Looking for high interest rates? Pick the right credit opportunities fund

Low interest rates make it difficult for many fixed income investors. Many of them opt for low-rated bonds and company fixed deposits to make some extra money. However, it is not only risky but also makes the investors to take an extra effort. In such a situation, experts advise going for credit opportunities fund. "Investors should consider open-ended credit opportunities funds as they offer liquidity to investors along with diversified portfolio which reduces risk," says Lakshmi Iyer, Chief Investment Officer (Debt) and Head of Products at Kotak Mutual Fund.

Need for higher interest rates

Indian fixed income investors have seen interest rates payable on deposits going down over past couple of years. For example, one year bank fixed deposit by State Bank of India (SBI) used to offer 8.25 percent in April 2015 whereas it offers 6.9 percent rate of interest now. SBI recently reduced rates for medium to long term fixed deposits. No wonder investors are looking for high interest rate earning options. When the interest rates were going down, the savvy lot opted to invest in long term gilt funds. Long term gilt funds as a category offered 10.6 percent returns over past one year. But as the yields are showing early signs of upward movement, long term gilt funds appear to be risky choices. In a rising interest rates scenario, long term bonds typically show fall in prices leading to losses for investors. That makes investors look for alternatives.

High paying fixed deposits

The fixed deposits issued by corporates, especially non banking financial companies are a good alternative. For example, HDFC offers 7.5 percent rate of interest on 15 months fixed deposit whereas HDFC Bank offers 6.25 percent rate of interest on a similar fixed deposit. If you are looking for yields in excess of 8 percent, there are not many options left. If you are looking for returns in excess of 8 percent then you have to go for two-three year fixed deposits. That exposes you to a couple of risks. First you compromise on liquidity. Most fixed deposit accepting NBFCs charge high penal interest in case of premature withdrawal. Second, if interest rates climb up fast in the interim, you do not enjoy higher interest rates. For two or three years you have to settle with the rate of interest you have contracted at. If you are in high income tax bracket of 30.9 percent and more, your post tax income is negligible.

The fund route

“Investments in bond funds mature at varying intervals. That allows the fund manager to reinvest some of the money at higher interest rates when the interest rates are on the way up,” explains Lakshmi Iyer. As bonds in the fund portfolio mature, the proceeds can be invested by the fund manager in the best possible options available at that time. The open ended bond funds including credit opportunities funds allow redemptions subject to exit loads. Exit loads too are in the range of 0.25 percent to 1 percent if redeemed in one month to one year from the date of allotment of units. Compared to this many company fixed deposits charge penal interest closer to one percentage point across the tenure.

The interest on the fixed deposits is added to income and taxed at a marginal rate of tax. The gains on investments in these bond funds held for three years or more are considered long-term capital gains and taxed at 20.6 percent after indexation benefit.

This makes one consider the fund route over fixed deposit. But before you jump to call your mutual fund distributor, know the fine print well.

Credit Opportunities Funds

For the uninitiated, credit opportunities funds are schemes that invest in bonds with relatively low rating. These funds invest in A and AA rated bonds that offer extra return for the extra risk borne by the investors, as compared to AAA rated bonds. Put simply, fund manager takes higher risk to generate high returns. Most of these schemes are open-ended in nature. You can enter and exit as per your convenience and there is no lock in. “Opt for these schemes if and only if you are comfortable with extra risk,” says Abhinav Angirish, Founder and Managing Director of Investonline.in, an online mutual fund distribution entity.

If you still want to bite the bullet, do not forget to check the portfolios and exit loads. “Credit opportunities funds do have varying modified duration. Higher modified duration entails high interest rate risk,” points out Abhinav Angirish. Schemes with high duration portfolios are exposed to interest rate risk. If interest rates move up quickly, these schemes may report capital losses for investors. If you are not keen to take too much of risk, stick to schemes with low duration.

Do not go with names of the schemes, they may not offer the same level of risk-return. For example, Invesco India Credit Opportunities Fund invests in investment grade low duration papers and has modified duration of 26 days. Invesco India Corporate Bond Opportunities Fund invests in a diversified portfolio of papers with rating from A to AAA and comes with a modified duration of 2.32 years as on March 31. While the former comes with low interest rate risk and low credit risk, the later has a riskier one. Of course, the returns are in the line with risks.

Credit opportunities funds can make money for you over next couple of years if you choose it right and sit tight.