A corporate bond fund is essentially a mutual fund that invests more than 80% of its total financial resources in corporate bonds. Business organisations sell these to fund their short expenses, such as working capital needs, advertising, insurance premium payments, etc.
Corporate bond funds are increasingly becoming a popular debt instrument for businesses to raise required finances as associated costs are lower as compared to bank loans.
There are broadly two types of corporate bond a mutual fund invests in -
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Corporate bond mutual funds have lower risk sensitivity as it is a debt instruments ensuring capital protection. It is ideal for risk-averse people looking for high returns on their investments. The time period of the top corporate bond funds generally ranges between 1 and 4 years, preserving the liquidity of the investor.
Corporate bonds offer higher interest rates because they carry higher credit risk. Government bonds are more stable, as it has negligible default risks. The risk on corporate bonds, on the other hand, depends on investment patterns followed by the respective portfolio managers. Companies with high credit ratings have low chances of defaulting, while the ones with relatively lower ratings have a higher risk factor.
The main advantages of investing in corporate bond funds are -
Corporate bond funds ensure significantly higher returns than other debt instruments in the market. Average yields of 8-10% can be expected from corporate debt instruments, while government-held bonds only provide approximately half of it.
Since corporate debt funds are generated to satisfy the short term financing requirements of a business, they too are short term in nature. Also, corporate bond mutual funds can be obtained and sold as per the wish of the investor. This provides high liquidity of the financial resource, allowing a person to convert it to cash as and when the need arises.
Corporate debt funds have a lower associated risk than shares, as the former poses a financial obligation (liability) on the company. Equity investments, on the other hand, are subject to the profits and losses generated by a company in one financial year, and thus, are relatively riskier.
Top corporate bond funds can be distinguished on the basis of fund tenure, as well as the credit ratings of the companies chosen for the development of the mutual fund portfolio. This distinction caters to different types of investors and their investing patterns in the market. For example, individuals looking for a short term investment opportunity in low-risk bonds can easily choose those who have a shorter maturity tenure. There are short-, medium- and long-term bonds, and there are also some perpetual bonds in the market.
The risk associated with a corporate bond mutual fund depends on the portfolio of the fund itself. If the fund manager chooses all high rated company bonds, the risk factor of the company defaulting is considerably less.
However, higher returns can also be obtained if low rated companies are targeted, provided the fund is managed properly by the concerned portfolio manager. Organisations with a lower credit rating offer higher coupon value to attract potential investors and several mutual funds. Highly trained portfolio managers decide to invest a considerable portion of the total resource in such funds during favourable market conditions while withdrawing the funds if fluctuations are foreseeable. This is a preferable option for people with a relatively higher risk.
Corporate bond mutual funds operate in the share market just like any standard mutual fund. An increase in the value of a corporate bond in the portfolio of the mutual fund increases the NAV of the fund, thereby realising profits. On the other hand, a fall in NAV value has a contrary effect on the aggregate value of the mutual fund.
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