0% Commission | Seamless Onboarding | 1100+ Direct Fund Options | ELSS Tax-saving Mutual Funds Invest Now

Debt mutual funds have become a popular option for investors seeking notable gains. One such scheme is a credit risk fund that allows you to earn better yields. However, these also have a higher risk potential as funds are invested in companies with low credit ratings.

What are Credit Risk Funds?

The biggest risk associated with an investment in a debt mutual fund is credit risk. You can reduce the credit risk in mutual funds by investing in companies with higher credit ratings. However, in these cases, your returns may be lower. 

 

In contrast, by investing in companies with lower credit ratings, you can get a higher yield. These companies offer competitive interest rates to compensate for their rating. Credit risk MFs invest at least 65% of the accumulated corpus in such companies. 

 

Although these funds could lead to higher returns, they carry a greater risk of default. This applies to the repayment of the principal and/or interest. 

How Do Credit Risk Funds Work?

As mentioned, these funds invest a greater amount of the corpus in companies having low credit ratings. Thus, these debt mutual fund schemes have the potential to generate returns that are higher than normal by taking on extra risk. 

 

In other words, the issuer pays higher interest to compensate for lower credit ratings.

Pros of Credit Risk Funds

Here are some benefits of investing in credit risk mutual funds: 

  • Offer Good Returns

While these funds have higher associated default and interest rate risk, they also have the potential to earn better returns. You can compare their earnings against most debt-based securities to see this difference. 

  • Ideal for Longer Horizon

These funds have a higher probability of incurring a loss in a shorter duration. However, you can earn optimal returns by investing in the funds for a longer tenor. Hence, if your ideal investment tenor is between 2 and 2 years, these funds are suitable for you. 

  • Rely on Fund Managers

These funds are passively managed, which means that fund managers control them on your behalf. Thus, you can rely on the fund manager’s expertise when investing in these funds.

Cons of Credit Risk Funds

The following are some limitations of investing in these mutual funds:

  • Credit Risk

As mentioned, these mutual fund schemes invest at least 65% of the invested corpus in companies with a credit rating below ‘AA’. This makes them susceptible to higher credit risk, which means there is a probability that you can lose your investment and earnings. 

  • Lower Liquidity

Since these mutual funds contain debt instruments with lower credit quality, you cannot sell them instantly. Hence, they have relatively less liquidity when compared to mutual funds consisting of higher credit-quality debt instruments.

Things to Consider Before Investing in Credit Risk Funds

When investing in a credit risk fund, evaluate the following factors: 

  • Financial Objective

These debt-based mutual funds are suitable for investors with a high risk tolerance who aim to diversify their portfolio. Hence, invest in these mutual funds only if you have a good risk appetite.

  • Expenses

A higher expense ratio will affect your returns and reduce your earnings. Hence, it is advisable to opt for a scheme that has a lower expense ratio.

  • Fund Performance

Another factor to consider when investing in the funds is their past performance. This will give you insights into how the fund performs in different cycles, enabling you to invest accordingly. 

 

However, remember there is no guarantee that a fund will replicate its historic performance. 

  • Management

The performance of this fund also depends on the expertise and track record of the fund manager. Evaluate the fund manager’s track record before you decide on which mutual fund to invest in.

Who Should Invest in Credit Risk Funds?

This debt-based mutual fund scheme is best for investors with a higher risk appetite who are planning to diversify their portfolios. You may also consider investing in these funds if your goal is to earn higher returns from fixed-income instruments in a medium-to-long investment horizon.

   

In conclusion, if you have a decent risk appetite, you can consider investing in credit risk funds, as they can be highly rewarding. On Bajaj Markets, you can compare different schemes and avenues to easily invest in one that best suits your needs.  

FAQs on Credit Risk Funds

What is credit risk in mutual funds?

Credit risk in mutual funds is the risk of default in repayment of the principal and/or interest by the fund issuer. Note that credit risk can be higher with companies having lower credit ratings and vice versa.

What is the ideal investment tenor for credit risk funds?

These funds possess greater potential for earning higher returns. However, they also come with higher associated risks. Hence, it is advisable to invest for a tenor ranging between 2 and 3 years.

What is the taxability of credit risk mutual funds?

The taxability of credit risk MFs depends on the duration. If the duration is less than 3 years, you will be liable to pay a Short-term Capital Gain (STCG) tax. If the investment horizon exceeds 3 years, you will have to pay Long-term Capital Gain (LTCG) tax.

Home
active_tab
Loan Offer
active_tab
Download App
active_tab
Credit Score
active_tab