Corporate bond funds: Assess portfolio quality, expense ratio before entry

Business Standard

19-06-2025

Corporate bond funds (CBFs) attracted ₹11,983 crore in net inflows in May, the highest among debt fund categories, according to data from the Association of Mutual Funds in India (Amfi). These funds invest in corporate bonds rated AAA and AA+, and hence carry low credit risk.
'The surge in investor interest in CBFs, leading to high inflows in May, is probably driven by relatively attractive yields compared to government securities, making high-rated bonds appealing. Ample system liquidity from the Reserve Bank of India (RBI) operations has also encouraged investment,' says Devang Shah, head – fixed income, Axis Mutual Fund.
Low default risk
CBFs are regarded as low-risk investments. According to Crisil Ratings' Default and Rating Transition Study (covering FY14–24), no AAA-rated issuer has defaulted over any three-year period. The likelihood of a AAA-rated bond avoiding a downgrade over the next one year stands at 98.83 per cent.
'CBFs invest a minimum 80 per cent in AA+ and above-rated corporate bonds. They offer lucrative yields over government securities with minimal credit risk,' says Sandeep Bagla, chief executive officer, TRUST Mutual Fund.
Competitive performance
CBFs have delivered attractive category average returns of 9.5 per cent over the past year. 'CBFs offer higher potential returns than traditional saving instruments, portfolio diversification, lower risk, professional management, and better liquidity than direct bond investments,' says Shah.
'The repo rate cuts and liquidity infusion have contributed towards the performance of these funds,' says Deepak Agrawal, chief investment officer – debt, Kotak Mutual Fund.
As of May 30, 2025, 21 CBFs together managed ₹1.95 trillion in assets.
Rate cuts drive gains
Decline in yields, in anticipation of RBI's rate cut cycle, boosted returns over the past year. Since February 2025, the RBI has cut the repo rate and cash reserve ratio (CRR) by 100 basis points each.
'Yields have declined sharply following RBI's 100-basis point repo rate cut and liquidity infusion, boosting returns on corporate bonds,' says Bagla.
Returns may moderate
With limited scope for further rate cuts, investors should temper return expectations. 'Investors should primarily anticipate stable accrual income rather than significant capital appreciation from large rate cuts,' says Shah.
The average yield to maturity of this category has come down to 6.88 per cent.
Assess portfolio
Investors must pay attention to the risks associated with these funds. 'Corporate bonds carry elements of credit and liquidity risk. While the probability of credit loss is slim, it exists, though the diversified portfolio does mitigate the impact,' says Agrawal.
Due diligence remains essential. 'Even within the AA+/AAA bracket, some instruments can carry materially higher default or liquidity risk than peers with a similar rating, making careful portfolio-level assessment essential,' says Bagla.
Agrawal suggests that investors match their investment horizon with the average maturity of the funds to mitigate the relative liquidity risk. Investors should also review the expense ratio before investing.
Suitable for conservative investors
These funds are well-suited for conservative investors. 'Conservative investors seeking stable income and individuals with a medium-term horizon could consider these funds. An allocation of 20–40 per cent to debt, including CBFs, could be considered, adjusted according to individual risk. An ideal holding period is at least 2–3 years, and preferably longer,' says Shah.