Should you invest in credit risk funds?

What are credit risk funds?

Credit risk funds are debt funds that invest a minimum of 65 percent in corporate bonds and debentures rated below AAA. These funds also invest a small part of their corpus in government securities and T-Bills to provide liquidity in case of heavy redemptions.

What is their investment strategy?

These schemes follow accrual strategy. They invest in low-rated securities with strong fundamentals, hoping for a rating upgrade in future. These schemes hold the securities until their maturity.

Are these schemes risky?

A default or a downgrade in the rating of the scheme's portfolio holdings may hit the net asset value of the scheme badly. In the past, multiple schemes of AMCs like Taurus Mutual Fund and JP Morgan AMC (now a part of Edelweiss Mutual Fund) were hit badly due to the rating downgrade of papers held by their schemes.

Do AMCs take any protective measures?

A few AMCs claim to have their research teams to evaluate the risk involved in the low-rated instruments. Some fund managers may also ask for a collateral from an issuer to cover the risk.

Who should invest in them?

Debt mutual fund Investors with high-risk appetite may invest in these schemes with a minimum investment horizon of three years.

How are the returns from these schemes taxed?

If investments in these schemes are held for more than three years, an investor can enjoy long-term capital gains tax of 20 percent with the indexation benefit. If redeemed before completion of three years, short-term capital gains would be added to the income and taxed according to the income tax slab rate applicable to the investor.

Source: Economic Times | Aug 10, 2018

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