Credit Risk Mutual Funds

• Conventionally, aggressive investors with a high-risk appetite invest in equity funds, especially those with a high component of small cap stocks. Debt funds, on the other hand are considered relatively less risky.
• However, credit risk funds are one such class of mutual funds that fall under the debt mutual funds category but are considered a fairly risky investment. They invest in the corporate sector via low-rated fixed-income securities. In other words, like debt funds, they invest in debt instruments, but they concentrate on those instruments which are more risky and rated low by credit rating agencies but also have a chance of higher returns.

• Despite belonging to the debt mutual funds category, credit-risk mutual funds are high-risk in nature. Investors who have high-income levels and fall under the highest income tax bracket are likely to have a higher risk appetite and such people are well suited for credit risk funds. Similarly, people who are already comfortable with investing in high-risk assets such as equity can definitely consider investing in credit risk funds. This is true, especially for those who believe that the risks in investing in the debt market is low (perhaps because of a favourable interest rate environment) and they therefore want to invest in instruments that give the highest returns possible.

1. SEBI guidelines dictate that credit risk mutual funds are required to invest a minimum of 65% of their fund portfolio in corporate debt securities having a rating of AA or lower. However, when the rating of the underlying securities is raised later, the fund benefits from such improved ratings (due to increased value of the bonds) which in turn results in higher capital gains for the investors.
2. Credit risk mutual funds carry a higher credit risk than funds that invest exclusively or primarily in top-rated debt instruments with the highest rating of AAA. Because the risk is high, the instruments also tend to offer interest at a higher rate. Credit risk here refers to the risk of default taken by investors, and it is on the higher side for such securities.

• The taxability of credit risk mutual funds remains the same as how we tax debt funds. These funds are liable to capital gains depending on the period of holding. It is taxed as per the investor’s income tax slab if the funds are held for less than 3 years. If the holding period exceeds 3 years, then the fund is taxed at 20% with an indexation benefit. As you may know already, the indexation benefit enables investors to inflate the purchase price to account for inflation adjustment. The taxation of these funds is simplified in the table given below.

The following are some fo the risk factors that an investor should look at when assessing whether to invest in a credit risk fund or not -

• Poor Liquidity:
  For example, if a fund has invested in assets which pay back at a much later date, but they need to resolve multiple large redemptions at the same time then the fund managers might face a problem. In such cases, they may have to sell off some of the assets that they own. At that point, if they fail to sell off their assets due to a lack of liquidity in the market then they might end up in a bit of a crisis.
  
  Furthermore, when too many assets of a scheme are downgraded then it becomes extremely difficult to liquidate them due to the bad reputation and expectation of further decline.
• High Credit Risk:
  Credit risk funds are not suitable for all types of investors, especially risk-averse ones. Investors should be able to resist the high risk involved when investing in these funds as the risk of default is high.

1. In comparison with other debt funds, credit risk mutual funds have the ability to provide higher returns to investors. The investment risk is higher in these funds and is complimented usually by a high coupon rate. Investors who are looking to fulfil their medium-term to long-term financial goals and earn regular income can opt for these funds.
2. That being said, the performance of these funds is purely dependent on the expertise of the fund manager. Investors would benefit from a skilled fund manager who is able to yield higher returns than risk-free debt funds.

• This fund is being managed by Manish Banthia since January 2018. As on April 30, 2023, the fund has an AUM of Rs. 7,828.43 crore and the minimum investment value is Rs. 100. expense ratio 0.88% under direct investment mode and there is no exit load if redeemed or switched out after one year from the date of allotment.

• This fund is being managed by Shobhit Mehrotra since March 2014. As on April 30, 2023, the fund has an AUM of Rs. 8,572.56 crore and the minimum investment value is Rs.100. expense ratio 0.95% under direct investment mode and there is no exit load if redeemed after eighteen months from the date of allotment.

• This fund is being managed by Alok Sahoo since January 2015. As on April 30, 2023, the fund has an AUM of Rs. 181.22 crore and the minimum investment value is Rs. 5000. expense ratio 0.78% under direct investment mode and there is no exit load if redeemed or switched out after one year from the date of allotment.

• This fund is being managed by Lokesh Mallya since February 2017. As of April 30, 2023, the fund has an AUM of Rs. 2,817.99 crore where the minimum investment value is Rs. 5000. The expense ratio of the fund stands at 0.92% under direct investment mode and has no exit load if redeemed or switched out after thirty-six months from the date of allotment.

• This fund is being managed by Devang Shah since June 2014. As of April 30, 2023, the fund has an AUM of Rs. 595.87 crore and the minimum investment value is Rs. 5000. expense ratio 0.81% under direct investment mode and currently has no exit load if redeemed or switched out after twelve months from the date of allotment.