How Should A Credit Risk Fund Be Selected By Investors?

In this article, we shall explore how a credit risk fund must be selected by investors. But first, a little more about what credit risk funds are all about.

Credit risk funds are a type of debt-oriented mutual funds that invest in securities that have a lower credit rating, thus giving them the name ‘credit risk’ funds. Credit risk funds in India are mandated to allocate at least 65% of their portfolio in debt instruments which are rated less than ‘AA’.Lower credit rating indicates lower credit quality as lower the rating, higher is the possibility of default. The risk-return tradeoff suggests that returns increase with a potential rise in risk. This makes investors perceive credit risk funds as high risk-high return investment opportunities.

Before investing in credit risk funds, investors should know that the portfolio of these schemes are associated with high liquidity risk. If some bonds which have a low credit-rating default, it will be difficult for the fund manager to find buyers for such bonds and sell their holdings.Such schemes operate on the premise that the attractive returns offered by junk bonds make up for the losses arising out of a few companies defaulting. Therefore, investors must stay away from schemes that have a portfolio which is highly concentrated or focuses on debt instruments of companies having similar credit-ratings.Another important aspect that investors must examine before investing in a credit risk scheme is the fund manager’s background as well as his or her association with the scheme. The experience and expertise of the fund manager matter here as these funds need to be actively managed.

Debt mutual funds are generally perceived as relatively safer investments. Despite being debt-oriented, credit risk funds come with a significant element of risk. Therefore, credit risk funds are more suited to those fixed-income investors that have a slightly higher risk appetite.Credit risk funds are thus not meant for completely risk-averse investors due to the riskiness attached to low-rated instruments. Investors who are to have an aggressive investment approach but prefer lesser risk than equity and equity-oriented funds fall in the sweet spot that credit risk funds have to offer. In Conclusion Although credit risk funds pose as a favourable investment opportunity, one must examine crucial details like the fund manager’s track record, investment objectives, one’s own investment goals, risk profile, portfolio, etc. so as to make an informed decision.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.