Highlighting the emergence of the changing Omicron of Covid-19 as a potential threat to economic growth, the RBI kept the repo rate unchanged at 4 per cent and maintained its consensual stance again, in its latest policy review in December. While a near-term rate hike appears unlikely, with inflation rising, the possibility of one or more hikes in the coming year cannot be ruled out.

Given the uncertainty, those with a moderate risk appetite and an investment horizon of up to 3 years can consider investing in a corporate bond fund. The HDFC Corporate Bond Fund is among the best performing funds in this category. If you remain an investor for more than 3 years, capital gains tax on redemption will be taxed at 20 percent with the advantage of comparison as with any mutual fund. Based on after-tax returns, corporate bond funds can be a good option compared to many bank fixed deposits for higher-tax individuals. However, these require a higher risk appetite because their returns are market-linked, unlike CFDs.

Limit your credit risk

Corporate bond funds are debt funds that must invest at least 80 percent of their assets in only the highest-rated corporate bonds (usually AA+ and above). This ensures that the credit quality of the portfolio does not fall below a certain level, which lends some safety to investors’ returns. Apart from credit quality, one also needs to measure interest rate risk. The higher the adjusted term of the system, the higher the interest rate sensitivity. That is, when interest rates rise, money with a longer term (simply, holding debt securities with a relatively higher maturity) is greatly affected in the form of a drop in bond prices and the resulting decrease in NAV.

strategy and performance

HDFC Corporate Bond Fund follows a combination of maturity and term strategy. That is, it derives returns from the interest accrued on the bonds in its portfolio and by adjusting its duration – increasing it when interest rates are expected to fall and vice versa – to take advantage of the changing rate cycle. In general, while a term strategy offers the potential for higher returns compared to a purely maturity strategy (for example, as in a short-term fund), it also exposes the fund to greater interest rate sensitivity. The HDFC Corporate Bond Fund typically has a term of between 1 and 5 years.

Over the past six years since January 2016, corporate debt funds have, on average, delivered a one- and three-year rolling return of 7.7 percent (the compound annual growth rate for both). In comparison, the HDFC Corporate Bond Fund had a one-year average return of 8.4 percent and a three-year return of 8.6 percent (total compound annual growth rate) over the same period. However, going forward, debt fund returns may not continue at the same levels, given the currently low coupons on bonds. This may change once prices start to recover.

Only charts with at least five years of history were considered here. The IDFC Corporate Bond Fund that has been in existence since January 2016 is the youngest among those included in the analysis.

The HDFC Corporate Bond Fund provided good protection from the downside as well. Since January 2016, the scheme has generated a one-year rolling return (CAGR) just under 5 percent 13 percent of the time. While this is not the lowest in the category, it is lower than that for many of its peers. During the same period, the program generated 1-year and 3-year rolling returns (CAGR) of 8 percent and above, 57 percent and 75 percent of the time, respectively. This is among the best in this category.

wallet details

The scheme is doing well in terms of credit quality. As of the end of November 2021, the HDFC Corporate Bond Fund held 96 percent of its portfolio in AAA rated sovereign debt securities. The rest was cash. Over the past few years too, the scheme has always kept 90 percent plus of its portfolio in such papers.

As of the end of November 2021, the duration of the scheme was 2.74 years. This follows a gradual decline over the past year – from 3.35 years in October 2020 to 2.74 years now – to be well positioned for the expected rise in the price cycle. However, this is higher than the duration of the corporate bond funds from Kotak MF and Aditya Birla Sun Life MF, while it is significantly lower than that of the corporate bond funds from BNP Paribas MF and L&T MF.

A detailed breakdown of the Ace MF shows that 19 percent and 25 percent of the HDFC corporate bond fund portfolio is invested in debt securities with residual maturities of up to one and one to three years, respectively. Another 16 percent and 36 percent are invested in two maturity pools of three to five years and over five years, respectively.

While the provisions for bonds of more than five years maturity are higher than many of its peers, the fund is likely to rely on higher yields (higher cumulative income) than bonds of longer maturity.

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