Know your debt funds: What is corporate bond fund?2 min read . Updated: 13 Jun 2017, 04:04 AM IST
Corporate bond funds invest significantly in debt paper of companies who need money
Corporate bond funds have been in the news for all the wrong reasons in the recent past due to the credit risk (holding lower rated debt paper) they carry. But not all corporate bond funds are bad. In fact, if used well, it can add valuable returns to your debt portfolio.
When companies need money, they borrow from banks or other financial institutions like mutual funds. These companies pay an interest throughout the scrip’s tenure. Once the tenure is over, the companies return the money to the lenders. Additionally, debt funds also invest in government securities and state development debt paper; this, is essentially a loan given to the central or state governments. Lending by debt funds (in lieu on interest payments they get) is what construes an investment.
Here’s where corporate funds differ. Corporate bond funds invest significantly in debt paper of companies. Broadly, there are two types of corporate bond funds. One type sticks to high-rated companies, like public sector unit (PSU) companies and banks. The second type invests in slightly lower ratings, such as ‘AA-' and below. These are popularly known as credit funds. But many times, the terms ‘corporate bond fund’ and ‘credit opportunity fund’ are used interchangeably. So look before you invest.
If your fund invests only in highly-rated companies, expect 8-10% returns, on an average, from well-managed funds. Risk is minimal here.
Credit funds can give you a spike in returns by investing in slightly low-rated, but well-managed, companies. These companies tend to give slightly higher coupon rates because that’s how they attract lenders. But if the fund manager’s call on the company goes wrong (i.e., if it defaults on interest payments or principal repayment or the company gets downgraded further and, worse, swiftly), it can cause a setback for you.
In 2015, two schemes of JP Morgan Asset Management (India) Co. Ltd tripped on the back of a downgrade in one of their underlying companies’ (Amtek Auto Ltd) credit rating. In 2016, some schemes of Franklin Templeton Asset Management (India) Pvt. Ltd sold their entire holding of Jindal Steel and Power Ltd (JSPL) debt securities at a loss after the company had its ratings downgraded by credit assessor Crisil Ltd. Earlier this year, four schemes of Taurus Asset Management Co. Ltd fell sharply when the credit rating of Ballarpur Industries—in which its debt schemes had invested—was downgraded by India Ratings & Research, a credit rating agency.
If you stick to credit or corporate bond funds that invest significantly in high quality debt instruments, it’s a good way to earn income that is regular and higher than fixed deposits. Long-term debt funds can get volatile when interest rates get volatile, so typically these funds minimize their volatility by investing in scrips that mature in 1-4 years. That’s an added advantage. Stay invested up to 3 years. If you invest with a year’s perspective, credit funds could prove dangerous as a single default by an underlying company could set back your fund’s net asset value by a lot and hurt you at the time of withdrawal.