Corporate bonds are longer-term debt instruments issued by companies to raise money for business expansion. These debt instruments usually have a maturity date of at least a year after issue. Corporate bonds with a shorter maturity are known as commercial papers.

If you are willing to take some risk and do some research, corporate bonds funds can offer recurring income. Many investors think that investing in corporate bonds is a low-risk, low-yield proposition. However, corporate bond funds can be risky at times. You can avoid the risks by investing in professionally managed corporate bond funds.

Significance of Corporate Bonds Funds

Usually corporate bonds funds choose bonds based on ratings and market sectors. Public bonds are rated on a scale from AAA to CCC. AAA corporate funds are of investment grade that can be compared to US Treasury bonds. CCC rated bonds or junk bonds offer higher yield, but involve a high risk of default (when the issuer of the bond fails to make payments). Corporate bonds are classified into two major groups, namely short term bonds and long term bonds. Long term bonds offer higher yield and carry higher risks.

Considerations

• You should compare corporate bonds based on projected returns and the fees involved.
• Taxes on corporate bonds are higher than those on US Treasury bonds.
• The values of these bonds can decline if the issuer enters into default or partial default conditions.
• When you are investing in a bond fund, it is better to do enough research on individual bonds that comprise the fund.
• When a bond is investment grade, it does not mean that the bond will retain its grade through the maturity period.

High Yield Junk Bonds

If the corporate bond funds you are going to invest in are termed as “high-yield,” you should be very careful. Highly risky junk bonds that have a rating of BBB or lower can offer high returns in a strong economic environment. However, investing in this sort of corporate bond funds can become very dangerous in bear markets.

Despite the risks that corporate bonds funds carry, they offer higher liquidity than investing in individual bonds. You can exit positions when you find you are undergoing losses. In case of a substantial drop in value, you can put a stop-loss order any time on your corporate bonds to protect your investments. Corporate bond funds let you enjoy the stability and good returns of bonds without taking much risk, as long as you keep a keen eye on your positions.

Benefits of Corporate Bonds

Here are some benefits of corporate bonds:

1. Attractive yields: Corporations generally offer higher yields than government bonds of the same maturity.
2. Dependable income: Corporate bonds offer investors the opportunity of a steady income, while preserving the principal.
3. Safety: Credit rating agencies, like Standard & Poor’s and Moody’s, rate corporate bonds according to associated risk and rewards. Ratings reflect the capability of the issuing authority to deliver timely returns. Higher the rating, safer the investment.
4. Diversity: An investor can choose from a variety of sectors and credit-quality characteristics.
5. Marketability: Most corporate bonds sell easily and quickly due to the market’s size and liquidity.

Drawbacks of Corporate Bonds

While corporate bonds offer a higher yield than some other investments, they are also accompanied by higher risks. These include:

1. Interest Rate Risk: Interest rate movements can significantly reduce the value of the bond.
2. Credit Risk: Corporate bonds are not secured by collateral. Thus an investor faces the risk of a corporation failing to meet the debt obligation.
3. Event Risk: Corporate bonds have exposure to event-based risks. Corporate reshuffles, takeovers or restructuring have far reaching consequences on the credit rating and price of such bonds.
4. Call Risk: Callable corporate bonds can be a nightmare when the issuer declares the purchase of bonds after a stipulated time period. Corporations usually call off a high-yielding bond when interest rates plummet. This gives the company a chance to reissue bonds at lower interest rates. In such cases, an investor receives only the par value of the bond.