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Investments in credit risk funds: what should you know?

Interested in learning more about credit risk funds, their performance, taxation, and returns? Read more about credit risk funds and factors to consider before investing.
credit-risk-funds.

In the debt mutual funds category, many credit risk funds have been among the top 10 performers in the two and three-year returns categories. In this article, we will learn all about credit risk funds, the factors you should consider for investing in them, their returns and taxation.

What are credit risk funds?

A credit risk fund is an open-ended fund that primarily invests in below highest-rated corporate bonds. As per SEBI guidelines, a credit risk fund has to invest a minimum of 65% of its total assets in below highest-rated corporate bonds.

For example, AAA is CRISIL’s highest rating. In this case, a credit risk fund will have to invest a minimum of 65% of its total assets in corporate bonds rated AA and below.

Investors should note that the lower the credit rating, the higher the risk of default. As the risk involved in credit risk funds is high, these funds are meant for investors with a high-risk appetite. As credit risk funds carry high risk, the investors expect higher returns from them compared to other debt funds.

Factors that you should consider for investing in credit risk funds

Some of the factors that you should consider while investing in credit risk funds include the following:

            Comparison of credit risk funds and corporate bond funds

            Not all debt funds are the same in terms of risks and returns. Credit risk funds and corporate bond funds are often compared. Let us look at the differences between the two.

            FeatureCredit risk fundsCorporate bond funds
            What is it?An open-ended debt scheme that has to invest a minimum of 65% of its total assets in below highest rated corporate bonds.An open-ended debt scheme that has to invest a minimum of 80% of its total assets in highest rated corporate bonds.
            Suitable forSuitable for investors with a high-risk appetite.Suitable for investors with a low-risk appetite.
            ReturnsInvestors expect relatively higher returns as these funds follow a high-risk, high-return strategy by investing in below highest rated corporate bonds.The return potential is relatively lower as they take a lower risk by investing in highest-rated corporate bonds.

            Performance of credit risk funds

            Let us look at the returns given by credit risk funds.

            Scheme nameAUM (Rs. crores)1-year3-years5-years
            ICICI Prudential Credit Risk Fund7,9034.94%7.93%7.93%
            HDFC Credit Risk Debt Fund8,6153.56%7.84%7.43%
            Baroda BNP Paribas Credit Risk Fund2014.56%8.96%7.40%
            SBI Credit Risk Fund2,9164.02%6.86%6.79%
            Axis Credit Risk Fund6524.00%7.19%6.60%

            Note: The above returns are as of 14th October 2022. The funds are for direct plans with growth option. The one-year returns are absolute. The three and five-year returns are CAGR. The funds have been ranked based on five-year returns.

            How much should you allocate to credit risk funds?

            You may allocate some portion of your investment portfolio to credit risk funds as per your risk profile and asset allocation.

                Please note the above percentage allocation are thumb rules, and the actual percentage may vary from individual to individual depending on circumstances.

                Taxation of credit risk funds

                Credit risk funds are a sub-category under the broader debt funds category. Hence, credit risk funds are taxed as debt funds.

                    Measures taken by SEBI and fund houses to protect investors

                    During 2018-20, there was a spate of credit defaults on corporate bonds. The credit risk funds and their investors had to bear the brunt of these defaults. Post these defaults, SEBI and fund houses have taken some measures in the interests of investors.

                      SEBI has mandated credit risk funds to invest 10% of their total assets in liquid assets such as Government securities (T-bills and bonds), cash, etc. The move will help enhance the liquidity of credit risk funds to meet redemption pressures if any.

                      Chart: Rise in liquid holdings of credit risk funds

                      The above chart shows how credit risk funds have increased their liquid holdings much higher than the 10% SEBI mandate.

                      2. Reduction in issuer concentration

                      Many credit funds have reduced their issuer concentration. So, now the percentage of net assets held by the top three and top five issuers has gone down. It has made the credit risk portfolios more diversified, thus reducing the risk for investors.

                      Chart: Reduction in issuer concentration

                      The above chart shows how the percentage holdings of the top three and top issuers have come down.

                      Allocate a small portion of your portfolio to credit risk funds

                      In this article, we have discussed how credit risk funds follow a high-risk, high-return investment strategy. Although credit risk funds have seen a spate of defaults in 2018-20, the current situation is better. Factors in favour of investing in credit risk funds include deleveraged corporate balance sheets, increase in interest rates, reduction in top issuers concentration, SEBI guidelines on maintaining 10% liquid assets, etc. Hence, if you have a high-risk appetite, you may allocate a small portion of your investment portfolio to credit risk funds.

                      Investing in mutual funds with the Glide Invest App

                      In this article, we have understood credit risk funds and whether you should include them in your investment portfolio. You can partner with the Glide Invest App for your financial planning journey to get recommendations for the appropriate mutual fund schemes based on your risk profile. You will get advice on planning and systematically investing towards your financial goals

                      With Glide Invest, you will get guidance for:

                        To start investing towards your financial goals, download the Glide Invest App from Google Play Store or Apple App Store and get started.

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