Why must you invest in Corporate Bonds?

With interest rates constantly declining in India, leading to stubbornly low returns from fixed or term deposits. Many investors continue to be faced with the question of where to invest for income in low yield environment.

Corporate Bonds – debt securities issued by companies – can diversify portfolios and generate a higher income return than term deposits and hence should be considered as a viable investment option for investors looking for a stable income.

  1. A strong buffer against share market volatility
    Corporate bonds can be a lower-risk way to gain exposure to corporates than equities because they pay investors relatively stable cash flows. So, when investors allocate a part of their portfolio to corporate bonds, it can make their portfolio ‘defensive’ – returns will be smoother and less volatile, particularly times of equity market turmoil.
  2. Higher-income than term deposits
    Corporate bonds are expected to provide investors with a relatively high excess yield over term deposits. However one should note, that a corporate bond can have different risk profiles as compared to a bank term deposit and investors should make a decision based on returns expected and risk appetite. In addition, given sound company fundamentals, corporate bonds are well-positioned to benefit from the continued recovery in the global economy.
  3. Risk of capital loss is reduced
    Active bond managers use multiple levels to manage downside risk, particularly in a rising interest rate environment. Primary amongst these is the ability of a manager to adjust the bond portfolio’s ‘duration’. Duration measures the sensitivity of a bond’s capital value to change in interest rates in years. For example, if a bond has a duration of five years, its price will rise if the interest rates drop and vice versa. Given this multiplicative outcome, corporate bonds with higher durations carry more risk and have higher price volatility than bonds with lower durations.
  4. Access to the benefits of diversification
    Investors in an actively managed corporate bond fund can spread their portfolio risk by being exposed to a range of issuers, industries, and geographies. Typically, when investors have exposure to a large number of securities, it minimizes the impact of default or systematic event on the portfolio.

Other considerations:

Corporate bonds are traditionally considered lower down the risk spectrum than equity shares. Nevertheless, when investors explore investing in corporate bonds it is prudent to have a focus on the investment-grade credit.

It is important to invest in companies with strong or improving corporate fundamentals, a solid management team with a bondholder focus, and where normalisation of global growth could translate into revenue and earnings growth.

Leave a Reply