Credit rating is critical while investing in corporate bond funds

According to a report by Crisil, the Indian corporate bond market can double by 2025. But the truth is the Indian bond market is still in a nascent stage. However, the consistent effort by the government and Sebi in the last few years has aided the corporate bond market to move in the direction of maturity. With the recent RBI’s announced Retail Direct Gilt (RDG) account, a common investor can now purchase and sell bonds through the bond-buying window; this indicates that the bond market in India is evolving.

For the low-risk averse investors or the investors searching for low-risk investment choices, corporate bond funds are considered a good alternative amongst other fixed-income products. Courtesy, this fund with a high rating is usually financially sound and has a good chance of repaying its creditors on time. Corporate bond funds which are debt funds are required by regulation to invest at least 80% of their assets in corporate bonds with the highest credit rating of AAA.

“Broadly, the three main factors for selecting corporate bond funds are Safety, Liquidity, and Return. In any investment, risk and return go hand in hand; thus, return expectation should be according to the risk profile of the individual investor,” said Abhishek Bisen, Debt Fund Manager, Kotak Mahindra Asset Management.

It is essential to understand why credit rating is critical while investing in corporate bond funds as an investor. Let’s take a look:

– Corporate bond funds are an open-ended debt fund that invests primarily in highly rated corporate debt. Credit ratings, on the other hand, are crucial when investing in corporate bond funds.

-As mentioned earlier, Indian bond markets are still somewhat hazy; investors have a limited understanding of the company’s borrowing activities. Further, this scant information often leads to misinformation by presenting a rosy picture of the borrowing organisation.

-To handle this situation, the concept of credit ratings was introduced to grade the bonds, so investors can know whether a company is genuine or not.

-In India, bonds, and debentures are rated by credit rating agencies such as CRISIL, ICRA, and CARE.

-Corporate Bonds are rated by independent Credit Rating Agencies (CRAs), which SEBI regulates. Simply put, the bond rating is a grade assigned by CRA to a particular bond that indicates its credit quality.

– “The CRAs take into account the Company’s credit profile, which is primarily financial health and flexibility while assigning the rating. Some of the other factors which get into assessing credit profile are – industry risk assessment, business risk analysis, financial flexibility, management assessment, and parentage of the issuer. There may be bond specific assessment also such as – security/ guarantees, terms, covenants, etc. for an underlying bond,” explained Bisen.

-When a company wants to raise money, they issue bonds in the market. These bonds are further given credit ratings from AAA rated (highly stable) to D (junk bonds).

-Your corporate bond fund manager will verify the bond’s credit rating and invest only in AAA-rated securities. According to SEBI, corporate bond funds must invest at least 80% in AAA-rated debt.

-Investors also need to consider the investment tenure for investing in bond funds as different categories of Bond Funds are suited for different time frames of investment. An investor needs to be cognizant of credit and interest rate risk in a bond fund and should invest as per investor’s risk appetite,” said Bisen.