We cover how corporate bonds differ from government bonds and what investors should prefer based on their risk tolerance.

The News

The inflows in corporate bonds mutual funds have risen to multi-year highs in recent months, hitting over ₹11821 crores in the past three months (Sept-Nov), compared to ₹5904 crores in Gilt (or government bond) mutual funds.

What sets these two investment options apart? How do they cater to different investor needs? And most importantly, which one should you choose?

Let’s break it down, starting with government bonds.

Government Bonds

These instruments are also known as G-Secs and they seek to provide protection against the default risk of the issuer, as they are backed by the guarantee of the government itself.

However, it costs investors with lower returns than the market. In recent times, stable interest rates by the RBI have been a crucial factor in determining bond yields—the return an investor earns on a bond.

However, the current low of 6.86% is because of anticipation regarding rate cuts, RBI’s buyback, and slowing economic growth reports.

Despite the lower yields, the inclusion of Indian Government Bonds in JP Morgan’s global bond index and the safety characteristics of government bonds instill investor confidence in them.

Corporate Bonds

Potentially high returns often overshadow the inherent higher risk of corporate bonds. The turnover of India’s corporate bond market has increased by nearly 42% in the past five years.

Investors are choosing corporate bonds over government bonds, majorly driven by improving risk-reward dynamics of AAA-rated corporate bonds. Other factors behind this growth are constant policy reforms, market exposure, and higher yields.

Corporate Bond v/s Government Bond

Bond investments can provide potential diversification for an investor’s portfolio. Selecting the best of government bonds and corporate bonds depends on investor’s return aspirations and risk appetite.

The phenomenon of the higher the risk, the better the returns is evident in the yields of these securities.

  • 10-year G-Sec yield (as of November 22, 2024) = 6.86%
  • Average yield of corporate bonds (as of November 18, 2024) = 8.78%

However, high yields are not everything, and history is evident that, in crunch situations, instruments like government bonds provided required relief to investors.

During the COVID-19 pandemic, almost all the financial aspects of the nation were hard hit by the crisis and safety was a prominent need then.

The yields, as of March 2021, indicate that government bonds offered better yields and stability during the crisis:

  • 10-year G-Sec Yield = 6.17%
  • The average yield of 5-year AAA corporate bonds = 6.11%

To Conclude

Investors should evaluate the bond ratings, yields, spread, and issuing authority to determine the suitable choice between corporate bonds and government bonds.

Government bonds provide safety and stability, making them ideal for those seeking portfolio diversification during uncertain times.

Corporate bonds, on the other hand, offer higher yields but come with greater risk, best suited for those willing to take calculated risks for better returns.