Here are the Best Corporate Bond Funds for 2017:
Corporate bond funds offer investors a range of options to choose the best risk-return combination. That’s why you may find these as one of the components of a well-diversified portfolio. The corporate bond fund, an open-ended debt fund, invests essentially in corporate bonds of public and private sector companies.
A corporate bond represents a debt of the issuer company. Whenever a company is in need of funds, it can choose to issue equity shares. The other way is to borrow funds. Using corporate bonds, the company raises funds for the particular purpose. The purpose may be open a new factory, boost the advertising campaign, enter the new market segment, etc.
The corporate bond fund makes money for the unit holders by investing in these corporate bonds. The fund objective is to generate accrual income along with preservation of capital.
The fund generates accrual income via periodic interest receipts. The bond issuer company promises to make interest payments to the bond fund at regular intervals.
The quantum of interest to be received depends upon the coupon rate. Coupon rate can be found on the face of the bond. Thus, a 6.5% corporate bond would pay semi-annual interest to the bond fund at 3.25%.
The bond fund, in turn, provides regular income to you out of these interest receipts. The fund earnings are distributed as per the mode chosen by you. You may wish to receive dividends. Or let the bond fund purchase additional units from that money for you.
Another objective of the bond fund is to protect the capital of investors from erosion. It allocates your money in high investment grade corporate bonds. Due emphasis is placed on choosing high-yield bonds of good credit quality and liquidity.
Corporate bond funds are, thus, favourites among the risk-averse investors. Additionally, these are used to provide a sound base to the equity-oriented portfolio.
In comparison to equity funds, corporate bond funds are less-aggressive investment havens. You may find the equity funds to have a double-digit standard deviation. But this is not the case with corporate bond funds. The standard deviation of these funds may hover around single digits.
Corporate bond funds generate lower returns than equity funds. However, these funds yield higher returns compared to GILT funds. The primary reason behind this is the former being riskier than the latter.
GILT funds are composed of sovereign bonds, and AAA-credit rated securities. But corporate bond funds may hold securities carrying a range of credit ratings. These can be as high as AAA to as low as BBB-.
Corporate bond funds need to be viewed as long-term investment vehicles. These funds invest in corporate debentures & bonds of medium to long term tenure. The average maturity of the fund holdings ranges from 3 to 7 years.
Average maturity refers to the average time taken to realise funds invested in the security. It’s believed that funds having shorter average maturity are better than longer maturity funds. In this way, you will get back the investment in lesser duration.
Fund managers adjust the average maturity of the bond fund as per interest rate fluctuations. They may increase/decrease the proportion of the existing fund holdings. They may incorporate new bonds/debentures as and when the external environment changes. In this way, average maturity varies with addition/deletion of securities.
Valuation of Corporate bond funds
These bonds funds are subject to interest rate risk & credit risk. Any increase/decrease in the interest rates would decrease/increase the price of the bonds. A decrease/increase in bond price leads to rise/fall in the bond yields. It interprets as the volatility of returns generated by the fund.
Before investing in any bond fund, check the coupon rate of fund holdings. Fund having holdings of higher coupon rates are less vulnerable to interest rate fluctuations. Conversely, funds having holdings of low coupon rates lose considerable value each time interest rates rises.
As regards credit risk, you need to examine credit ratings of fund holdings. A fund having more number of AAA-rated holdings is considered a safe investment. Conversely, a fund having low-credit-rated securities is a risky one. The chances of default on payment are higher in such funds.
Funds having higher duration, take greater time to generate cash flows on investment. Additionally, these are more susceptible to volatility owing to interest rate fluctuations.
Conversely, funds having shorter duration generate cash flows quickly on the invested amount. The fund NAV will fluctuate less frequently. There will be minor erosion in the fund value.
You need to match the fund’s duration with your investment horizon. It will keep fund returns in line with expectations. It ensures financial goals accomplishment along with proper channelization of funds
3. Fund Returns
An ideal bond fund needs to generate stable returns year after year. Funds giving higher performance consistently are considered superior. In contrast, funds offering lower/volatile returns are considered inferior.
Compare the fund returns with the benchmark and peer funds. Funds outperforming the benchmark most of the times are superior to others.
4. Expense Ratio
Expense ratio refers to the costs of managing the fund including fund manager’s fee. High expense ratios cut into your fund returns. An ideal fund is one having the lowest expense ratio. It will ensure that your overall returns are maintained at higher levels.
5. Beta and Alpha
The beta of the bond fund indicates how much the fund gains/lose each time the index moves up/down. The beta of 1 means fund replicates index movements. Higher beta means fund gains/lose more than the benchmark during the boom. Lower beta indicates fund gains/lose less than the benchmark during the burst.
Combine lower and higher beta bond funds in your portfolio. During up markets, the higher beta bonds will keep returns buoyant. During down markets, low beta bonds will prevent fund value erosion.
Alpha relates to excess fund returns in relation to benchmark. Fund having high alpha and low beta is the best combination than otherwise.
6. Risk-adjusted returns
A corporate bond fund needs to give higher return per unit of risk assumed. Sharpe and Sortino Ratio reflect the risk-adjusted performance of bond funds. Choose a fund that has higher Sharpe and Sortino ratio.
Following are top 5 corporate bond funds shortlisted after an in-depth analysis:
SBI Corporate Bond Fund is meant for those seeking high risk-adjusted returns. It has the relatively low beta and highest Sharpe ratio. Birla Sun Life Medium Term Plan is the most aggressive fund with the highest standard deviation. However, it has given highest annualised returns year-after-year.
Mutual fund returns are subject to market risk. Please consult your financial advisor before investing.