If you’re an investor who prioritizes stable returns with controlled risk, you’re not alone. With interest rates shifting and credit cycles evolving, investors are exploring relatively safe options like corporate bond mutual funds and gilt funds.
While both of these are debt mutual funds, they behave differently in various market conditions. So, if you’re wondering why it makes sense to include these types of mutual funds in your portfolio, we have got you covered in this blog.
What Are Corporate Bond Funds?
Corporate bond funds primarily invest in debt instruments that are issued by high-rated companies, typically AA+ and above. As per regulations, corporate bond funds must allocate at least 80% of their assets to such corporate bonds. Their goal is to generate regular income while keeping credit risk in check, choosing issuers who are financially sound.
Mutual funds investing in corporate bonds appeal to investors looking for slightly higher returns compared to traditional fixed deposits or government securities without venturing into high-risk debt categories.
Corporate bond funds benefit when credit spreads widen and when high-quality corporates offer better yields compared to sovereign instruments.
What Are Gilt Funds?
Gilt funds invest exclusively in government securities issued by both the central and state governments. These funds do not have any exposure to corporate debt. Backed by the government, gilt funds are virtually free from credit risk.
However, these funds are highly sensitive to movements in interest rates. Based on changes in benchmark interest rates, the value of gilt funds changes. When the rates drop, the NAVs of gilt funds tend to rise significantly, and vice versa. This sensitivity to interest rates makes them attractive when rate cycles drop, but riskier during volatile periods.
Key Differences Between Corporate Bond and Gilt Funds
Now, have a look at the four key differences between corporate bonds and gilt mutual funds.
- Credit Risk
Corporate Bond Funds
These funds come with some level of credit risk as they depend on the financial strength of private companies. However, most schemes stick to high-rated bonds that minimize the probability of default.
Gilt Funds
Since gilt funds invest in sovereign debt, their credit risk is virtually zero. This makes them ideal for conservative investors who prioritize the safety of their capital over high returns.
- Sensitivity to Interest Rates
Corporate Bond Funds
While corporate bond mutual funds aren’t immune to rate changes, they are less volatile than gilt funds. Their shorter to medium-term maturities cushion the impact of changing interest rates.
Gilt Funds
Gilt funds are highly sensitive to rate changes, particularly when they hold long-duration bonds. They can deliver strong gains in an environment with falling interest rates. However, gilt funds tend to underperform sharply when interest rates rise.
- Return Potential
Corporate Bond Funds
Generally, returns come from the interest income of high-rated corporate issuers. They offer relatively stable returns, with limited upside due to conservative choices of portfolios.
Gilt Funds
These funds deliver higher returns at a time when interest rates are falling, thanks to price appreciation. However, they are not as predictable and can deliver subpar returns or even short-term losses in rising rate cycles.
- Liquidity and Market Demand
Corporate Bond Funds
The market appetite for corporate bonds largely defines liquidity. This can vary, depending on the reputation of the issuer and market conditions. During periods of stress, liquidity may be constrained.
Gilt Funds
Government securities, particularly long-term bonds, are usually more liquid due to the consistent participation from banks, insurance firms, and institutional investors.
Wrapping Up
Investors must prioritize their financial goals, time, horizon, and risk appetite when choosing between corporate bond funds and gilt funds.
Corporate bond funds are ideal for you if you are looking for relatively stable returns with manageable credit risk and lower volatility. They are suitable for those with medium-term financial goals like home renovation or educational expenses for children.
On the other hand, if you don’t want to expose yourself to any sort of credit risk and are looking for a long-term investment, go for gilt funds.
As an investor, you can strategically balance your priorities and include both in your portfolio. Evaluate market conditions and your financial goals before you invest in these mutual funds.
