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Stock Analysis, IPO, Mutual Funds, Bonds & More

All credit risk debt mutual funds are not junk

Several funds have given healthy returns over the past year and are worth considering by investors.

, ET Bureau|
Oct 14, 2019, 06.30 AM IST
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Fund managers say this is in fact a good time for investors to consider good quality credit risk funds.
A string of defaults and rating downgrades over the past year has hurt perceptions about debt funds. Credit risk funds in particular have got a bad name. Sharp fall in NAVs of a handful of credit risk funds have led to large outflows from this category. The total corpus managed in this basket has shrunk from Rs 91,000 crore in August last year to Rs 68,500 crore in August this year. However, investors should look deeper instead of painting the entire basket with the same brush.

Credit risk funds are so named because they are mandated to invest a large chunk of their assets (at least 65% of corpus) in instruments rated AA or lower. Investment in lower rated bonds entails higher risk as it signifies lower capability of borrower to repay obligations. At the same time, these offer higher yield, with potential for capital gains in the event of a future upgrade in credit rating of the bonds. These funds can potentially deliver upto 2-3% higher returns than liquid funds.

On the face of it, this category has yielded a paltry 1.2% returns over the past year—the lowest among all debt fund categories. However, the returns have been dragged down by three or four credit funds, which have been singed by credit events.

Some of the funds had taken concentrated exposure in issuers that defaulted. BOI AXA Credit Risk was the worst hit, tanking 48% during this period. In June, the scheme had to write down the entire value of its investment in Sintex BAPL— constituting a quarter of its net assets as on May end—when its parent company Sintex Industries defaulted. Sundaram Short Term Credit Risk, UTI Credit Risk and Invesco Credit Risk also saw falling NAVs, to a lesser extent. Some credit funds have seen stressed issuers assume higher proportion of their assets after large redemptions forced the fund manager to sell more liquid investments.

This is one side of the story. There are several credit risk funds, with more diversified portfolios, that have delivered healthy returns. IDFC Credit Risk Fund, ICICI Prudential Credit Risk Fund, HDFC Credit Risk Fund and Kotak Credit Fund have fetched 9% returns over the past year. Several schemes have clocked more than 7%. Junking all such funds on account of a few rotten apples would be unfair.

Fund managers say this is in fact a good time for investors to consider good quality credit risk funds. The gap between yields of AAA or highest grade corporate bonds and lower rated bonds have widened considerably in the past few months. Bond prices and yields move in opposite directions. The elevated yield on lower rated bonds suggests prices of these bonds have been beaten down. This offers potential for high returns in coming years.

Concentrated holdings are risky
Large scale outflows from some funds have artificially increased the degree of concentration.
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Pick funds with large asset base
Adequate diversification and quality portfolios have allowed these funds to steer clear of problems facing others.
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Amandeep Chopra, Group President & Head of Fixed Income, UTI AMC, says, “Those with a slightly higher risk appetite should definitely look at credit risk funds. Most corporate bonds are priced cheap and provide a degree of upside when the market settles.” The quality funds in this basket are currently running a yield to maturity (what the fund would fetch if it held on to all underlying bonds till maturity) in excess of 9%.

Lakshmi Iyer, CIO, Debt, and Head, Products, Kotak AMC, insists this is a good opportunity to accumulate credits with well-run balance sheets. “Spreads have widened considerably as confidence in corporate credit is still low. Once normalcy returns to the market, this segment will fetch healthy returns.”

However, investors will have to keep in mind the risk involved in these funds. Only those who have sufficient risk appetite should consider these funds, preferably limiting the allocation to not more than 10-15% of the portfolio.

The choice of fund is critical in this space, so ascertain the fund’s portfolio composition and size carefully. Avoid funds that run a compact portfolio or concentrated exposure in a few issuers. Liquidity is poor in lower rated bonds so when any of these bonds faces a downgrade or default, it is difficult for the fund manager to exit the holding. This risk is amplified in funds with concentrated holdings.

A large asset base gives the fund manager better leeway to diversify and spread risks. The worst may not be over in terms of credit profile of India Inc, so more credit events may hit firms that have borrowed from debt funds. However, the impact of such events on the fund’s returns will be minimised with a diversified portfolio.

Also Read

Are debt mutual funds losing credibility?

Debt mutual fund managers react to RBI policy

How to choose an ideal debt mutual fund?

How side pocketing works in debt mutual funds

What is waterfall valuation approach in debt mutual funds?

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