Credit Risk Fund – Rise From The Ashes
MF shots (Part 12)- is an exclusive series of article which will try to explain in each category of mutual fund. This article focuses on Credit Risk funds which invest in corporate securities.
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Estimated time to read - 6 minutes
Overview -
MF shots - name describes itself where Mutual Fund categories are explained in a brief manner to avoid clutter of information. The current article is continuation of MF shots series by Cellestial Wealth. Previously I have written about short term & medium term debt mutual funds of which can be found by clicking on each category. Each article takes less than 6 minutes but states a few key pointers to be looked upon when choosing a category.
Overnight fund – invests in securities with maturity of 1 day.
Liquid fund – invests in securities with maturity of 91 days.
Ultra short duration funds – invests in securities with maturity of 3-6 months
Low duration funds - invests in securities with maturity of 6 months to 1 year.
Money market funds - invest in securities with maturity upto 1 year.
Short duration funds - invest in securities with maturity ranging from 1 to 3 years.
Medium duration funds - invest in securities with maturity ranging from 3-4 years.
Medium to Long Duration funds - invest in securities with maturity ranging from 4-7 years.
Long duration funds - invest in security with maturity of more than 7 years.
Dynamic Bond funds - invests in securities with varying maturities.
Corporate bond fund - invests in corporate & government securities with varying maturities.
Brief –
The credit risk fund category is unique in itself & has seen outflows in past couple of years due to mis-selling to investors & panic selling. The category objective is to enhance yield by taking risk through investments in AA & below securities This article delves deeper into the category.
Investment objective –
The credit risk funds can invest in securities with credit rating of AA & Below. These funds don’t have restrictions on maturity.
Suitable for which type of goals –
Goals which have a very high risk tolerance & goal amount can be reduced in case there is a default in the fund.
What parameters to check –
1. Investments in BB & below instruments –
Instruments rated BB & below are non investment grade & carry high risk of default along with high yield. One should try to check through credit rating reports whether the yield being provided is appropriate given the credit rating.
2. Segregated portfolio (if any) –
If there is a default in the portfolio, the securities are separated from the rest of the portfolio into a new portfolio with defaulted securities in it & the new portfolio is called segregated portfolio. If segregated portfolio already exists, it reflects the manager didn’t do required due diligence which caused losses to investors. Also, one should check
3. Research team of fund house –
The research should be diligent & scrutinize each company carefully as the funds are managed by the team.
What to avoid –
1. Investing solely on high yield –
One should be cautious when one notices past high yields compared to peers as it might have been earned by investing in very low investment grade security.
2. Investing for short time horizon –
Usually the credit risk funds don’t have mandate regarding maturity of security. Also, if default occurs one might need to wait for couple of years if company requests for moratorium. Hence one should avoid investing for short time horizon.
3. High expense ratio -
Expense ratio in the category varies from 0.28% to 1.28%. The high expense ratio reduces investor returns hence one should be watchful about it.
Interesting insights –
All funds have portfolio duration below 3 years.
BOI AXA Credit Risk fund has macaulay duration of 0.37 reflecting manager rate hike expectation in near future.
The yields are higher in this category due to higher risk / lower rated securities in the portfolio.
BOI AXA has seen 30% of capital being wiped out due to default in underlying instruments. So while the focus should be on Return ON Capital but one must not forget about Return OF Capital.
Conclusion –
The category might be appropriate for an investor looking to enhance his yield on his surplus funds which has long time horizon & can tolerate reduced amount in case of default. The category has very low AUM of 27,000 crores compared to other debt fund category AUM which might have occurred due to outflows post closure by Franklin Templeton India.
{You might have heard about the closure of 6 debt schemes by Franklin Templeton (https://economictimes.indiatimes.com/mf/analysis/how-franklin-fiasco-happened-and-what-we-learnt-from-it/articleshow/82210625.cms). }
But many other schemes in the category too incurred defaults, but they created segregated portfolio or reported markdowns without controversy. This category has seen some bloodbath but the regulations have been tightened following the fiasco.
Investment in the category should be made only portfolio part which can bear high risk of defaults & where one wants to increase his risk & return.
I am AMFI registered Mutual Fund Distributor . In case you have mutual fund queries or would like to invest in mutual funds, let me know on my Email - chirag.jain48@yahoo.com or +91-7567473055.
AMFI registration number - ARN-187955
Notes -
Top 10 funds by AUM in the category -
Top 10 funds by lowest expense ratio in category -
Complete data sheet can be accessed here.