Is it time to invest in corporate bonds?

By Morningstar |  18-06-18 | 
 

Last week, a post in the media stated that amid rising interest rates, investors are dumping debt funds and looking towards fixed deposits and retail bonds. So should you be looking at Corporate Bond funds or Credit Risk funds?

According to the new fund classification, a Credit Risk fund will invest a minimum of 65% of its assets in corporate bonds. While a Corporate Bond fund will invest a minimum of 80% of its assets in corporate bonds.

If you go by the above allocation, the Corporate Bond fund would appear to be more risky. However, the Corporate Bond fund will balance its risk by investing only in the highest rated instruments (AAA). On the other hand, the Credit Risk fund will invest a lower portion in corporate bonds but will do so in those which are not the highest rated (AA or lower).

Three heads of debt at mutual funds tell us what they believe is the apt move for investors right now.

Yes. We believe that the time is apt for the investors to consider investing in corporate credit funds.

- Santosh Kamath, Managing Director, Local Asset Management – Fixed Income, Franklin Templeton Investments, India

WHY?

On the macroeconomic front, oil prices have moved up, the rupee has depreciated, and higher Minimum Support Prices (MSPs) are likely to push inflation up in FY19. Recently the RBI raised the interest for the first time since January 2014, citing higher core inflation. The market is expecting further rate hikes during the year.

However, GDP numbers for Q4FY18 indicate that the domestic economy is beginning a productive growth phase. Better upgrade to downgrade ratio along with economic growth would provide opportunities to find mispriced corporate bonds.

Higher accrual and lower volatility make corporate credit funds a good investment option in the current environment.

Preference should be for short- and medium-term funds that largely invest in high quality bonds or sovereign paper.

- Suyash Choudhary, Head - Fixed Income, IDFC Mutual Fund

WHY?

We strongly think that this is an opportune time to de-risk fixed income books and focus on short term and medium term AAA / sovereign oriented strategies. Spreads on lower rated assets have actually compressed over the past year as AAA / sovereign rates have adjusted the most sharply upwards. Thus value has conclusively shifted in favour of high quality bonds. Also, given rising global financial volatility and tightening financial conditions it is prudent to favor higher quality versus lower rated strategies as a means to also build some ‘counter-cyclicality’ in fixed income books. Hence preference should be for short term and medium term funds that largely invest in AAA / sovereign paper only.

We believe there is still some way to go before high quality bonds become a compelling buy.

- Dhawal Dalal, Chief Investment Officer - Fixed Income, Edelweiss Asset Management Ltd

WHY?

Yields of high quality (HQ) corporate bonds maturing in two to five-year tenor have hardened in the last six to nine months due to a number of reasons. Higher inflation, strengthening crude oil prices, prospects of higher government borrowing to fund increasing government expenditures, FPI outflows, demand-supply imbalance in the bond market, etc. have been challenging for the bond market. As a result, yields of 3Y AAA PSU bonds hardened by around 95 basis points since the beginning of the year to around 8.45% by May 31, 2018 according to Bloomberg data.

While the corporate bond yield curve has more-or-less adjusted to the present macro-economic landscape and has probably factored in some amount of tightening by the RBI, we believe global macro-economic landscape is presenting a fresh set of concerns for the Indian financial markets.

We recommend that investors approach investments in high quality corporate bond funds in a staggered manner and spread out the investments over a number of months in order to average out their investments and get invested by the time yields are closer to their peak.

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