I got queries from clients and a few other mails recently about credit risk funds. I am not much in favor of taking credit risk. But given the recent outperformance of the credit funds compared to other debt fund categories (look at the table below), the category is once again generating some interest.
These funds were doing very poorly for the last couple of years (2019 & 2020), mostly post the credit crisis of 2018 and its aftermath. Have a look at the annual category returns for credit risk funds when compared to other debt fund categories in 2019 and 2020 (table below). It’s abysmal:
But if you look at the last 1-year performance of all the credit risk funds, then they seem to be doing good. Have a look yourself in the 1-year return list of all credit funds in India (2021) below:
- Baroda Credit Risk Fund – 17.64% (AUM Rs 178 Cr.)
- Franklin Credit Risk Fund – 16.43% (AUM Rs 2572 Cr.)
- BOI AXA Credit Risk Fund – 14.32% (AUM Rs 72 Cr.)
- HDFC Credit Risk Debt Fund – 12.75% (AUM Rs 7368 Cr.)
- ABSL Credit Risk Fund – 12.42% (AUM Rs 1517 Cr.)
- IDBI Credit Risk Fund – 11.25% (AUM Rs 38 Cr.)
- L&T Credit Risk Fund – 10.71% (AUM Rs 223 Cr.)
- Nippon India Credit Risk Fund – 10.59% (AUM Rs 1032 Cr.)
- ICICI Pru Credit Risk Fund – 10.47% (AUM Rs 7228 Cr.)
- Axis Credit Risk Fund – 10.04% (AUM Rs 621 Cr.)
- PGIM India Credit Risk Fund – 9.91% (AUM Rs 46 Cr.)
- Kotak Credit Risk Fund – 9.80% (AUM Rs 1797 Cr.)
- SBI Credit Risk Fund – 9.63% (AUM Rs 3497 Cr.)
- IDFC Credit Risk Fund – 8.22% (AUM Rs 821 Cr.)
- DSP Credit Risk Fund – 7.55% (AUM Rs 278 Cr.)
- Invesco India Credit Risk Fund – 6.68% (AUM Rs 130 Cr.)
- UTI Credit Risk Fund – (-)2.39% (AUM Rs 319 Cr.)
Source – Valueresearch (28-May-2021)
So with an improvement in performance, does it make sense to reconsider credit risk funds?
I don’t think so.
The credit risk fund category should still be a big avoid for most investors unless someone is a bit adventurous.
Irrespective of the returns being generated, this is a very risk category. As per the SEBI debt fund category rules, the Credit Risk funds need to invest at least 65% of their assets in bonds below the highest-rated bonds, i.e. AAA / AA+ or below.
These funds try to generate higher returns by investing in lower-rated corporate debts. Since such low-rated corporate securities pay out a higher yield than high-rated corporate debt or government bonds, they have the potential to generate good returns for their investors. But with high return potential, comes the additional risk of default or downgrade of the low-rated underlying securities. Now the problem with defaults is that as soon as any bond issuer announces its inability to honor its payments, even temporarily, the sentiment drops suddenly. There will then be no takers for such a bond and the fund manager would find it very difficult to sell that bond in the market. So liquidity dries up and if many investors start redeeming together simultaneously, it can lead to serious liquidity issues and the fund would find it almost impossible to honour the redemptions. Something that came to light very clearly in the Franklin India debt fund crisis of 2020.
So in general, I don’t think it is worth taking credit risk.
I would say that inspite of what your view about credit risk and credit fund category might be, I think it is not worth taking too much credit risk. Not now not later.
On the debt side of the portfolio, I have a strong bias for prioritizing return OF capital over return ON capital. Remember that Debt is mainly for capital preservation. It is not about return maximization. They never were even if you were told so or you misunderstood them. If you want to maximize returns and beat inflation, do it via equity in your portfolio. Not debt. Don’t take unnecessary risks with debt fund choices. And please remember that debt funds are good alternatives for fixed deposits, but they are still not risk-free. You want better than FD returns, you got to take some risk. Plain and simple.
Related Reading – How to pick debt funds correctly? Also, read my article in Morningstar India about What debt funds are NOT?
So if you are a conservative or a moderately aggressive investor, just ignore the credit risk funds category. If you are adventurous and have a high-risk appetite, you might consider taking around 10-20% exposure to this category in your debt portfolio. And when taking that exposure, stick to funds with large AUM from the top few AMCs only. Don’t run blindly after table-toppers or small AUMs offering other incentives like lower expenses, etc.