Investing in Corporate Bonds - Features, Risk-Rewards and Process

What are Corporate Bonds?

Corporate bonds are a type of debt security offered to investors by corporations that need to raise finance for their tasks. Repayment is made in full principal or interest earned throughout some time.

In straightforward terms, in the event that you buy this kind of bond, you are loaning the amount to the corporation for its activity. These bonds are not quite the same as stocks. They are legal contracts that tight spot the corporation to repay the acquired money to you with interest at fixed stretches. Typically, corporate bonds offer a higher rate of interest than government bonds.

For investing straightforwardly in individual corporate bonds, the investor ought to have top to bottom information on the fundamentals of the responsible company. This assists the investor with guaranteeing that they don't get it at risk of default. In the event of corporate bonds, the risk of default has been remarkable; be that as it may, it shouldn't be overlooked at the hour of settling on investment choices.

To keep away from the issue of getting into an examination of fundamentals of the company, one can invest through options, for example, mutual funds or ETFs that attention on corporate bonds as it gives benefits as broadening and expert administration. The risk related with this investment choice contrasts from the risk implied in buying individual bonds. Investing in corporate bonds makes it simpler for the investor to investigate as the investor is needed to check just the holding of that particular fund to choose whether or not one should buy it. For instance, assuming a XYZ plot is 100% holding in AAA corporate bonds, less information is left for an investor to certify prior to investing.

Highlights/Features and Advantages of corporate bond funds

1. Segments of corporate bonds

Corporate bond funds invest dominatingly in debt papers. Organizations issue debt papers, which incorporate bonds, debentures, commercial papers, and organized commitments. These parts convey an exceptional risk profile, and the maturity date additionally shifts.

2. Price of the bond

Each bond suffers a heart attack, and it is dynamic. You can purchase similar bond at various prices, in view of the time you decide to purchase. Investors should check how it changes from the standard worth – it will give data about the market movement.

3. Standard Value of the bond

This is the amount the company (bond guarantor) pays you when the bond develops. It is the loan principal. In India, a corporate bond's standard worth is typically Rs 1,000.

4. Coupon (interest)

At the point when you purchase a bond, the company will payout interest consistently until you leave the corporate bond or the bond develops. This interest is known as the coupon, which is a sure level of the standard worth.

5. Current Yield

The yearly returns you make from the bond is known as the current yield. For instance, if the coupon rate of a bond with Rs 1,000 standard worth is 20%, at that point the guarantor pays Rs 200 as the interest each year.

6. Yield to Maturity (YTM)

This is the in-house rate of returns of all the cash-flows in the bond, the current bond price, the coupon installments until maturity and the principal. More noteworthy the YTM, higher will be your returns and the other way around.

7. Tax-proficiency

In the event that you are holding your corporate bond fund for under three years, at that point you should pay short-term capital gains tax (STCG) in view of your tax slab. Then again, Section 112 of the Indian Income Tax orders 20% tax on long-term capital gains. This applies to the individuals who hold the bond for over three years.

8. Openness and allocation

Corporate bond funds, in some cases, do take little openings to government securities also. Be that as it may, they do so just whenever no appropriate open doors in the credit space are accessible. By and large, corporate bond funds will have roughly 5.22% allocation to sovereign fixed income.

(Also Read: Municipal Bonds)

Risk factors and returns

There's consistently the chance of bond issuers defaulting on their commitments. This default risk is higher for low-rated securities and goes up dramatically with expanding maturities. In the event that your fund manager invests just in exceptionally rated organizations, expect a normal return in the scope of 8% to 10%. Here, the risk is additionally insignificant.

Then again, on the off chance that you invest in a somewhat low-rated however an all around oversaw fund, at that point it very well may be fulfilling. For example, organizations will in general give fairly higher coupon rates to draw in investors. Notwithstanding, there is additionally an opportunity that the fund manager's approach a company turning out badly. Thus, if a company defaults on interest installments or principal repayment or the company gets downsized further, at that point it is a misfortune for investors.

Why do Companies issue Bonds?

Corporate bonds are debt instruments, released in the market to raise funds from the investors. Like issuing stocks, debt financing is also typical for firms. Debt funds are usually cheaper and don’t have any relation with the selling of ownership stake. Companies issue debt bonds to get instant cash to meet an immediate funds requirement for business activities.

However, to issue corporate bonds, the company must show strong financials. Corporate bonds are given ratings from credit agencies based on various factors like creditworthiness, business performance, track record and more. Buyers compare the ratings before buying these bonds.

Differences Between Corporate Bonds, Stocks, And Government Securities

Stocks and bonds are two famous options available to the investors in India. Investing in stocks is a popular way, wherein companies sell some part of their ownership general investors. When it comes to investing in bonds, investors have quite a few choices like corporate bonds, G-sec bonds, sovereign gold bonds, capital gain bonds and more.

Stocks and bonds both serve to different segments of investors. Corporate bonds are issued by profit-oriented organisations and offer a higher rate of return. On the other hand, G-sec bonds provide the guarantee of payment from the government. While investing, it is important to understand the differences between the various investment instruments available to create a portfolio that give you returns in any market condition.

How to invest in corporate bonds in India?

Corporate bonds offer stable returns and the interest rate is usually higher than the government bonds, which are suitable for portfolio diversification. You can invest in these bonds through a broker or from the exchange where all the corporate bonds are listed for investment.

These bonds give you passive income and become payable on maturity.

(Also Read: Municipal Bonds)

How returns on corporate bonds are decided?

There is a debt market where various bonds are traded. In this market, the prices of various bonds can increase or decrease, just like stock markets.

For example, If a mutual fund purchases a bond and its price subsequently rises, then it can make additional returns over and above what it would have made out of the interest income alone. However, it could also go in opposite way.

Types of corporate bond funds

Generally, there are two types of corporate bond funds:

(A) Corporate bonds of high-rated companies – public sector unit (PSU) companies and banks.

(B) Corporate bonds of slightly lower rated companies such as ‘AA-‘ and below.

Let’s understand with a simple example. Suppose, a CRISIL “A” rated bond with 1-year maturity period has a 0.56% chance of defaulting and a CRISIL “A” rated bond with a 3-years maturity period has a 4.79% chance of defaulting. Generally, corporate bond funds allocate at least half of their portfolios to bonds with AA rank or lower. So, there’s always a risk of some or the other bond in the portfolio defaulting, resulting in the up-down of portfolio returns.

Points to know before investing in Corporate Bond Funds

(A) Corporate bond funds invest in corporate debentures and bonds of medium to long-term period. So, we must consider them as a long-term investment vehicle.

(B) If you are not an experienced debt fund investor, then it will be challenging for you to understand potential risks and various market movements.

(C) Remember that a large number of mistakes within a fund’s portfolio can lead to a serious fall in returns. If you invest in them, then don’t let your past-year returns affect your decision.

(D) In the case of corporate bond funds, it is better to go with the offerings of large AMCs, preferably, the top five funds. Otherwise, it's better for the new investors to go with high-rated short-term debt funds with lower credit risk.

(Also Read: Various types of Government Bonds in India)