Preference for safety over the growth of capital has become an important criterion for debt mutual fund selection, and rightly so.
You may recall how the deepening credit crisis in the Indian bond markets came as a nightmare for debt mutual fund investors. Post the IL&FS crisis and default by several reputed entities like DHFL, Zee backed Essel Group, Reliance ADAG Group companies, Yes Bank, Coffee Day Group, Altico Capital, Vodafone-Idea, and the more recent Franklin Templeton fiasco, there has been a loss of confidence among debt market participants.
Therefore, it is important to analyse the quality of instruments your debt mutual fund holds. Funds that assume higher credit risk (including short duration funds) are a strict no if you cannot digest volatility and loss of capital.
A ray of hope amidst the crisis is one category that has evolved strongly over the last couple of years - the Corporate Bond Fund. Its nature of predominantly holding top-rated instruments and resistance from taking credit risk is what differentiates this type of fund from the rest.
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What are Corporate Bond Funds?
Corporate Bond Funds are open-ended debt schemes mandated to invest a minimum 80% of their assets in the highest rated corporate bond instruments. These funds predominantly invest in AA+ and above rated corporate debt securities, though they are free to hold exposure across the yield curve.
The portfolio duration of a corporate bond fund remains at the discretion of the fund manager, who assesses various micro and macro-economic factors while deciding the duration. Though there is no limit or restriction on portfolio duration, the duration for most of the corporate bond funds is typically in the range of 2 to 3 years or even higher for few funds.
Graph: Placement of Corporate Bond Funds on the Risk-Return spectrum
For illustration purpose only
Corporate Bond Funds are moderately sensitive to interest rate changes, and thus tend to witness fluctuations typically in an uncertain and rising interest rate scenario. However, they have the potential to benefit during stable and falling interest rate conditions. Although a bit stable in nature, Corporate Bond Funds come with a slightly higher interest rate risk.
And even though these funds invest in high-quality papers, it cannot be considered as completely safe from credit risk point of view. Corporate Bond Funds are ideal for investors with a moderately high risk-appetite looking to benefit from exposure to top-rated corporate bond instruments, with a time horizon of at least 3 years.
Table: Performance scorecard of Corporate Bond Fund
Data as on May 21, 2021
(Source: ACE MF)
*Please note, this table only represents the best performing Corporate Bond Fund based solely on past returns and is NOT a recommendation. Mutual Fund investments are subject to market risks. Read all scheme related documents carefully. Past performance is not an indicator for future returns. The percentage returns shown are only for an indicative purpose. Speak to your investment advisor for further assistance before investing
Corporate Bond Funds not only fare better on safety parameters, but also have impressive performance track record.
Corporate bonds (also known as NCDs) are generally issued by companies to fund their short term expenses such as working capital requirements since it is a less expensive route compared to bank loans. The higher the credit quality of the instrument, the more likely the company is to repay its loan. However, some high quality instruments may still be prone to credit risk if the issuer's financial position suddenly deteriorates.
Besides, some funds in the category may resort to having a higher allocation to low to medium quality instruments (compared to peers) to boost returns. The only downside is that they carry higher credit risk as well. You should ideally stay away from such funds.
Therefore when you invest in a corporate bond fund,determine whether the higher returns are because the fund invested in low quality instruments or through prudent investment practices.
Best Corporate Bond Funds to invest in 2021:
Some of the best performing corporate bond fund based on our analysis and research at PersonalFN that fare well on both quantitative and qualitative parameters are as follows:
These funds have shown superior performance and consistency in terms of returns and have adequately compensated its investors for the level of risk they have taken by focusing on high-quality instruments.
Here are the parameters to look into while selecting the best Corporate Bond Fund
Quantitative parameters
The fund should have a decent track record of delivering adequate and stable returns across time horizons when compared to the category average and the benchmark index. Moreover, it should be able to take active and timely duration calls to reduce interest rate risk and reward investors across interest rate cycles.
Furthermore, the fund should be able to justify the returns by generating competitive risk-adjusted returns for its investors. To determine whether the fund has rewarded its investors well for the risk they have taken, assess risk-reward ratios like Sharpe Ratio, Sortino Ratio, and Standard Deviation over a 2-year period.
So when you are shortlisting funds for your portfolio, give preference to those funds that stand strong on risk-reward parameters.
Qualitative parameters
The fund should be well-placed to determine the general maturity range for the portfolio after considering the interest rate outlook based on the economic environment (inflation, government's borrowing plan, fiscal deficit, etc.), the performance of the corporate sector, general liquidity situation, and so on.
Ensure that fund resists taking high credit risk by limiting exposure to moderate and low-rated securities and makes optimal use of portfolio diversification to mitigate risk. If your preference is safety over returns, you should consider funds primarily focusing on high quality papers issued by private entities along with significant allocation Government and Quasi-government securities to offset the risk.
The fund's portfolio should be well-diversified across securities issued by various companies and group of companies. Remember that a concentrated exposure towards a company or group of companies in the portfolio can expose you, the investor, to higher risk.
Additionally, keep a tab on the expense ratio of the fund. Moreover, since the performance of a Corporate Bond Fund depends on the fund manager's ability to accurately and timely gauge the interest rate movement and keep a check on the credit risk, determine the qualification, experience, and track record of schemes they manage.
Most importantly, always give higher importance to fund houses that follow robust investment processes and systems along with sound risk management techniques in place.
Watch this short video on the lessons an investor can remember while investing in Debt Mutual Funds
At PersonalFN, we select and recommend mutual funds based on quantitative and qualitative parameters using our S.M.A.R.T Score Matrix:
S - Systems and Processes
M - Market Cycle Performance
A - Asset Management Style
R - Risk-Reward Ratios
T - Performance Track Record
The outlook for Corporate Bond Fund in 2021:
The massive surge in COVID-19 cases across the country due to the second wave and the resultant lockdown-like restrictions in many parts of the country have hit various economic activities. With this, the ability of businesses to return to normalcy may be delayed which may result in higher chances of defaults and bad loans by private entities.
Notably, the recognition and classification norms of non-performing assets were temporarily relaxed amidst the pandemic. But as and when the relaxation is gradually lifted, the stress on corporate assets may become clearer. However, large-sized companies with strong balance sheet and healthy cashflows may be able to deal with the stress in a better way.
Since corporate bond funds invest predominantly in corporate debt instruments, it can be prone to some credit risk, depending on the quality of securities in the portfolio, though the risk will be significantly lower than credit-risk oriented fund.
Furthermore, the government's borrowing plans, India's already high debt-to-GDP, and higher fiscal deficit (which could prove inflationary) are concerning; it may push bond yields up over a period leading to interest rate fluctuation. Therefore, going forward, debt securities, having exposure to longer maturity instruments, may be highly volatile going forward.
Since most corporate bond funds have an average maturity of 2-3 years, it can be less volatile to interest rate fluctuation than long duration debt funds.
If you are looking to invest in corporate bond funds, determine its suitability to your risk appetite, investment objective, and time horizon and invest in a worthy scheme in the category.
PS: If you are looking for quality mutual fund schemes to add to your investment portfolio, I suggest you subscribe to PersonalFN's premium research service, FundSelect. Currently, with the subscription to FundSelect, you could also get Free Bonus access to PersonalFN's Debt Fund recommendation service DebtSelect.
Under DebtSelect, we give high weightage to schemes displaying worthy portfolio characteristics. We avoid debt mutual fund schemes that aim for higher yields by taking undue higher credit risk with substantial exposure in instruments issued by private issuers.
If you are serious about investing in a rewarding mutual fund scheme, Subscribe now!
Warm Regards,
Divya Grover
Research Analyst
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