Mutual funds have been a popular investment instrument for several investors. One of the main advantages of mutual funds is that you can invest in small portions across different large institutions and companies at a nominal price. When it comes to mutual funds, there are several types available. Credit risk is one of the basic risks while investing in debt funds. It is essentially the risk that is present by default pertaining to repaying the principal and interest. In this article, we will have a look at credit risk mutual funds and dive deep into it.
What is a Credit Risk Fund?
Credit risk funds are also called credit risk debt funds. They are essentially debt funds that invest in debt securities that are of low credit quality. As they invest in low-quality instruments, they have higher credit risk. However, many wonder why a fund would invest in securities that have low credit ratings. The main reason behind this is that securities with a low credit rating usually provide high rates of interest. Each of these debt instruments is ranked with an alphabetic code.
The instruments that have a credit rating below AA are considered to have a high credit risk. To boost the overall rating, fund managers typically choose other highly ranked securities along with credit risk debt funds. Balancing the risk will reflect positively on your Net Asset Value (NAV).
Features of a Credit Risk Fund
Credit risk debt funds are usually picked by several fund managers as they bring along several benefits. In addition to providing higher interest rates, there are several other benefits that make credit risk funds attractive to investors. Let us have a look at the 2 main benefits of credit risk debt funds.
Tax Benefits
One of the primary benefits of credit risk debt funds is that they are tax-efficient. This applies especially for investors who are in the highest tax slab. For investors in the highest tax slab, the rates are at 30%. Whereas, the taxes charged for LTCG (Long Term Capital Gain) is less at 20%.
Fund Manager Responsibility
While you invest in a credit risk debt fund, you do not have to worry about picking the right fund that can help you make the maximum profits. The fund manager plays an important role when it comes to picking the good funds by balancing the risk ratio while simultaneously bringing potentially great returns.
How do Credit Risk Funds Work?
It is well-known that credit risk debt funds invest in debt securities and other money market instruments. These securities and instruments have a low credit rating. Nearly 65% of the portfolio of an investor would comprise funds that are lower than AA-rated securities. The main reason behind this rating is that they provide higher interest rates. Moreover, when the rating of the security gets an upgrade, the credit risk debt funds are greatly benefited. Credit risk debt funds have risks when it comes to lower-interest-rate. However, the fund manager would ensure to maintain the average credit quality of the fund at a reasonable level. Generally, credit risk debt funds offer an increase in interest rate by 2-3% compared to other risk-free debt funds.
Top 3 Credit Risk Funds
As credit risk funds are invested for a shorter span of time, they carry lower interest risk. They can produce high returns on the securities that are held. It is also essential to invest in good credit risk debt funds. Let us have a look at the top 3 credit risk funds.
Please note that the information below is for educational purposes only
ICICI Prudential Credit Risk Debt FundDirect Plan-Growth
You would require a minimum of ₹100 to invest in this credit risk debt fund. This fund is very popular as it provided an annual return of 9.44% over the last 3 years. Over the last year, it provided 8.59% in annual returns. This plan is considered to be one of the better credit risk debt funds in India as it has consistently outperformed other similar funds. This fund has an AUM of ₹7,626 Crores and a one-year return of 8.59%.
HDFC Credit Risk Debt FundDirect Growth
This HDFC risk fund provided a 9.6% annual return over the past 3 years. It has also continually hit its benchmark in the credit risk debt fund segment. It also has an AUM of ₹7.784 Crores with a 1-year return of 10.2%. The minimum investment you would require to invest in this credit risk debt fund is ₹5,000. However, you can also avail of the SIP option that starts at ₹500.
Kotak Credit Risk FundDirect Growth
With Kotak’s credit risk debt fund, you can expect a yearly return of 7.8%. Over the last 3 years, this fund has provided annual returns of 8.23%. To invest in this fund, you would need a minimum capital of ₹5,000. This credit risk fund has an AUM of ₹1,785 Crores and is considered to be a remarkable fund as it has outperformed similar funds. If the minimum investment is out of your budget, you can also opt for the SIP scheme that starts at ₹1,000.
Factors to Consider Before Investing in Credit Risk Funds
Credit risk debt funds can be rewarding if you invest in them the right way after understanding the basics. However, it is important to consider a few factors before investing in any of them. Here are some aspects that you should consider before investing in credit risk debt funds.
- Pick a credit risk fund that is diversified across different securities.
- Check the expense ratio of the fund before investing.
- Consider investing through a credit risk mutual fund as it carries lesser risk.
- Invest about 10% to 20% of your portfolio in a credit risk debt fund
- Check for credit risk debt funds that have a large corpus as it reduces risk.
Final Thoughts
When it comes to making profits in the stock market, investing in credit risk debt funds can be potentially rewarding. While they carry a certain amount of risk, they offer higher interest rates and provide potentially higher returns. However, while investing credit risk funds, ensure to be mindful and diversify your portfolio to reduce risks.
