Credit risk funds are back on top of return charts | Economic Times

With over 9% returns in one year, credit risk funds have topped the return charts in the debt category after a really long time. These funds had earned a bad name for themselves during the credit crisis of 2018. Many credit risk funds saw a huge dip in NAVs due to defaults and eventually investors started to exit from these schemes. However, it looks like these schemes are back in action after two long years. Is it a prudent decision to give these schemes a second chance? In the first quarter of FY 2020-21, these funds saw a massive outflow of Rs 25,905.71 crore. Compared to this, the quarter ending March 2021 saw a net outflow of Rs 632.80 crore from this category. The total 16 schemes in this category mobilised a total sum of Rs 326.91 crore in April, 2021. The situation has definitely improved over time. However, many mutual fund advisors are still asking investors to not jump the gun and be cautious about taking extra risk for extra returns."Credit risk funds are a tricky case. Broadly, you may allocate some component of your fixed income allocation to credit risk funds. The performance has improved because yields have eased. Last year in April-May, the corporate bond market was at a standstill and yields were high. It has normalized now. Moreover, the previous default cycle is over. Now there may be incipient risks due to economic slowdown, which may surface later, but my view is that even if that happens the impact would be less than the previous cycle," says Joydeep Sen, Corporate trainer (debt markets) and author, based in Mumbai. From August, 2018 to the beginning of 2020, the credit risk funds saw a number of defaults that led to NAV dips in many schemes including those from big AMCs. These defaults happened in companies that were well established and big names. Some of these defaulting companies included IL&FS, ADAG, DHFL, Yes Bank, Altico and Essel. These defaults also impacted various liquid funds, but the major sufferers in this fiasco were the credit risk. Some schemes were hit more than the others and have still not been able to get out of the negative territory- BOI AXA Credit Risk Fund, UTI Credit Risk Fund and IDBI Credit Risk Fund are examples. Here's a look at their three year performance since the defaults hit: Scheme name3-year returns (%)BOI AXA Credit Risk-31.89UTI Credit Risk-9.26IDBI Credit Risk Dir-0.27However, schemes like HDFC Credit Risk Debt, ICICI Pru Credit Risk, Kotak Credit Risk etc are examples of some schemes that have come out of the credit crisis to offer 9.61%, 9.48% and 8.43% returns in the last three years.. Now, many ask if these schemes continue to be very risky still. The answer is YES. By the mandate given to them by Sebi, credit risk funds invest a large chunk of their assets (at least 65%) in instruments rated AA or lower. However, these offer higher yield and have the potential to give higher returns in the event of a future upgrade in credit rating of the bonds."I think since December, 2020 these funds started looking good and they are probably the best option to consider at the moment. Since, many investors come for 36 months plus horizon in fixed income for tax efficiency, these funds ca be a good option. For three year time horizon, the risk - reward is in favour of credit risk. Also, after the violent shakeout in the last years, many credit risk funds have re-aligned to the label and maturity profile. However, this is for a moderate to aggressive fixed income investors who can stay at least 3 years," says Santosh Joseph, founder- Germinate Investor Services, based in Bengaluru.So, if you don't want to expose your debt portfolio to extra risk, you better stay away from credit risk funds. However, if you want to earn better than the other debt funds and are willing to take the risk, choose funds that are diversified and evaluate whether the risk is worth taking. Advisors ask investors to go for bigger funds and diversified portfolios. "Stick to the AMCs that have a solid track record in the default cycle i.e. capability to understand that risk. Whether or not these funds are worth the risk is a tricky part. Duration risk is not advisable now as RBI would not cut rates further. If the investor is looking for some alpha may be some allocation to credit risk funds of AMCs that did well in the previous default cycle is advisable. However, due diligence and portfolio analysis is very important," says Joydeep Sen.