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Corporate Bond Debt Funds – Meaning, Features & Suitability

Last Updated : 08 Nov, 2023
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What are Corporate Bond Debt Funds?

Corporate Bond Debt Funds are defined as mutual funds that primarily invest in debt instruments, such as corporate bonds. Corporate Bonds are the debt instruments that businesses issue in order to raise funds from investors and/or the public, to fund their short-term expenditures such as working capital, advertising, insurance premium payments, etc. Corporate bonds provide a series of fixed-interest payments against the principal amount. Corporate bond funds are becoming a popular debt instrument for firms to generate the required funds since the charges are cheaper than bank loans.

Key takeaways from Corporate Bond Debt Funds:

  • Corporate Bond Debt Fund is a type of debt issued by a company to raise capital.
  • When an investor buys a corporate bond, he or she is lending money to the firm in exchange for a series of interest payments.
  • Corporate bonds are traditionally considered riskier than government bonds in the United States, therefore their interest rates are normally higher to compensate for this additional risk.


Features of Corporate Bond Debt Funds

1. Investment Allocation: These mutual funds primarily invest in corporate debt instruments. Bonds, commercial papers, debentures, and structured obligations are examples of these funds. Each of them may have a different maturity period and risk profile. When there are no feasible opportunities for high-quality corporate debt, corporate bond funds invest a small proportion in government securities. They can also invest in sovereign fixed-income securities.

2. Higher Returns: Corporate bond funds provide much better returns than other debt instrument on the market. Corporate debt instruments may pay average returns of 8-10%, but government-held bonds only provide around half of that.

3. Liquidity of Funds: Corporate debt funds are short-term in nature because they are generated to satisfy a company’s short-term financial needs. Additionally, corporate bond mutual funds can be purchased and sold at the investor’s discretion. This increases the liquidity of the financial resource, allowing it to be converted to cash as needed.

4. Security: Corporate debt funds carry less risk than shares since the former imposes a financial obligation (liability) on the corporation. Equity investments are subject to a company’s profits and losses in a single fiscal year, which makes them riskier.

5. Variety of Funds: Top corporate bond funds can be identified based on fund tenure as well as the credit ratings of the companies chose for the mutual fund portfolio growth. This differentiation caters to different sorts of investors and their market investment behaviours. Individuals searching for a short-term investment opportunity in low-risk bonds can easily select those with a shorter maturity period. There are short-term, medium-term, and long-term bonds available as well as some perpetual bonds in the market.

6. Bond Yields: A bond’s current yield is the sum of its yearly returns. Yield to Maturity (YTM) is the internal rate of return on a bond’s cash flows. This includes the bond’s coupon payments, principle investment, and price change gains. The higher the YTM, the higher will be the profits.

7. Maturity Duration: The maturity term of securities held by a corporate bond fund is unrestricted. While some funds invest in bonds with short maturities, others invest in bonds with medium to long maturities ranging from 4 to 7 years.

Purpose of Corporate Bond Debt Funds

1. Functionality: Corporate bond mutual funds function on the stock market in the same way as other mutual funds.

2. Impact of NAV: Profits are realised when the NAV of a mutual fund increases due to an increase in the value of a corporate bond in the portfolio of the fund. A decrease in NAV value has the opposite impact on the mutual fund’s aggregate value.

3. Raise Capital: Corporate bond debt funds are used by businesses to raise capital. An investor and a company borrow money from one another through bonds. The investor agrees to loan money to the firm for a set length of time. In exchange, the investor receives monthly interest payments. The corporation repays the investor when the bond reaches maturity.

Who Should Invest in Corporate Bond Debt Funds?

Investors who should invest in Corporate Bond Debt Funds are looking for the following points :

1. Investors Looking for Stable Income: Returns on corporate debt funds are usually predictable. However, there is no assurance of consistent profits. When interest rates vary, long-term debt funds, such as corporate bond funds become riskier.

2. Investors with a Moderate Risk Profile: Corporate bond funds are less risky than other types of debt funds. However, they are not fully risk-free. As a result, while investing in these funds, investors should have a moderate risk tolerance.

3. For Conservative Investors: Corporate bond funds that invest in high-quality debt securities preserve capital. As a result, they are better suited to risk-averse investors seeking fixed income rather than aggressive investors.

4. For Medium-Long Term Horizon: These debt funds are appropriate for investors with a 2-3 year investment horizon. Investors who wish to take advantage of the indexation benefit on capital gains taxes must invest for at least three years. businesses

Factors to Consider Before Investing in Corporate Bond Debt Funds

1. Returns Expectation: To get an overview of a corporate bond fund’s predicted returns, look at its previous performance. However, keep in mind that this is not a guarantee of future profits, and many corporations have defaulted in the past.

2. Associated Risk: The risks associated with these debt funds vary according to the quality of bond investments. While top-rated debt instruments entail the least risk, they frequently generate average returns. On the other hand, Lower-rated bonds incur higher risk but can be extremely profitable.

3. Investment Horizon: These debt funds invest in corporate bonds with maturity periods from medium to long term. They are best suited for investors with a long investment horizon. However, Long-term investments in debt funds encounter higher risks.

4. Fund Manager’s Role: Corporate bond fund managers choose which credit ratings to use to balance risks and profits. Skilled fund managers can assess market circumstances to choose which investments to pursue. As a result, before investing, you should look at the fund manager’s track record.

5. Cost and Expenses: All mutual funds charge former management and operating expenses. This fee is known as an expense ratio. A mutual fund scheme’s expenses include distribution fees, fund administration fees, advertising costs, and so on. To avoid premature withdrawals, certain fund institutions charge an exit load.

Advantages of Corporate Bond Debt Funds

1. Higher Returns than Government Bonds: Corporate bonds often provide higher returns than government bonds. However, corporate bonds carry slightly more risk than government bonds or other forms of bonds. Surprisingly, even if interest rates fall, you can still exchange bonds from respectable firms.

2. Fixed Income and Structured Payment Schedule: When you invest in a corporate bond, you know exactly what interest payments you’ll get. Unlike dividends, which are paid at the discretion of the corporation, coupon payments are designed so that you know you’ll earn a return on your investment.

3. Bondholders have a Higher Ranking than Shareholders: Bondholders are paid first from the company’s assets in the case of insolvency, then the shareholders. This higher priority increases your chances of recovering most, if not all, of your investment even if the firm fails.

4. Pricing Consistency: The price of these debt funds is more consistent than that of shares. Corporate bonds will not experience the same price volatility as shares or other investment opportunities. So you may know with certainty what the face value of the bond will be and have some predictability about the income stream over the life of the investment.

5. Opportunity to Convert them to Shares: Some bonds can be converted into shares of the issuing company. This increases the investor’s risk, but it also means that the investment can be sold at the current market value. Under the correct conditions, investors can utilise this approach to increase their earnings.

Disadvantages of Corporate Bond Debt Funds

1. Capital Stagnation: Corporate bonds do not deliver considerable capital growth because the investment is not intended to increase in value throughout the life of the bond. While you are entitled to timely interest payments if the firm does not default on them and will receive your initial investment back in full plus interest at the maturity date, there will be no significant growth in capital even if you sell before maturity at the secondary market.

2. Does not Broaden the Portfolio: Buying bonds and shares in the same company will not diversify your portfolio. If the company fails for whatever reason, you might be left with significant losses and no hope of recovery.

3. Not Easy to Sell: Selling a corporate bond on the secondary market might be tough if you want to get out before it matures. There’s a significant possibility you will not get the full face value of the bond, especially if interest rates have risen since you invested.

4. Low Liquidity: On the secondary market, you may not even be able to find buyers interested in a corporate bond as an investment. This might be difficult if you need to liquidate assets quickly.

5. Profitability is Reduced as Interest Rates Rise: A rise in interest rates might make corporate bond investing less profitable. Furthermore, the value will be affected by the company’s stability. Individual bond investments can be affected by both a rise in interest rates and a decrease in corporate profitability.

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