporate bond funds.

How do Corporate Bond Funds Work?

Any organization requires funds for smooth business operations. They can either take bank loans or offer equity instruments. 

However, there are several reasons a company would prefer issuing bonds such as exhausted bank limits, banks not funding a sector, or banks slowing down disbursement to name a few. Also, the company may not be ready for equity dilution. 

So instead, companies issue bonds to generate funds for business operations. 

Corporate bond funds open a gateway for investors to explore these debt instruments.

As per SEBI regulations, these funds need to invest at least 80% of the total assets into corporate bonds with an AA+ and above credit rating. The remaining 20% can be allocated to other debt instruments of varying credit ratings, which may or may not be AA+. Fund managers strategically invest the remaining 20% to benefit from the interest rate cycle. 

Underlying bonds can be of variable maturity periods. You may expect between 1 to 4 years of investment horizon with these funds. 

Benefits of Investing in Corporate Bond Funds

1. Superior Returns 

Corporate bonds carry higher credit risk compared to government bonds but at the same time, offer higher coupon rates to match the additional risk.

So if you are seeking higher returns than government bond funds or fixed deposits, and have the required risk appetite, you can invest in corporate bond funds. 

2. Safe to Invest in

Corporate bond funds invest 80% of the total assets in AA+ rated bonds.

The highest bond rating indicates that the company will not default on your investment. 

3. Portfolio Diversification

Corporate bond funds can be ideal for portfolio diversification. 

Equity funds may deliver superior returns than debt funds, but they are quite volatile. Debt funds, being comparatively less volatile, balance the risk and rewards. 

Things to Consider Before Investing in Corporate Bond Funds

1. Allocation

As mentioned above, these funds have two types of allocation strategies. Funds with AA+ rated bonds would be safer than funds having bonds with lower credit ratings.

If you have a low to moderate risk appetite, go with funds that invest in AA+ rated bonds. Else, you can explore lower-credit rating bond funds as they may deliver superior returns. 

Be sure to check the allocation before investing in corporate bond funds. 

2. Risk Factor

With the highest-rated bond funds, the credit risk would be lower but returns may also be lower. On the other hand, slightly low-rated bonds might be risky but may deliver better returns.  

The interest rate risk can also affect the overall returns. The bond prices are inversely proportional to the interest rate. When the interest rate rises, the bond prices fall, and vice versa. 

You can lower the interest rate risk by holding your investment until maturity. 

3. Investment Horizon

Corporate bond funds are best suited for 1 to 4 years of the investment horizon. Invest only if the tenure matches your portfolio and your investment goals.

4. Underlying Assets

In these funds, 80% of the total assets would be high-rated corporate bonds. However, fund managers may invest the remaining 20% in slightly low-rated bonds. 

The overall risk of the fund changes with the remaining 20% allocation.

5. Fund Manager’s Track Record

A fund manager’s strategy plays a vital role in managing debt funds. Their analysis and decisions will reflect upon your portfolio. Hence, it is essential to check the track record of the asset management company and the fund managers. 

Tax Implications

The tax rules on debt funds have been updated since April 2023.

Both Long Term Capital Gains (Investment redeemed after 36 months) and Short Term Capital Gains (Investment redeemed before 36 months) will be taxed as per the investor’s tax slab.

The indexation benefit on long-term capital gains is only applicable for hybrid funds with more than 35% and less than 65% exposure to equity. 

Find out tax rules across all mutual fund categories.

Who Should Invest in Corporate Bond Funds?

Corporate bond funds are suitable for investors with 1 to 4 years of investment horizon. 

These funds can be an alternative investment avenue to fixed deposits. With slightly higher risk, investors can benefit from superior rewards.

If you are an aggressive investor, you can consider investing in low-rated bond funds. These funds may offer higher returns, but the risk of default increases. We recommend talking to a professional financial advisor before investing in these funds.

Final Thoughts

Corporate bond funds are ideal for investors looking to park their money for 1-4 years. 

Invest in high-rated bond funds to avoid default risk, unless you are an aggressive investor. In that case, you can explore low-rated bond funds provided it aligns with your risk appetite. 

Holding your investment till maturity can lower the interest rate risk as well. 

If you have any further queries, get in touch with VNN Wealth advisors. You can get your portfolio reviewed and plan your next investment strategy.