Debt funds: Betting on corporate bond funds?

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

Corporate bond funds offer an additional yield to investors to compensate for the credit and liquidity risk they carry, in addition to the corresponding G-Sec yields at maturity. These appeal to investors looking for higher yield in the fixed income space, as these funds invest in higher 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 compared to long duration funds. “Therefore, this category makes a good investment case for individual investors,” he says.

What to consider before investing
Investors should note that fixed income funds are also subject to the risk of capital loss, as evidenced by recent market events over the past two to three years, which have resulted in significant writedowns in several fixed income debt funds. the series of downgrades and failures of various transmitters. . Investors should review the current spreads offered by corporate bonds over the corresponding maturity G-Secs and long-term historical spreads to get an idea of ​​prevailing valuations.

Dhaval Kapadia, Director, Investment Advisory, Morningstar Investment Adviser (India), says those considering investing in corporate bond funds should assess the credit quality of the portfolio of potential funds being considered. “Investors can check debt exposure to AA securities and undervalued instruments to assess the inherent risk of potential funds. Preferably, one should consider well-diversified portfolios in terms of issuers and instruments” , he said.

Investment term
In any fixed income fund, you should stay invested for a period similar to the duration of the fund, as this will help ride out movements in the rate cycle and lessen the impact of changes in interest rates. Corporate debt funds are among the few categories in the mutual fund platform that have flexible duration criteria and the industry duration range extends from just under one year to five. year. In these funds, it is necessary to seek to remain invested for a period of two to three years to optimize the investments.

Dwijendra Srivastava, Chief Investment Officer, Fixed Income, Sundaram Mutual, says you should consider your investment horizon and your intuition for volatility (maximum drawdown on return) before selecting the duration of the corporate debt fund in which invest. “Assuming an investor has a three-year investment horizon, we suggest a duration range of around three years. interest will be reduced considerably given the investment horizon,” he said.

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Modification of credit ratings
Changes in credit ratings are one of the important factors that determine the long-term performance of debt investments. There may be small shifts (a notch) depending on many macro/micro factors relating to any transmitter, which may not be an immediate cause for concern. “Any sharp deterioration in credit rating (by two notches or more at one time, or continuous downgrades at shorter time intervals) should be carefully investigated. In the event of a material adverse development, consideration could be given to reducing exposure to that fund/issuer,” says Mittal.

Taxation
Income from the disposal of corporate bond funds is taxable under “capital gains income” and the tax rate depends on how long the fund has been held. Neeraj Agarwala, Partner, Nangia Andersen India, says that if the holding period of the investment is more than 36 months, then only investing in corporate bond funds is more tax efficient. “In the case of corporate bond funds, if the holding period is longer than 36 months, not only are you taxed at a lower tax rate of 20%, but you also get the benefit of the indexing, which could significantly reduce your tax liability,” he says.

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