Is this prudent to use corporate bond funds to achieve your financial goals faster?

Many investors are risk-averse and, therefore, seek returns greater than those from bank deposits. Parking money in corporate bond funds suits them the most. These funds are required to invest at least 80 per cent of their corpus in corporate bonds with ratings of AA+ and higher. They also invest in high-quality instruments that carry a lower credit risk than other debt funds.

Apart from the yields offered by the matching maturity G-Sec securities, corporate bond funds also yield their investors returns that make up for the credit and liquidity risk inherent in these securities. Due to their investments in higher-yielding securities than G-Secs, these are attractive to investors looking for a greater yield in the fixed-income market.

Investment checklist

Market events over the past two to three years have illustrated major showdowns in debt funds resulting from downgrades and defaults by different issuers. Investors must realize that fixed-income funds are at the risk of capital loss too. To gain a sense of current valuations, investors can consider the current spreads given by corporate bonds over the equivalent maturity G-Secs as well as long-term history spreads.

The credit quality of the portfolio of any prospective corporate bond funds must be reviewed by investors interested in parking their money in such funds. This they can do by assessing the risk associated with potential funds after looking at the debt instruments’ exposure to AA and below-rated instruments. In terms of issuers and instruments, one must consider well-diversified portfolios.

How long should one stay invested?

Investors are sometimes unsure of how long they must stay invested in fixed-income investment options. The ideal way is to stay invested for a period more or less equal to the fund’s tenure so that investors may benefit from the continued market swings, thus, lessening the impact of interest rate changes. Most corporate debt funds are available for one to five years. This flexibility in their tenure explains investors’ interest in them. To enhance investments in these funds, investors must aim to hold onto their investments for a minimum of two to three years.

One of the key factors that affect the performance of a debt investment over the long run is changes in credit ratings. There may not be an instant cause of concern if there are only minor changes (one notch) dependent on several macros and micro aspects relating to each issuer. Any sharp decline in credit rating, irrespective of the reason, must be carefully checked. Investors might consider limiting their exposure to a particular corporate bond fund in case of negative major events.

Taxation of corporate bonds

The tax rate on income derived from the transfer of corporate bond funds is evaluated by the holding period of the fund. Under the Income Tax Act, 1961, the income from corporate bonds is taxed under the heading “Income from capital gains”. Investing in corporate bond funds is tax effective than other debt instruments if held for more than three years.

This is because if the holding period is more than three years in the case of corporate bond funds, not only are investors taxed at a reduced tax rate of 20 per cent but they also receive the benefit of indexation that might cut their tax obligations substantially.

Here is the list of top-performing corporate bonds with their returns

Corporate bonds are a great addition to your investment portfolio considering their high returns backed by companies with high credibility. If you are looking to invest in some debt funds, parking money in corporate bonds may be the next best thing for you to look at.