Moneycontrol
Dec 05, 2017 08:57 AM IST | Source: Moneycontrol.com

Don’t ignore credit risk; Top four factors to consider before investing in Credit Funds

Looking at the average credit rating exposure of the industry, we observe that the exposure to ‘A and below’ rated securities saw a steady increase up till the end of 2015, when the Amtek Auto incident occurred.

Investing in mutual funds (MFs) is the best option for those who want to take advantage of capital market to create wealth. The earlier you start, the better it is. Young investors in their 20s or 30s can take the benefit of rolling returns while investing money for a longer period of time. Here are 5 things which a young investor should keep in mind before investing in to MFs:
Investing in mutual funds (MFs) is the best option for those who want to take advantage of capital market to create wealth. The earlier you start, the better it is. Young investors in their 20s or 30s can take the benefit of rolling returns while investing money for a longer period of time. Here are 5 things which a young investor should keep in mind before investing in to MFs:

Kaustubh Belapurkar

Morningstar India

With the equity markets making new highs, investor interest in Equity Mutual Funds is at an all-time high. While most of the focus has been on equities, another category of funds has been receiving outsized flows but has flown under the radar so far.

Credit Opportunities, or Accrual funds as they are popularly known (Credit Risk as per the new SEBI categorization), have also been a popular investment avenue for investors.

Assets under Management (AUM) of these funds have doubled over the last 18 months and are up 6 times in the last 5 years!

The journey though has not been a one-way street, there were outflows towards the end of 2015 as sentiments turned for the worse after the Amtek Auto incident, but investors came back in a big way in 2016 and 2017.

Understanding Credit Funds:

Credit Funds have been receiving flows as the historical returns delivered by these funds have been superior to other fixed income strategies.

Additionally, post demonetization, as more money starting flowing from physical assets to financial assets as well as from bank deposits to mutual funds, fixed income funds were one of the larger beneficiaries.

Investors should understand that purely looking at past returns is not a wise way to invest. Firstly, it is important to acknowledge that the higher returns are being achieved by taking higher credit risk in the portfolios.

We have seen a few ‘credit’ incidents in the past – Amtek Auto, JSPL, BILT to name a few that have affected the value of the funds. Liquidity is another concern, as most of these securities don’t have ready liquidity and may be hard to liquidate in distress times.

While Asset Managers have been beefing up their credit research teams and spending more time and resources in originating, structuring and researching credit, these strategies are not without risk.

Despite having these measures in place, the credit risk in these funds will always elevate as compared to funds with higher-rated instruments.

Looking at the average credit rating exposure of the industry, we observe that the exposure to ‘A and below’ rated securities saw a steady increase up till the end of 2015, when the Amtek Auto incident occurred.

Post that most managers have been pruning credit in their portfolio and this has witnessed a decline ever since.

Now you can find clearly differentiated credit profile funds available within the segment, from the pure ‘credit’ funds with investments largely in ‘A’ rated securities, to funds that balance the credit exposure by largely investing into ‘AA’ and a smaller proportion in ‘A’ rated securities

Factors to consider before investing:

a) Investors should understand the positioning of the fund by studying the overall credit breakup of the funds before investing and choose a fund that best suits their risk-return profile.

b) Studying individual securities is beyond the scope of investors, rather understanding the credit breakup of the fund’s portfolio, can be helpful. Pick pedigreed asset managers who have the track record and the resources in place to manage such strategies.

c) Look at additional factors such as expense ratios and exit loads. Given that yields are trending lower, the expense ratio charged to the fund becomes even more important, ideally if all things equal a lower expense ratio fund will be more attractive.

d) Most funds in these categories carry multiyear exit loads; it is prudent to consider these before investing.

Disclaimer: The author is Director of Fund Research at Morningstar Investment Adviser. The views and investment tips expressed by investment experts on Moneycontrol are their own and not that of the website or its management. Moneycontrol advises users to check with certified experts before taking any investment decisions
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