Credit Risk Funds: Higher Yield Debt Fund Investment

What is a Credit Risk Funds ?

A credit risk fund is a debt mutual fund investing a major part of its portfolio in debt instruments below the highest-rated instruments. Since such instruments carry credit risk, they offer a higher interest rate.

Advantages of Credit Risk Funds

Good returns

To compensate for the higher credit risk, the underlying securities offer higher returns which add to the portfolio allowing you to earn good investment returns.

Liquidity

Credit risk funds usually invest in short-term debt instruments to limit the exposure to credit risk. Hence, they offer good liquidity

Capital appreciation

If the rating of the underlying securities increases, their value also rises. This helps in generating capital appreciation for investors.

Taxation as per Income Slab

Being debt mutual funds, their returns are taxed according to the investor's applicable income tax slab.

Credit Risk Funds Returns Calculator

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Understanding Credit Risk Funds

Table of Contents

What are credit risk funds?What are the features of credit risk funds?Things to keep in mind when investing in credit risk funds What are the types of risks that credit risk funds face?What is the tax implication of credit risk funds?What are the payout options?

What are credit risk funds?

A type of open-ended debt mutual fund, a credit risk fund is one that invests a minimum of 65% of its portfolio in debt securities which carry AA or below credit rating. Since these securities are not highly rated, the fund has an element of risk for investors.

What are the features of credit risk funds?

High credit risk due to the nature of the portfolio
The potential of return generation is high since low-rated securities have higher interest rates
There’s no capping on the maximum investment amount
You can get better returns compared to fixed deposits
The funds aim to grow the portfolio through interest earned and also through the rise in the price of the underlying securities

Things to keep in mind when investing in credit risk funds

Check the expense ratio of such schemes. A high ratio eats into the fund’s returns and should be avoided

Compare credit risk funds on their returns. A fund with the highest return is better

Check the portfolio for the credit rating of the underlying securities. A fund with securities carrying a good rating is better

You might incur short-term losses if the bond values fall in the short-term

What are the types of risks that credit risk funds face?

Credit risk

Risk of default on the debt instrument
Interest rate risk

Risk of rising interest rates, which reduces the value of debt instruments
Inflation risk

Risk of inflation reducing the returns from the debt fund
Liquidity risk

Risk of not being able to trade in debt instruments

What is the tax implication of credit risk funds?

Returns earned are taxed at your income tax slab rates
Dividends earned, if any, are taxed at your income tax slab rate

What are the payout options?

Dividend option

Earn dividends on your investment at regular intervals
Growth option

Accumulate the returns over the investment tenure and get a lump sum amount on redemption

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FAQs On Credit Risk Funds

Credit risk funds are debt mutual funds that invest at least 65% of the investment in low-rated companies. What happens is that these companies pay higher interests as a means to compensate for lower credit ratings.

At a higher risk, credit risk funds can potentially offer better returns than bank FDs and quite a few other instruments in the short run.

Like any other category of debt mutual funds, credit risk funds are taxed as capital gains. Investments with a holding period of less than 36 months are taxed as STCGs (short-term capital gains) as per prevailing tax rates upon redemption. Meanwhile, redemption payouts from investments held for 36+ months, classified as LTCGs (long-term capital gains), are taxed at a rate of 20%.

Yes, credit risk funds carry a significantly high amount of risk compared to a lot of other debt funds.

Depending upon the specific fund, you can invest in credit risk funds via SIP or lumpsum