CREDIT RISK FUNDS
Posted By: Admin
CREDIT RISK FUNDS
A Credit Risk fund would be suitable for the investor who is looking for a long term minimum 3 to 5 years of tenure and who is also ready to take risk more than other debt funds. The prime risk involved in debt fund investments is the credit risk. Credit risk refers to the risk of default by the issuer of the security in paying the principal or the interest. Low-credit rated securities have high credit risk. Hence, such securities are generally chosen by investors who have a high-risk appetite.
What is a credit risk fund?
Credit risk is a type of debt mutual funds that primarily invest (nearly 65% of your investment corpus) in low-rated market securities, typically AA-rated paper. But when you are looking for a long term, you can hold a maximum of 20% of your portfolio into credit risk.
How does a credit risk mutual fund work?
Generally, when you invest in a mutual fund, you have the option to choose between equity, debt or balanced mutual funds schemes as per your risk and tenure. In equity mutual funds, you primarily invest in stocks. Debt funds invest in fixed income securities like bonds.
Bonds are again classified as per their rating and credit quality. AAA are the highest-rated and secure bonds followed by AA, A, BBB, BB, B, etc. Credit risk funds are bonds with an AA or lower rating.
Highest rated bond will have lower risk and the lower rated bond will have higher risk.
There are two methods by which credit risk funds generate returns.
- These funds earn interest on the securities they hold.
- Secondly, since these funds invest in low-rated bonds, they create potentially high capital gains when the security rating of these funds rises.
Things to consider before investing
Yes, credit risk has some risk, but when you are clear about your holding period then you should not worry on short term volatile. If you go through hard times, you can see a better results.
(a)if you are an informed investor and have a strong understanding of when to enter and exit the market, you can likely earn good returns in credit risk fund investments.
(b) Funds with bigger AUM have a better probability at diversifying the portfolio and spreading the risk. Hence investor should consider funds from the fund house with higher AUM
(c) It is important to invest in credit risk fund whose portfolio isn’t highly concentrated. Avoid credit-risk funds that are concentrated in a single sector or business groupIf the economy continues to do well, then the low-rated corporates see good profitability and they can keep refinancing their existing loans easily. Robust equity markets have also helped some corporates to raise money and there is not much pressure to raise money by issuing bonds.
Who should invest in credit risk funds?
Even though credit risk funds are for long term investments. Hence, they can be a considerable investment if you have a high-risk appetite and want to invest for a long term of 3-5 years. Moreover, if you are an informed investor and can time their exit from the market, credit risk funds can be a good investment.
Alternatively, if you are in the high-income tax slab, investing in credit risk funds can help save on taxes. You would be paying taxes on long-term capital gains of 20% instead of 30%.
Before investing in credit risk, you should know that…
Debt mutual funds can follow two kinds of strategies to make extra returns.
(a)They can buy safe long-term bonds and pocket gains when interest rates fall.
(b) They can buy bonds with lower credit ratings (and high yields) in the hope they’ll get upgraded, or at least not default on their dues in both interest payout and at maturity.
Credit risk funds rely on the second strategy, investing over 65% of their portfolios in corporate bonds below the highest credit grade
Credit risk funds deliver their best performance when markets are over-estimating the risk of defaults or downgrades on corporate bonds. If you manage to invest in such situations, you get twin benefits – high interest receipts and capital gains on the lower rated bonds when they get upgraded or markets mark them up.
Conclusion:
Credit risk funds in India have fared poorly since 2018, after the IL&FS group default. The debt crisis has become severe with multiple downgrades and defaults by other groups such as Vodafone Idea and DHFL.
If you have an elevated risk tolerance, you can invest in a credit risk fund. A scheme with a wide asset base is preferable because it offers a better scope of diversification and risk spreading.
By Bhuvaneswari, Sherpani
Category Finsherpa | Tags Financial Freedom
