For Anusha, the stream of losses that she incurred in her corporate bond fund portfolio came as a rude shock to her. She had purchased various corporate bonds in the last few months but what with Anusha just having started her investment journey, she missed out on a lot of details that she should have taken into account before investing. “I learnt that buying corporate bonds carries low-risk and that made me complacent. I did not bother to look at the fine print that every retail investor should take into account before investing in corporate bond funds,” she rues.

If you eyeing an investment in a corporate bond fund, here are a few things to keep in mind to ensure that you hard-earned money doesn’t evaporate into thin air.

Creditworthiness

A major risk factor that you should aim to take into account while investing in bond funds is the creditworthiness of the issuer which can give you an idea of whether the issuer can default on your payment. The default can happen in two ways – the issuer may not make timely payment of coupons or there may be non-payment of the principal at the time of maturity (face value). The rating assigned to a particular corporate bond by credit rating agencies on the basis of a rating scale can serve as a guidepost for you. A higher rating denotes a better credit quality which means the chances of default are less while a low rating should be taken as a sign of higher chance of default. It is also important to remember that a change in the rating issued by the rating agency also impacts bond prices – if the rating is upgraded, bond prices may go up and should the ratings be slashed, bond prices may slide.

Returns

Returns offered by corporate bond funds vary in accordance with the risk rating of the fund's portfolio. Should you may invest in the highest-rated bonds, you may get probable returns and seek a higher degree of immunity to market volatility than equity funds. Funds invested in slightly lower-rated bonds may also generate potential returns but they may also carry a higher default-risk. Corporate bonds also offer probable returns than government bonds because the former carries greater risk and thus offers greater potential for capital appreciation.

Beyond credit ratings

While credit ratings can act as the litmus test before you decide to zero in on a corporate bond fund, there are other intricacies too that you should not lose sight of. Even if a bond fund has top notch ratings, your capital could still be at risk should there be any changes in the issuing company that may cause a dent in its creditworthiness. For instance, if the issuer’s debt burden suddenly increases or if the company is going through significant structural changes or if it is in a consolidation phase, it may have an impact on the issuer’s liability to service bond holders. Also, if a strong undercurrent of change in the company’s situation has a bearing on its revenues, then it increases the risk factor of investing in such bonds. In a nutshell, it is imperative to keep a tab on a company’s latest moves apart from its credit rating to avoid taking unnecessary risks.

Interest rate risks

It is common for many investors, especially those who do not have in-depth knowledge about the arena of investments tend to overlook the risk posed by interest rate changes to corporate bond investments. There is an inverse relationship between market interest rates and the prices of corporate bonds. When interest rates increase, bond prices go down and when interest rates decrease, bond prices move upward and due to this the interest rate risk also varies according to the maturity period of the bond. Should you wish to prematurely sell your bond, you will have to take the prevailing interest rate into consideration because if the interest rates have moved up, you will have to sell your bind at a lower price. While investors in bond funds cannot completely immunize themselves from the volatility in interest rate because it moves in accordance with inflation, there are ways to minimize the risk of losses posed by interest rate changes. You can seek expert advice to get a clearer idea of how certain corporate bonds may be impacted by interest rate movements in a given time frame.

Liquidity

Liquidity in the bond market will help you gauge whether you can sell bonds quickly without the asset’s price crashing. To put it simply, as a bondholder, you need to know that if you want to sell your bonds, there will be buyers in the market who would want to buy it. Hence it is important to consider the liquidity of the bond market before investing because trading bonds in an illiquid market can be a nightmare as you may have to sell the bond at drastically lower prices. Also, a company’s market position and performance can also help you determine whether its bonds will be liquid. According to experts, bonds of established companies tend to be more liquid than those of smaller companies because of the perception that larger companies are less likely to default on payments.

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