Why HDFC Corporate Bond Fund is a safe investment option

Highlighting the emergence of Covid-19 variant Omicron as a possible threat to economic growth, the RBI kept the repo rate unchanged at 4 per cent and maintained its accommodative stance yet again, in the latest policy review in December. While a near-term rate hike appears unlikely, with the rise in inflation, 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. HDFC Corporate Bond Fund is among the top-performing funds in the category. If you stay invested for over 3 years, your capital gains on redemption will be taxed at 20 per cent with indexation benefit as is with any debt mutual fund. Purely based on post-tax returns, corporate bond funds can be a good option compared to many bank fixed deposits for high-tax individuals. However, these require a higher risk appetite because, unlike FDs, their returns are market-linked.

Cap your credit risk

Corporate bond funds are debt funds that must invest at least 80 per cent of their assets in only the highest rated corporate bonds (typically AA+ and above). This ensures that the credit quality of the portfolio does not dip below a certain level, thereby lending some safety to investor returns. Apart from credit quality, one also needs to gauge the interest rate risk. The higher the modified duration of the scheme, the greater the interest rate sensitivity. That is, when interest rates rise, funds that have a higher duration (simply put, hold relatively higher maturity debt papers) get impacted to a larger extent in the form of fall in bond prices and the resultant fall in the scheme NAV.

Strategy and performance

HDFC Corporate Bond Fund follows a mix of accrual and duration strategy. That is, it derives returns from the accruing interest on the bonds in its portfolio and by modifying its duration — raising it when interest rates are expected to fall and vice versa — to benefit from the changing rate cycle. In general, while duration strategy provides potential for higher returns compared to a pure accrual strategy (say, as in a short duration fund), it also exposes a fund to greater interest rate sensitivity. HDFC Corporate Bond Fund typically keeps its duration between 1 and 5 years.

During the last six-year period since January 2016, corporate debt funds have offered, on average, one-year and three-year rolling return of 7.7 per cent (CAGR for both). Compared to this, HDFC Corporate Bond Fund has generated an average one-year return of 8.4 per cent and three-year return of 8.6 per cent (all CAGR) over the same period. Going forward, however, returns for debt funds may not sustain at the same levels, given the currently low coupons on bonds. This may change once rates start picking up.

Only schemes with a minimum of five years’ history have been considered here. IDFC Corporate Bond Fund which has been in existence since January 2016 is the youngest among those included in the analysis.

HDFC Corporate Bond Fund has provided good downside protection too. Since January 2016, the scheme has generated one-year rolling return (CAGR) of under 5 per cent only 13 per cent 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 scheme has generated 1-year and 3-year rolling returns (CAGR) of 8 per cent and above, 57 per cent and 75 per cent of the time, respectively. This is among the best in the category.

Portfolio details

The scheme fares well on the credit quality front. As of November-end 2021, HDFC Corporate Bond Fund held 96 per cent of its portfolio in AAA-rated and sovereign debt papers. The rest was in cash. Over the past few years too, the scheme has almost always held 90 per cent plus of its portfolio in such papers.

As of November-end 2021, the scheme duration was 2.74 years. This is after a gradual reduction over the past one year — from 3.35 years in October 2020 to 2.74 years now — to be well-positioned for the expected upturn in rate cycle. That said, this is higher than the duration for corporate bond funds from Kotak MF and Aditya Birla Sun Life MF, while it is significantly lower than that for corporate bond funds from BNP Paribas MF and L&T MF.

A detailed break-up from Ace MF shows that 19 per cent and 25 per cent of the HDFC Corporate Bond Fund portfolio is invested in debt papers with a residual maturity of up to a year and one-to-three-years, respectively. Another 16 per cent and 36 per cent is invested in the three-to-five-year and above five years maturity buckets, respectively.

While the allocation to above five-year maturity bonds is higher compared to many peers, the fund is likely banking on the higher yields (higher accrual income) from the longer maturity bonds.