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Should investors consider credit risk funds now? Experts weigh in

Positive financial results from corporates are supportive of credit strategies

February 22, 2022 / 09:48 AM IST

From late 2018, credit risk funds had a rough run, under the hammer as they were with payment defaults. The Franklin Templeton crisis worsened the problem in 2020. Investors exited credit risk funds due to worries of more blow-ups happening.  But the regulator SEBI and fund managers got their act together. Over the past couple of years, portfolios have been de-risked and brought back into investor contention. Smart investors knew better and some of them stayed put. These funds have delivered 9.4 percent returns on an average in the last one year, as against to 4.9 percent from short-term debt funds, 4.6 percent each by Banking & PSU funds and corporate debt funds. Credit risk funds, on an average, outperformed all other debt funds last year at a time when interest rates were kept low. With inflation at nearly 6 percent, credit risk is the only category with inflation-beating returns. Still, investing in credit risk funds is a high-risk strategy.

Moneycontrol spoke to industry experts on how investors should wade through credit risk funds in the current environment

R Sivakumar, Head fixed-income, Axis MF

We are in a rising rate environment globally and over the last year or so, we have even seen domestic yields firm up. Credits tend to outperform in such an environment and this happens because of couple of reasons. One is credits already have higher yields vis-à-vis a debt paper of a comparable maturity on AAA or G-Sec yield curve. The second is that the macroeconomic environment we are in, which allows rates to go up, is also typically positive for economic growth. Credit strategy tends to do better in such an environment. We have already seen an improvement in growth in recent quarters with RBI and government projecting growth of close to eight percent in coming financial year. So, one expects to see positive financial results from corporates, which are, again, supportive of credit strategies.

Credit funds by and large tend to be of shorter duration than other AAA-rated-oriented portfolios. So, the duration impact in a rising interest rate environment is less to start with. And within that also, when you have a rising interest rate environment, typically the G-Sec and AAA-rated yields tend to rise more than credit, that is to say the spreads compress in a rising interest rate environment. Lower-rated bonds like those rated single A tend to be priced on an absolute basis or relative to other single A or AA-rated instrument, rather than relative to G-Secs. So, they often don’t move in sync with G-Sec yields and this is why the credit spreads compress. This again provides protection against duration risk or mark-to-market impact of rising interest rate.

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Nitin Rao, chief executive officer, InCred Wealth

Taking credit risk on companies is definitely less risky than what it was two years back. The only way in which you can increase your debt returns right now is by putting some part of your portfolio – 10-15 percent – in credit exposures. But, make sure that such an allocation fits your risk-profile. Investors can either do direct credit where they can buy debentures of AA-rated or single A-rated corporates. With the latter they can even get yield to maturity (YTM) of 9 percent, but this comes with high risks. Or investors looking for a diversified portfolio can go for credit risk funds, which are offering YTM of 6.7 percent on an average, which is also attractive.

Today, credit risk funds still not have enough papers in their portfolios, which can potentially take their YTMs to close to 8 percent. As and when interest rates go up, credit risk funds will also need to invest in fresh papers yielding higher rates, which are available in the single-A rated segment. So, there is scope for returns to further improve as YTMs in these funds inch closer to 8 percent. Investors can consider credit risk funds from one-two-year perspective.

Vidya Bala, co-founder, Primeinvestor.in

After April 2020, there has been quite a bit of clean-up in the credit risk category and also there have been regulatory changes brought in by the Securities and Exchange Board of India (SEBI) to improve risk-management practices. Now, credit risk funds have better liquidity in their portfolios so that if there is any repeat of redemption pressure like the one seen in 2020 following COVID-19 outbreak, they can handle it better. Credit risk funds have also reduced the risks in the portfolios. This is not true for all the credit risk funds, but this is the broad trend we have been seeing.

The nature of risks they are taking, the time-frame for which they are making these investments, all this has been tweaked a bit. However, this category is still not for all investors. This category is for risk-taking investors who are looking for additional returns. This can't be just another debt fund for diversification in your portfolio. For that, a corporate bond fund or short duration fund should fit the bill. The former is suitable for a medium duration investment. Investors looking for slightly higher returns can invest in credit risk funds, but should make sure to check for any group concentration risk in the portfolio and come in with a 3-5 year investment horizon. The risks around credit risk category might have reduced than before, provided you pick the right fund.

Vikram Dalal, managing director, Synergee Capital

We will have to wait and see if there are any major NPA issues in the books of non-bank financial companies (NBFCs) after the additional six-month window given to NBFCs to comply with asset classification norms, is over. So, the picture is not yet fully clear there. We still don’t know exactly how much NPAs they are carrying their books. A large chunk of credit investments are in NBFCs as they are major players in credit markets to meet their funding requirements.

Apart from credit risk, there is also duration risk that can impact credit risk funds, which are holding longer duration papers. This depends on the fund manager and how he has built the portfolio, whether he has been savvy enough to shift to shorter duration papers before interest rates start to rise. So, investors should review the portfolio, check the duration of the portfolio, whether the credit investments are in known companies or in completely unknown entities, and then decide on which credit fund they want to invest in.



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Jash Kriplani is a journalist with over ten years of experience. Based in Mumbai. Covering mutual funds, personal finance. His last stint was with Business Standard, where he covered mutual funds and other developments in the financial markets
first published: Feb 22, 2022 09:48 am
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