Financial Planning

When it comes to investing, investors have a variety of options to choose from. Within the debt universe itself, there are a variety of offerings based on the risk appetite and timeframe one is ready to stay invested. In every portfolio, debt has an important role to play. This is especially true in times of turbulence. For instance, when the global economic crisis struck in 2008, the equity return for the year was -51 per cent while the return from debt instruments stood at 28 per cent. Similarly, during the onset of the pandemic, debt was largely resilient in nature. 

While most of the debt mutual fund categories are for a risk-averse investor, there exists one category which can be worth consideration for investors who are willing to take marginally more risk. In return, they can potentially get extra returns that could beat all the debt mutual fund categories. This scheme in this category is known as the credit risk fund. Engaging in a tightrope walk between risk and gain, credit risk funds are known as optimizers that take advantage of credit opportunities that come up in the fixed income space.

What is a Credit Risk Fund?
As per the scheme category rule set out by market regulator SEBI (Securities and Exchange Board of India), this is a fund wherein the fund manager will invest a minimum 65 per cent of the fund corpus in securities that have AA or lower ratings. In other words, these funds cannot invest in top-rated (AAA) debt instruments. As the investment is in the topmost rated debt instruments, the interest paid by the bond issuer tends to be higher. Accordingly, the risk associated also tends to be on the higher side, and consequently the opportunity for generating a higher return.

Investment Strategy
Credit risk funds scout for opportunities to maximise portfolio yield by investing in AA and below rated corporate bonds. Such a fund will predominantly invest in corporate bonds, which offer good opportunity to leverage credit risk. However, while at it, what the fund manager will strive for is a create a diversified portfolio through various caps on individual and group level issuances. Also, in such an offering the fund manager will aim to capitalize on potential credit rating upgrades, thereby generating extra alpha. This occurs because lower rated bonds generally offer higher coupon rate and as and when their ratings get upgraded, the bond price gets rerated higher. 

Choosing a Credit Risk Fund
For a savvy fixed income investor, one of the smartest moves in the current market environment is to invest in a well-managed credit risk fund that has stood the test of time. When the debt incident in one of the fund houses roiled the category, there were a couple of names which withstood the development and managed to thrive even on the worse days. Hence, remember a credit risk fund is only as good as the investment process followed by the fund house. As an investor, one should be able to understand the investment process followed. Safety, liquidity and returns should be the preferred order of priority. Apart from this, the credit risk fund should have a proper risk control mechanism. And finally, the credit risk fund should personify discipline. Being focused on investment process is the key. This is because even a seasoned fund manager on occasions could get swayed in the quest for attractive yields. 

Who Should Invest?
If you are ready to stay invested for more than 36 months and have a higher risk appetite for credit, then credit risk funds are for you. Before investing, consider your time horizon and financial goals as the maturity profile of the credit risk mutual fund must coincide with your time horizon. Entrust your investments to a credit risk fund which has a dependable track record across credit and interest rate cycles. Since there are some technical aspects to look into while selecting, it may not be possible for a layman to reach an optimal decision. In such a situation it is better to seek the help of a financial advisor.

The writer is Founder, AJ Investments & Services ■ Email : ajinvestments2016@gmail.com