Only investors with high risk appetite should opt for them; limit allocation to 5-10%
Over the past year, credit risk funds (regular plans) have delivered a category average return of 7.45 per cent. These funds are required to allocate at least 65 per cent of their assets to corporate bonds carrying below-highest ratings.
Their fund managers often go down the credit quality curve in the quest for additional returns. Currently, there are fourteen funds in this category managing total assets of Rs 23,141.4 crore. Investors should consider not just past performance but also the inherent risks of these funds before investing in them.
Some of these funds recouped investments that were previously written off. “This contributed to their current double-digit returns,” says Vivek Banka, co-founder, Goalteller.
According to him, foreign institutional investor flows into Indian corporate bonds, driven by improvements in ratings, will positively affect the performance of these funds.
Key risks
Inflation could take longer than expected to soften. “If geopolitical tensions intensify and crude oil prices exceed $100 per barrel, or if the monsoon is unfavourable, inflation could rise, reducing the likelihood of rate cuts”.
Following the IL&FS debacle, many credit risk funds have become safer.
“However, as investors seek higher returns, some funds may lower their credit quality standards, leading to defaults and negative returns in the future,” says Vivek.
Who should invest?
Vivek Investors should limit exposure to these funds to 5-10 per cent of their total debt fund allocation. Those with a low risk appetite may avoid them entirely. Banka advises against investing in funds within this category that have high expense ratios and portfolio durations exceeding three years. Finally, before investing, review a fund’s bond holdings to understand its risk level.
He recommends that individuals in lower tax brackets, who can hold these funds for 12 to 24 months, should consider investing in them. With gains being taxed at the slab rate, the risk-return may not be advantageous for those in the highest brackets.
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