What is credit risk?
Credit risk is the risk connected with a borrower’s failure to repay the borrowed amount. In terms of returns, it is frequently offset by increased cash flows. A high credit risk bond will have a low credit rating and a high coupon rate. Lenders often evaluate borrowers’ credit risk based on their credit history, repayment capacity, loan amount or principal, loan terms, and collateral.
Top 10 Credit Risk Funds
Below is a list of top 10 Credit Risk Funds basis their 5 year compounded annual growth rate (CAGR), as on 30 June, 2022. CAGR is an effective instrument in measuring the performance of your mutual fund. CAGR. CAGR in simple terms, is the consistent rate of growth of your funds. Your actual investment may have shown a different rate of growth in different years, CAGR helps you to visualize what would have been the return on investment if your funds had grown at the same rate throughout the tenure of your investment.
| Fund Name | 5-Year CAGR |
| ICICI Prudential Credit Risk Fund | 8.07% |
| HDFC Credit Risk Debt Fund | 7.53% |
| Baroda BNP Paribas Credit Risk Fund | 7.51% |
| SBI Credit Risk Fund | 6.93% |
| Axis Credit Risk Fund | 6.77% |
| IDFC Credit Risk Fund | 6.62% |
| Aditya Birla Sun Life Credit Risk Fund | 6.60% |
| Kotak Credit Risk Fund | 6.58% |
| Franklin India Credit Risk Fund | 6.12% |
| L&T Credit Risk Fund | 5.06% |
What are Credit Risk Funds?
Credit Risk Funds are mutual funds that invest in corporate debt (fixed income) assets with a relatively poor credit rating. High-rated corporate or government bonds, on the other hand, pose a reduced risk.
Features of Credit Risk Funds
- Distribution of resources: As per SEBI, credit risk mutual funds must invest 65% of their assets in corporate bonds with a grade of less than AA+.
- Threat-compensation proportion: Low cost corporate bonds offer a higher potential of returns than bonds/NCDs with a strong credit grade. It is important to note that, credit-risk funds have reduced market risk compared to most equity mutual funds such as smallcap mutual funds. When the grades of debentures/NCDs wherein the Credit Risk Funds have invested are enhanced, these mutual fund benefit. Top credit risk investment managers monitor the median creditworthiness of such programs to reduce the risk of collapse.
Who should invest in Credit Risk Funds?
Credit risk mutual funds are associated with certain amount of default risk since they deal in bonds with a relatively poor grade. The overall effectiveness of such assets suffers in instances when the there is general downturn in the economy and the ability of the companies (in which the Credit Risk Funds have invested) to payback interest and principal is affected. As a result, even the finest credit risk mutual funds may not be optimised for low-risk clients or conservative clients.
How are Credit Risk Funds taxed?
Since Credit Risk Funds are a type of debt fund, the tax treatment for them is as follows: short term capital gains for up to three years are taxed according to the income tax slab of the investor, and long term capital gains for more than three years are taxed at 20%.
Risks involved with Credit Risk Funds
Two common types of risks make them highly volatile in the near term. They are as follows:
- Credit risk: The entire foundation of credit risk mutual funds is based on investments in assets with a relatively low credit rating because of which there is a higher probability of default associated with these assets. In other words, it is the risk that the issuer of the security will not be able to repay the principal and/or interest on the security in which Credit Risk Funds have invested. Credit risk is higher with low-quality securities. However, higher risk is also associated higher return possibility too.
- Interest rate risk: Another risk associated with Credit Risk Funds is interest rate risk, which refers to the possibility that the interest rate would diminish the value of a bond or other fixed-income debt instrument. A debt fund is a type of mutual fund that invests in fixed-income assets. Interest rate risk is related to debt funds since such fixed income yielding instruments are vulnerable to interest rate risk.
Things an investor should consider while investing in Credit Risk Funds
There are some factors that investors should examine in addition to the level of risk before investing in any of the top credit risk mutual funds.
- An investor’s goals: Credit Risk Funds invest in relatively poor assets to earn better returns than most other forms of mutual funds. Different stakeholders have different investment objectives. Individuals with a relatively lower appetite for risk may seek lesser returns than those offered by these schemes. As a result, consumers must determine their investment objectives before investing in Credit Risk Funds.
- Funds’ manager: The best credit risk mutual funds investment managers are responsible for devising successful financial plans to meet the scheme’s goals. They employ a variety of methodologies and conduct extensive reviews and studies to make sensible investment choices that affect investment returns. A financial adviser with an established reputation and several years of professional experience has the highest chance of achieving the best returns. As a result, it’s critical to look at a portfolio manager’s history.
- Expense ratio: A fee charged to investors by asset management firms to fund the program’s running and overhead costs. It accounts for a minor portion of the total investment made by you. The greater the expense ration, the lower the earnings will be. As a result, clients should evaluate the expense ratio while allocating assets to any Credit Risk Fund.
- History of the fund: Companies should look at past performance for the best credit-risk mutual funds, although they should keep in mind that past performance is not a guarantee for future returns. A plan that can generate positive outcomes from the start is likely to provide maximum performance. Though, it must be considered that previous success somehow doesn’t promise future results. History shows how the fund has fared in different economic climates.
- Plan type: Investors should understand the difference between regular and direct mutual funds, all mutual funds schemes typically have 2 schemes: (a) regular and (b) direct. Regular scheme of a mutual fund is distributed through a broker or an agent or a distributor, they get a commission for this, direct scheme on the other hand is offered directly to the investors through platforms like Kuvara (direct mutual fund platform).
In case of regular scheme the expense ration will be higher since agent/distributor/broker is charging certain amount of commission, consequently your returns will be lower. If you want higher return pick direct schemes of the mutual fund through Kuvera.
How to evaluate the best credit risk funds?
Here are some of the factors one should consider while evaluating the credit risk funds:
- Funds with a large corpus (total amount invested) are suitable for credit risk funds as they allow the asset manager to diversify the portfolio to decrease the risk involved.
- Always check the expense ratio related to the credit risk funds.
- Take help from a registered investment advisor as they can assist you with their expertise.
Advantages of investing in a credit risk fund
- An investor’s returns are generally higher: Such funds put their money into debt instruments with relative poor credit rating. As a result, they are linked to the danger of default. They have historically provided better returns that certain other category of mutual funds such as Ultra Low Duration Mutual Funds.
- Taxation benefits: Short-term capital gains from a Credit Risk Fund get taxed according to the investor’s tax bracket. On the other hand, long-term capital gains are charged at a fixed rate of 20% along with indexation benefits. This difference in taxation between STCG & LTCG is especially advantageous among unitholders within the highest income tax band because investors pay just 20% tax upon the profits, conserving 10% in taxes.
- Route of investment: These Credit Risk Funds may be purchased in two different ways: a systematic investment plan (SIP) or a single amount. If they choose the SIP mechanism, traders can deploy their cash in a scheme by spending predetermined monthly, quarterly, or yearly payments. On the other hand, a lump sum approach enables buyers to invest scheme shares with a single payment.
Disadvantages of investing in a Credit Risk Fund
- High risk: When it comes to credit risk debt funds, the possibility of default is hight if the interest rate rises sharply. Moreover, the underlying securities of this fund can also be downgraded, resulting in further loss in the investment. Overall they have higher risk than certain other categories of mutual funds such Corporate Bonds Mutual Funds.
- Not suitable for low-risk appetite investors: Investors who have an appetite to take higher risks while investing their money can invest in credit risk funds. The nature of this fund is not suitable for every investor. Traditional and low-risk-taking investors are suggested not to park their money here.
So, what would you do now that you’ve discovered that credit risk isn’t a very high-yielding investment? Would you adhere to secure investment options or take on more risk to get higher returns?
Regular investors should explore other debt mutual funds too, before making an investment decision. They predict that rates will continue to rise and that certain businesses will be affected by increasing interest rates.
After examining the overall creditworthiness of the portfolio using trusted platforms like Kuvera, informed investors can bet on credit quality funds. However, shareholders must remember that perhaps the debt issue is expected to remain turbulent for some time and that equity mutual funds will follow suit.
Pro tip: Start investing through a platform that brings goal planning and investing to your fingertips. Visit Kuvera to discover Direct Plans and Fixed Deposits and start investing today.
FAQ
-
Are Credit Risk Funds different from Debt Funds?
Credit Risk Funds are simply debt funds that invest in high-risk debt instruments. They are a sub-category of debt mutual funds. They are taxed like any other debt fund, and like other debt funds, they primarily invest in debt instruments.
-
How are they taxed?
Investors have to pay short-term capital gains tax on their investments in Credit Risk Fund if they choose to sell their units within 3 years from the date of purchase. In that case, their gains would be taxed according to their income tax slab. In case they hold the mutual fund units for 3 years or a longer period, their gains would be taxed at the rate of 20% along with indexation funds.
-
Are these funds safe for all investors?
These funds are suitable for investors with medium and high risk appetite.
Interested in how we think about the markets?
Read more: Zen And The Art Of Investing
Watch/hear on YouTube:
Start investing through a platform that brings goal planning and investing to your fingertips. Visit Kuvera.in to discover Direct Plans and Fixed Deposits and start investing today.
#MutualFundSahiHai #KuveraSabseSahiHai!
