Is it time for investors to consider credit risk funds? Experts offer their opinions

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Credit risk funds have had a challenging time since late 2018, when they were hit hard by payment defaults. In 2020, the Franklin Templeton scandal exacerbated the dilemma. Fears of more bankruptcies prompted investors to exit credit risk funds. SEBI, the regulator, and fund managers, on the other hand, had their act together. Portfolios have been de-risked and brought back into investor contention in recent years. Smart investors recognized this and chose to stay put. Last year, credit risk funds beat all other debt funds on average during a period when interest rates were held low. With inflation hovering around 6%, credit risk is the only asset class that has outperformed inflation. Investing in credit risk funds, on the other hand, is a high-risk approach.

Industry professionals share their thoughts on how investors should navigate credit risk funds in the current climate.

R Sivakumar, Head fixed-income, Axis MF

We are in a rising rate environment globally, and domestic yields have firmed up in the previous year or so. Credits in investment banking companies tend to outperform in such an environment for a variety of reasons. One is that credits already have higher yields than a comparable maturity debt instrument on the AAA or G-Sec yield curve. The second point is that the current macroeconomic situation, which allows rates to rise, is normally favourable to economic growth. In such circumstances, the credit approach tends to perform better. In recent quarters, we have seen an improvement in growth, with the RBI and government expecting growth of close to 8% in the 2018 fiscal year. As a result, positive financial results from corporations are expected, which are, once again, supportive of credit strategies.

Credit funds, on the whole, have a shorter duration than other AAA-rated portfolios. As a result, in a rising interest rate environment, the duration impact is lower to begin with. And, within that, in a rising interest rate environment, G-Sec and AAA-rated yields often climb more than credit yields, implying that spreads contract. Lower-graded bonds, such as those rated single A, are typically valued in absolute terms or in comparison to comparable single A or AA-rated instruments rather than in comparison to G-Secs. As a result, they frequently do not move in lockstep with G-Sec yields, compressing credit spreads. This protects against duration risk or the impact of rising interest rates on mark-to-market.

Vidya Bala, co-founder, Primeinvestor.in

There has been a lot of cleaning up in the credit risk category of investment banking

since April 2020, and the Securities and Exchange Board of India (SEBI) has made regulatory adjustments to improve risk-management methods. Credit risk funds now have more liquidity in their portfolios, allowing them to better absorb redemption pressures like the one observed in 2020 following the COVID-19 outbreak. Credit risk funds have also helped to lower portfolio risks. This isn’t true for all credit risk funds, but it’s the general trend we’ve noticed.

The kind of risks they’re taking, as well as the timeframes in which they’re making these investments, have all been modified. This category of credit solutions is for investors who are willing to take risks in exchange for higher rewards. A corporate bond fund or a short duration fund should suffice in this case. The former is appropriate for a medium-term investment. Credit risk funds are a good option for investors seeking slightly better returns, but they should check for any group concentration risk in the portfolio and have a 3–5 year investment horizon. If you choose the right fund, the risks associated with credit risk may be lower than before.