Credit Risk Funds : What Are They ? Should you Invest ?

Are you an investor of Debt Mutual Funds? If so, then you might have heard about the credit risk. However, you may surprise with an idea of how much credit risk be utilized by debt mutual funds. These Credit Risk Funds are new types of funds, which utilize the credit opportunity.

A Credit Risk Fund has suddenly gained popularity among investors as recent credit rating downgrades of bonds. We shall cover everything from which you'll get a fair idea about Credit Risk Funds

What is Credit Risk Fund?

These types of mutual funds which invest in corporate bonds with a lower rating, hence are risky in nature.

• Also known as Credit Opportunity Funds these are Type of debt fund, which is having Credit Risk Fund is having a separate category. 
• These are funds which invest in low rated, medium to long-term debt instruments with an aim of generating a higher yield. Credit Risk Fund invests at least 65% of its asset in corporate bonds having rating AA or below. 
• These types of fund are expected to generate higher returns as it takes a higher risk of investing in low rated bonds. These funds generate 2-3% higher returns compared to risk-free corporate bonds

How do these funds work?

Usually, mutual fund investors prefer to invest in the high rating funds (having rating AAA and above) investor may get low returns on investments. But this fund invests in debt instruments especially in the corporate bond with a rating below AA and securities. The primary idea of this fund is to generate higher returns by taking a higher risk. The fund manager selects the fund having strong fundamental or various prevailing factors.

Returns of Credit Risk Funds

Credit Risk fund gives returns in two ways 

• Returns by accruing the coupon (interest) payments on security on hold
• Capital appreciation at the time of rating upgrade.

As the chance of an upgrade in rating is high during an economic recovery period. It advisable to avoid these type of funds during an economic slowdown.

Things to consider while investing in Credit Risk Funds

1. This fund comes with the inherent credit risk of a rating downgrade. In case of rating downgrade fund may not generate expected returns.
2. If you are not a market-savvy person, you should make yourself away from these types of fund. You can go for diversified mutual funds.
3. You should select a fund with a reputed and experienced fund manager.
4. Investors should also look at a fund with a lower expense ratio.
5. Make sure to select large-sized funds. It is because higher the corpus better scope of manageability.
6. The portfolio should be well distributed and not concentrated. It reduces the risk of credit incident.
7. Dividend from this scheme is exempted provided fund pays DDT. LTCG and STCG are applicable to this fund.
8. These types of funds are more suitable for high-risk high returns investors.

Should you invest in Credit Risk Fund?

As we are discussing that Credit Risk Fund comes a with high-risk high return in spite it is a debt fund. so we'll categorize into two part 

New Investors  

These types of funds are not for new investors or investor with low-risk appetite. An investor looking for steady income and low risk also should stay away from these funds. 

Experienced Investors Or Active Investors

If you are having a good market knowledge and surplus money you can go for these type of funds. It can be ideal for a person with the highest tax bracket and planning to invest in this fund as they need to pay 20% LTCG instated of 30% tax. 

We are not advising to have your exposure to these type of funds more than 20% of your portfolio, and you should always consult a financial advisor or experts before making any investment in credit risk fund.