Are you searching for investment options that give competitive returns with low-risk investments in securities? If so, the credit risk fund will be a suitable option. These funds aim to explore the untapped potential of lower-rated bonds and debentures.
But the question is, what is a credit risk fund, and who should invest in it? Read this guide to explore everything you need about credit risk funds.
Understanding Credit Risk Funds
Credit risk funds are debt mutual funds invested in low-credit quality debentures and bonds. As per SEBI, these funds invest at least 65% of their portfolio in AA and below-rated corporate bonds.
The primary features of the credit risk funds include:
- The investment is in the low-credit debts that typically offer higher returns.
- These funds are usually long-term investments ranging over 3 years.
- Long-term capital gains are taxed at 20% with indexation benefits.
- These funds are associated with high risk.
- It allows portfolio diversification within the fixed-income asset category.
Fund managers carefully manage these funds and select bonds that offer stable returns despite their lower ratings. This is to manage the risk of default. Fund managers also select securities that might get an upgrade in rating, which can have a positive impact on the fund’s NAV.
Advantages of Investing in Credit Risk Funds
Credit risk funds are a great choice if you are looking to diversify your portfolio. The primary advantages are as follows:
1. Diversification
Credit risk funds diversify the investment by allowing you to invest in a mix of lower-rated bonds. This strategy spreads out risk and minimizes the impact of any single investment’s poor performance, making it a safer choice for risk-averse investors looking to stabilize their returns.
2. High Growth Potential
These funds target bonds with higher yields that inherently carry more risk, offering the potential for higher returns. This approach can significantly enhance the earnings from fixed-income investments, making them an attractive option for investors aiming to boost their portfolio’s growth rate.
3. Better Stability
By investing across various sectors and credit qualities, credit risk funds better withstand market volatility. This diversification ensures a more stable performance during economic downturns, providing a cushion that can help maintain investment value.
4. Ideal for Long-Term Investment Strategies
Investors with a long-term outlook design credit risk funds. They balance higher-yielding, riskier investments with the goal of achieving better returns over time, which can be particularly beneficial for retirement portfolios or other long-term financial goals.
Risk Associated with Credit Risk Funds
Now that you know what a credit risk fund is, you should understand the risks involved:
1. Market Volatility and Economic Downturns
Credit risk funds are sensitive to broader economic changes. Corporate bond defaults may increase during economic downturns, and bond prices typically fall, which can sharply reduce the fund’s value. This sensitivity can lead to larger-than-expected losses for investors, especially if the downturn is prolonged or severe.
2. Liquidity Risks
Bonds within credit risk funds, particularly those that are lower-rated, often suffer from low liquidity. This means in a rapidly falling market, these bonds can be hard to sell without incurring significant losses.
This risk is compounded during financial crises when the number of willing buyers may plummet, forcing sellers to accept lower prices.
3. Default Risk
This is the risk of default by bond issuers, which can significantly impact the fund’s performance. If an issuer fails to meet its financial obligations, it can lead to a capital loss for investors in the fund. This risk is heightened in unstable economic conditions where default rates can escalate.
Who Should Consider Investing in Credit Risk Funds?
Every investor has a different risk and return appetite. Based on the same, the credit risk fund will be suitable for:
- These funds are well-suited for those looking for attractive returns by investing in debt funds.
- These funds are ideal for investors ready to take the increased risk of default associated with lower-rated securities.
- Investors also need to have a long-term investment horizon in order to benefit from investing in this fund category.
Conclusion
Credit risk funds are a suitable choice for those looking for high returns by investing in debt funds. By balancing the risk and return opportunity, the credit risk funds offer a unique opportunity to diversify investment in the credit market.
Remember to carefully assess your own risk tolerance and investment goals before investing in Mutual Funds. This will help you to make the right investment decision and meet your financial goals easily.
