Credit risk funds offer returns of 15%. Should you invest in them?

Credit risk funds are enjoying their place in the sun. In fact, those schemes that invest at least 65% of the corpus in instruments rated below AAA, offer double-digit returns over the past year. Meanwhile, other mutual funds offer sub-single-digit returns. Should you invest in credit risk funds?

According to Value Research, a mutual fund research firm, the credit risk category offered an average return of about 15.82% in one year. The category was number two in the performance chart. At the top of the list, the category of PSU funds, thematic schemes dedicated to PSU actions. These plans were offering around 15.87% over the same period. However, credit risk funds were also affected by the rise in rates. Over the past month, the category has offered returns of -0.63%. Most categories of debt mutual funds offered 2.00-3.60% over the past year.

Bond mutual funds had a bad year as the money market had been expecting a rate hike from RBI for some time. Rising interest rates are bad news for mutual funds because of the inverse relationship between yields and bond prices.

“Credit risk funds have offered good returns in the recent past for a variety of reasons – some have recovered depreciated papers. In others the returns they have invested in have been high and have not fallen as much when interest rates have fallen, so despite recent interest rate hikes, their valuations have held up,” said Vivek Ramakrishnan, Vice President of Investments, DSP Investment Managers.

Mutual fund investors had shunned credit risk funds for the past couple of years or so after a slew of defaults and downgrades hit the mutual fund space. It started with IL&FS and moved on to DHLL, Essel Group, etc. The Franklin Templeton fiasco has also further spooked conservative debt fund investors. Cautious investors, although in no mood to take on additional risk, are turning to credit risk funds with renewed interest due to attractive yields.

“Credit risk funds will always be at risk in one way or another. The primary objective of investing in debt funds should be capital preservation and then appreciation. Debt is not not the right asset class If someone wants to take risk If someone takes that kind of risk investing in credit risk funds might as well invest in stocks,” said Rushabh Desai, founder of Rupee With Rushabh Investment Services, a mutual fund distribution company, based in Mumbai.

A closer look at the performance of these systems reveals another story. Only two schemes – BOI AXA Credit Risk Fund and UTI Credit Risk Fund managed to offer more than 15% over the one year period. Apart from them, only three other diets managed to deliver double-digit returns. BOI AXA Credit Risk Fund has offered around 144% over the past year, inflating the category’s one-year average return.

ETMutualFunds announced last month that BOI AXA Credit Risk Fund posted returns of 150% due to the turnaround of two companies -Sintex BAPL and Amanta Healthcare, which had been written down earlier. BOI AXA Credit Risk Fund was one of the worst-hit default schemes of 2019. The fund house had written down various debt securities and its entire exposure to the IL&FS group.

Read more: BOI AXA Credit Risk Fund offers 150% return in one year

“The sharp rise in the net asset value of some credit risk funds does not mean that they offer higher returns. It could simply mean that some companies within the fund have made their redemption, because over the past few years, we saw many downgrades and flaws that had hampered the regime’s NAVs,” Desai added.

Now that you know the credit risk category doesn’t exactly offer extraordinary returns, what should you do? Should you stick with safer programs like Rushabh Desai suggests or should you take extra risks to get extra returns? Most advisers say regular investors shouldn’t chase returns in the current market and stick to safer debt funds. They believe rates are about to rise further and some businesses may be hit by higher interest rates. Sophisticated investors can bet on credit risk funds after taking a closer look at the credit quality of the portfolio. However, investors should keep in mind that the debt market is expected to remain volatile for some time and debt mutual funds will also mirror the trend.

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