The widening spread between AAA-rated corporate bonds and government securities has enhanced the appeal of corporate bond funds as an income-generating investment option. As interest rates peak, investing in these funds can help individuals achieve better risk-adjusted returns while effectively managing portfolio risk.
Corporate bond funds maintain a balanced exposure, with 40-45% invested in securities with durations ranging between one to three years and 45-50% in securities with durations exceeding three years.
Nirav Karkera, head, Research, Fisdom, says corporate bond funds offer the appropriate balance, providing the flexibility to invest across various durations based on prevailing market conditions and macro indicators. “The widening of spreads between long-term corporate bonds and long-term government securities, now nearing 100 basis points, has become a compelling draw for investors,” he says. “This increased spread offers an attractive opportunity amidst global and domestic interest rate cycles reaching their peaks, enticing investors with the potential for higher yields compared to government securities.”
There are two drivers for returns on bonds. First is the coupon yield and second is the price yield. When bonds are issued, they are discounted at prevailing treasury yields. Abhishek Banerjee, founder and CEO, Lotusdew Wealth & Investment Advisors, says as the yields or interest rate drops, the discounting factor becomes smaller, inflating the price. “Our view is that the Reserve Bank of India (RBI) will do everything to keep inflation within target and for a long-term investor, corporate bond funds will deliver decent fixed income returns along with potential price returns,” he explains.
Sweet spot
In February this year, corporate bond funds reported net inflows of Rs 3,029 crore, making it the second-highest inflows in debt-oriented schemes after liquid funds. The RBI has allowed banks to allocate up to 23% of their deposits to corporate bonds under the held maturity category. This shift, from previously limited allocations to government securities and state debt, has opened up new avenues for banks and institutional investors.
The combination of potentially higher returns and regulatory support has spurred a surge in investments into corporate bond funds, signalling the evolving dynamics of India’s debt market landscape.
Mukesh Kochar, national head, Wealth, AUM Capital, says corporate bond funds invest in good quality corporate bonds with residual maturity of around three years, which is a sweet spot in terms of yield curve and spread. “The yield in this segment is very attractive. The corporate bonds market is expected to remain buoyant and the involvement of retail investors is expected to remain very high in the future,” he adds.
Scrutinise credit quality
When considering investments in corporate bond funds, investors should scrutinise the credit quality of the bonds held within the fund. They should keep a close watch on any changes in credit ratings, especially for non-AAA-rated bonds. They should monitor prevailing interest rates, as fluctuations can impact bond yields significantly.
Investors should consider liquidity conditions in the market and their potential effects on corporate borrowing costs, as well as their investment time horizon to select funds that suit your goals. “Evaluate the returns and yields offered by the fund, particularly for bonds with durations ranging from three to five years, ensuring they align with your investment objectives,” says Karkera.
Holding period
The ideal holding period depends on market conditions, interest rate movements and individual investment goals. Corporate bond funds are suitable for those with a medium to long-term investment horizon. Holding these funds for three to five years or longer may provide the opportunity to capture higher returns while minimising the impact of short-term market fluctuations.
