Corporate bond funds, which invest at least 80% of the assets beneath management in AA+ and above rated instruments, have gained recognition with investors. In FY21, this category reported net inflows of Rs 69,305 crore although credit threat funds saw the highest net outflows of Rs 28,923 crore. Investors took benefit of the flexibility presented by the duration technique, and Reserve Bank of India preferred an accommodative stance to aid pursue development more than inflation.
Flight to security
Dhaval Kapadia, director, Investment Advisory, Morningstar Investment Adviser (India), says investing in corporate bond funds was perceived to be safer than investing in credit threat funds or other funds operating equivalent approaches. “The ‘Flight to Safety’ accelerated with the onset of the pandemic resulting in nationwide lockdowns and raising concerns around its economic impact, particularly on companies with lower credit ratings which could potentially increase downgrades and defaults,” he says.
In reality, immediately after Franklin Templeton announced winding up of six debt schemes investing in reduce credit rated papers in April final year, investors redeemed from credit threat funds and other funds investing in reduce credit rated instruments. It seems that some of this revenue and other fresh debt investments discovered its way into categories such as corporate bond funds and banking & PSU debt funds.
Harshad Chetanwala, co-founder, MyWealthGrowth, says investors have been more cautious in the final one year investing in debt funds. “Corporate bond funds along with banking & PSU debt funds have been top performers within debt funds in the last one year and investors have preferred short and medium maturity duration funds as the interest rates remained low,” he says.
What need to investors do now?
Corporate bond funds can be perfect for these investors obtaining a longer-term investment horizon. Investors have to look at the actual percentage of the portfolio in AA+ and above rated bonds, especially if they are concerned about security and how properly it is diversified in terms of instruments and issuers. Investors have to also look at the expense ratio as larger expenditures will cut down returns. It is especially significant in a situation exactly where interest prices / yields are low.
As a outcome of the flight to security and considerable inflows into corporate bond funds, banking & PSU debt funds and other categories holding mostly higher top quality papers, the demand for such instruments elevated as compared with the provide. In turn, this has resulted in a fall in yields of AA+ and above rated instruments, especially in the one to 3-year maturity segment.
Alongside, spreads (or extra yields) for such instruments more than government securities also decreased. These are trading beneath their extended-term averages, generating them fairly significantly less appealing from a threat-reward point of view as compared with 12-15 months ago.
On the other hand, yields and spreads on reduce rated papers (AA and be-low) stay elevated due to reduce demand.
Kapadia says yields and spreads on medium to extended duration (5 years and above) government securities and corporate bonds are hunting appealing.
“Accordingly, investors with a three to five-year horizon can consider debt allocation to a mix of corporate bond funds / banking & PSU debt funds, medium to long duration funds and a small portion in moderate credit risk funds with diversified portfolios backed by a strong investment process,” says Kapadia.
Chetanwala says investors can continue to take into account corporate bond funds in their portfolio as a element of their debt allocation. “However, they should look at the portfolio of these funds from a credit risk and duration risk perspective. Better the quality of companies in the portfolios, lesser the credit or default risk. As far as duration risk goes, we have to keep in mind that longer the duration, higher the risk,” he says.
Flight to security
Investors with a 3 to 5-year horizon can take into account a mix of corporate bond funds / banking & PSU debt funds, medium to extended duration funds and a compact portion in moderate credit threat funds
They need to look at the portfolio of these funds from a credit threat and duration threat point of view. Better the top quality of organizations in the portfolios, lesser the credit or default threat
In FY21, corporate bond funds saw net inflows of `69,305 crore