8 Things To Keep In Mind While Investing In Corporate Bonds

Corporate bonds provide a source of income and the potential for capital growth. They are debt instruments companies issue to raise funds for various corporate needs, such as research and development, expansion projects, or buying back stock. Generally speaking, corporate bonds offer higher yields than government bonds while carrying more risk.

In the past two years, the global corporate bond market has been reviving from the impact of COVID-19. With returns plunging to a historic low of 27% in 2022, the market needed help with low yields and high risks. However, bonds are now ready to return, with high-credit quality bonds reaping better returns for long-term investors.

According to EY, the Indian corporate bond market is largely under-utilized, at 16% of GDP. It offers a great opportunity for investors. ICICI Asset Management Company (AMC) issued an annual report titled Annual Outlook 2023: Beginning Of A New Era, which predicts the comeback of bonds and other debt instruments.

Investing in corporate bonds can be a great way to diversify your portfolio and earn steady returns. However, it is important to understand the risks associated with these investments before diving in. Here are 8 things you should consider before investing in corporate bonds:

8 Things to Keep in Mind While Investing in Corporate Bonds

1. Understand the Credit Rating

The risk associated with corporate bonds mainly depends on the issuer's creditworthiness. So make sure to check the credit ratings with rating agencies like CRISIL, ICRA, CARE, Standard & Poor's, and Moody's for an independent assessment of the risk associated with investing in corporate bonds issued by a particular company. These credit ratings will help you determine how likely the issuer is to repay the debt on time.

An AAA rated corporate bond is considered the highest quality, while BBB rated bonds are considered the lowest-grade investments. Investing in higher-quality corporate bonds offers a degree of assurance that your investment will remain secure for the duration of its maturity.

2. Consider Liquidity

Before buying corporate bonds, consider how easy they will be to sell should you need money quickly or if market conditions change suddenly. Corporate bonds are typically less liquid than government-issued bonds, so it is important to do your research and make sure you can get out of the investment quickly if needed. 

Generally speaking, AAA rated corporate bonds are more liquid and offer more security than high-yielding, less liquid corporate bond investments. For low-rated corporate bonds, liquidity impacts 14% of a corporate bond’s yield during stable markets and nearly 30% during volatility.

3. Check The Maturity Date

The maturity period of corporate bonds may range from a few months to 30 years. Therefore, it is important to consider the potential interest rate environment when selecting corporate bonds with different maturities since longer-term corporate bonds are more sensitive to changes in market interest rates than shorter-term corporate bonds.

For example, if market interest rates rise after you purchase a bond with long-term maturity, the value of your bond may decrease because it pays lower than newer bonds being issued at higher yields. On the flip side, if market interest rates decline after you purchase your bond, its value will likely increase since it pays a higher yield than newer bonds being issued at lower yields.

4. Look For Call Protection

Another key factor to keep in mind when investing in corporate bonds is whether or not they have a call protection or a buy-back option. Call protection prevents issuers from redeeming corporate bonds before their stated maturity date. 

Call protection is important, as it can provide added security and help guard your portfolio against losses. In addition, it assures you that your corporate bond investments are securely locked in for a certain amount of time.

5. Compare Yields

Corporate bonds often offer higher yields than government-issued bonds. However, you should compare corporate bond yields to similar corporate bonds with different maturities and ratings. It can help to offset any losses associated with individual corporate bonds.

It is also beneficial to monitor economic indicators when comparing yields between different bonds. For example, interest rate fluctuations can affect corporate bonds' value and yield.

6. Spread The Risk

Investing in corporate bonds is a great way to diversify your portfolio and spread risk across numerous investments. It is important to consider not only the corporate issuer but also the quality of the bond itself. Be sure to invest in a range of corporate bonds from various issuers so that you have an adequate level of protection against potential losses or defaults.

Additionally, it is important to consider how much of your portfolio should be allocated to corporate bonds. It ensures that you have a well-balanced portfolio with enough liquidity and protection against potential losses from defaults.

7. Research The Issuer

Before investing in corporate bonds, it is important to research the company issuing the bond so you understand its financial health, business prospects, competitive position, debt load, and other important variables that could affect your investment returns over time.

You should also consider any investments in the issuer’s portfolio and their overall performance history. If the portfolio has performed poorly in past years, then it indicates increased risk in investing in the company’s corporate bonds.

8. Ensure Security

A Corporate bond’s security status defines the risk associated with it. Secured bonds are backed by collateral, such as real estate. If the issuer goes into bankruptcy or fails to repay a loan, the bondholder can use the underlying assets to recoup their losses. 

Unsecured bonds, on the other hand, are not backed by any tangible asset, and there is no legal guarantee that holders will get their money back if the issuer defaults on its debt obligations. Therefore, it is important to carefully research whether you are investing in secured or unsecured corporate bonds before making any investment decisions.

Key Takeaway

With the proper knowledge, research, and strategy, investing in corporate bonds can be a valuable addition to your portfolio. Keep in mind the essential points when making investment decisions. 

Ensure you understand the risk associated with the bond issuer, research credit ratings and market trends, assess the liquidity levels of the bonds, and prepare for interest rate fluctuations. With this information, you can confidently make wiser investments in corporate bonds. 

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FAQs

What to look for when buying corporate bonds?

You must look for the company's credit rating when buying corporate bonds. Also, consider the current yield and coupon rate to determine if it is an attractive investment. Additionally, check the maturity date and any call provisions that may affect your return. Finally, verify liquidity by researching how easily you can buy and sell these bonds in both normal and distressed markets. With careful research, you can choose a corporate bond that fits your needs and offers maximum returns on your investment.

What are the risks of investing in corporate bonds?

Investing in corporate bonds comes with the following risks:

• Credit risk as you can potentially lose the principal if the company issuing the bond defaults on its payments. 
• Interest rate risk is also a potential concern because if market rates increase, the value of existing bonds will decrease. 
• Inflation risk can also be an issue, as rising inflation can erode bond returns over time. 
• Liquidity risk is another factor to consider, as corporate bonds may be difficult to sell in certain markets.

Are corporate bonds worth investing in?

Corporate bonds are great investment options if you wish to diversify your portfolio. The risks associated with investing in them can be managed through careful research and assessment of the issuer's creditworthiness. Additionally, corporate bonds have the potential for capital appreciation if held until maturity, while it depends on market conditions.