As corporate bond funds are offering higher yields compared to bank fixed deposits, investing in these long-duration debt schemes can be a good option. However, investors must evaluate the credit quality of the portfolio and ensure that a larger portion of the portfolio is invested in bonds with ratings AA+ and above for safety.
After a series of rate hikes since May last year, the Reserve Bank of India had left the repo rate unchanged at 6.50% for the second consecutive monetary policy. The rate-setting panel also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. As a result, corporate bond issuances have spiked in the last two months.
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Attractive spreads
Most of such bond issuances can be seen in the medium-term bucket of three to five years. The spreads are indeed looking attractive, especially for investors seeking to invest with a maturity profile of between four to six years. Also, with systemic liquidity not expected to give any negative surprise as the RBI has committed to comfortable liquidity, the spreads will likely stay in current range.
Akhil Mittal, senior fund manager, Fixed Income, Tata Mutual Fund, says given the current interest rates where many corporate bond funds have comparatively higher yields, it makes a compelling case to invest in these funds. “With the belief that policy rates have pivoted, the future broader trend of interest rates would likely be downwards. Hence corporate bond funds will be an efficient way to capture the current rate cycle,” he says.
Similarly, Nirav Karkera, head of research, Fisdom, says a gradual strengthening of the macroeconomic environment warrants some allocation to corporate bonds. “While corporate bonds come along with inherent risk from perspectives of credit, duration as well as liquidity, the environment supports incremental allocation to these bonds while managing risks in alignment with the investment profile of the individual,” he says.
Corporate bonds do not offer predefined interest on investment like fixed deposits and the returns will vary based on factors such as portfolio quality, average maturity and interest rates. Harshad Chetanwala, co-founder, MyWealthGrowth.com, says due to these factors, it also offers opportunities to generate higher returns when compared to FDs. “Investors should follow a diversified approach while working on debt-based investments where some part of the allocation can be considered in corporate bonds,” he says.
Duration call
As interest rates have pivoted, longer-term investments make more sense in the corporate bond category. Investors must note that short-term investments in longish duration funds could end up with below expected performance in case the market volatility coincides with the redemption period.
Corporate bonds, unlike traditional alternatives, carry a higher degree of risk which is compensated through the higher yields. Investors must ensure that the risks inherent to bonds of choice are in alignment with their personal risk and investment profile. While conservative investors must restrict smaller allocations to AA and above-rated papers, the aggressive ones could explore credit opportunities in relatively lower rated papers.
The ideal way to mitigate duration risk is by investing in papers with a residual maturity matching the investment horizon so that it can be held to maturity. Karkera says for longer-term investors with an aggressive profile, yields are looking attractive in the four to six year tenure. “Smaller allocations could be made to papers with much longer tenure on the premise of a possibly early reversal in the interest rate regime,” he explains. “We expect rates to plateau for longer with a smaller probability of an early reversal. So, the quantum of allocation to the longer tenure could align with the same.”
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Credit risk
Credit rating is one of the important factors that determine the long-term performance of debt investment. As 80% of scheme assets under management is invested in AA+ and above rated corporate bonds, the credit quality of this category is high. However, investors must note changes in credit rating and in case of any adverse developments should reduce exposure to such funds. Mittal says that an investor should avoid taking exposure in any scheme which is running much higher credit risk in the residual portfolio.