Expert advice

Jun 06, 2016,17.04 IST

Why credit opportunities funds make sense for young investors

Adhil Shetty

If you are a seasoned investor, chances are that both debt and equity funds would be part of your investment portfolio. In a falling interest rate scenario, your returns from debt instruments will be on the lower side. But if you can invest in credit opportunity funds, you can still make decent returns. Here is a look at what credit opportunity funds are and why they may be good for young investors.

What are credit opportunity funds?

At their core, credit opportunity funds are debt mutual funds that invest in commercial papers and corporate bonds. Credit opportunity funds fundamentally invest in low-rated bonds that may see an upgrade in rating.

While success and failure of any market-driven fund depends on various parameters like overall economic health, interest rates, etc, the average return on credit opportunity funds has been the highest among all mutual fund categories till February 2016 averaging about at 8.70 per cent annually.

How credit opportunity funds are different from debt funds

Typically, a debt mutual fund scheme invests in bonds that have a high credit rating. Since credit rating is an indication of the company’s financial health and its ability to repay, most fund managers choose bonds based on credit ratings.

But credit opportunity funds invest in bonds that do not necessarily have the highest credit rating. Typically, a bond with AA credit rating is considered high risk compared to one with AAA rating. Credit opportunity fund managers may take a call on investing in the AA bond, preferring it over AAA ones. This may be because of a potential rating upgrade down the line or assured returns due to strong fundamentals.

When the economy improves, the improvement trickles down to the corporate sector. This sees improvement in its balance sheet and financials. With improving balance sheets, the rating agency upgrades the bonds issued by the company. A bond with high rating typically offers lower interest rate than a bond that comes with low rating. Hence a rating upgrade leads to a fall in yield and a rise in bond price. In a recovering economy there are more chances of rating upgrades and one can play this theme with credit opportunities fund.

Taxation aspects of credit opportunity funds

If you sell your investments in these funds within a year of investment, your gains are liable for income tax as per your tax slab, with capital gains being added to your individual income for the financial year.

If you redeem your fund after holding it for more than one year, you will be liable to pay tax at the rate of 20% after indexation on the capital gains.

Credit opportunity funds for young investors

If you are a young investor with an appetite for risk, you could consider diversifying your portfolio by investing in credit opportunity funds. Invest with a minimum two to three year time frame. This long term investment of more than two years allows the credit opportunity fund to offer better returns than most other investments including even bank fixed deposits. Also, being a debt investment instrument, your risks are far lower than investment in equity based funds. If you remain invested for more than three years, your post tax returns are much better than most fixed deposits.

Credit opportunity funds in India

When you design your financial portfolio, you have to carefully choose products that suit your needs. Opting for credit opportunity funds can be a good idea provided you have the resources to ride over intermittent volatility in bond markets and liquidity requirements you may have in the short term.
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