What are credit risk funds? Exploring the benefits and risks associated

Credit risk funds are a type of debt mutual fund designed to achieve greater returns by investing in debt instruments that have comparatively lower credit ratings.

Kirti Jha, MintGenie Team
First Published25 Jul 2023, 09:49 AM IST
Credit risk funds are a type of debt mutual fund designed to achieve greater returns by investing in debt instruments.
Credit risk funds are a type of debt mutual fund designed to achieve greater returns by investing in debt instruments.

The popularity of mutual funds has been steadily increasing in recent years. Investors are now recognizing the benefits of mutual funds as a convenient and accessible investment option.

Mutual funds offer diversification, professional management, and the ability to invest in a wide range of asset classes and market segments.

In the market, investors can choose from a diverse range of mutual funds, and among these options is the credit risk fund. In this article, we discuss its benefits and risks associated in detail.

What are credit risk funds?

Credit risk funds are a type of debt mutual fund designed to achieve greater returns by investing in debt instruments that have comparatively lower credit ratings.

In the Indian financial market, these funds have become increasingly favored by investors who are looking for potentially higher yields in contrast to conventional fixed-income investments.

The main focus of credit risk funds is to allocate their investments in debt securities issued by entities with lower credit ratings, including non-banking financial companies (NBFCs), corporate bonds with lower ratings, and sometimes distressed assets.

READ MORE: Mutual funds: Make note of these four key factors before you invest

By assuming the additional risk associated with investing in lower-rated debt instruments, these funds offer an opportunity to earn enhanced yields compared to traditional debt funds.

What are the benefits of credit risk funds?

Yield potential: Credit risk funds aim to generate higher yields than traditional fixed-income instruments by investing in lower-rated debt securities. The potential for higher returns attracts investors looking for enhanced income generation opportunities.

Diversification: Credit risk funds typically have a diversified portfolio, spreading investments across various issuers and sectors. This diversification helps mitigate the impact of any individual default or credit event, reducing the overall risk.

Professional management: Credit risk funds are managed by experienced fund managers who specialize in credit analysis and risk assessment. Their expertise in evaluating creditworthiness and monitoring credit quality helps in making informed investment decisions.

READ MORE: Mutual funds: Why are investors exiting large cap and index funds? Experts say this

Liquidity:While credit risk funds primarily invest in less liquid debt securities, most funds provide daily liquidity to investors. However, it is important to note that during periods of market stress or heightened credit risk, liquidity in these funds may be impacted.

Are there any risks associated?

Credit risk is the primary risk associated with credit-risk funds. Investing in lower-rated debt instruments increases the likelihood of default or delay in interest payments by the issuer.

This risk can impact the overall returns of the fund and lead to potential capital erosion. Other risks associated with credit risk funds include:

Interest rate risk: Changes in interest rates can affect the value of debt securities held by credit risk funds. When interest rates rise, the prices of existing bonds tend to fall, impacting the net asset value (NAV) of the fund.

Liquidity risk:Investing in less liquid debt securities may pose challenges in terms of selling or exiting positions quickly, especially during periods of market stress. This can impact the liquidity and pricing of credit risk funds.

Concentration risk: Some credit risk funds may have concentrated exposure to specific sectors or issuers, increasing the vulnerability to adverse events impacting those segments.

Credit risk funds provide an avenue for investors to potentially earn higher yields by investing in lower-rated debt instruments. Investors should carefully evaluate their risk tolerance, investment objectives, and consult with financial advisors before considering credit risk funds as part of their investment portfolio.

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First Published:25 Jul 2023, 09:49 AM IST
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