These are the types of mutual funds that offer attractive returns to the investors by taking the opportunity of the volatility of the low rated securities. These funds come under debt funds where the fund manager invests a major portion (minimum 65%) in less than AA-rated securities. Some of the best credit risk funds allow the investors to expose their investments to the low-rated securities which have the potential of a future upgrade in the credit ratings. The credit risk funds operate on the principle that when the company improves, the bond ratings issued by the company also upgrades.
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As the funds contain high credit risk, the investors suffer from a high risk of liquidity in such investments. Thus there are chances that the investors may suffer a heavy loss due to a downgrade of the funds. Thus these funds are best suited for investors who have a higher risk-bearing ability. Here are some of the things you might consider while investing in these funds:
The main objective of the credit risk funds is to generate an interest income by adding papers of companies with low credit ratings to the fund’s portfolio. Thus these mutual fund schemes aim to yield 2-3% higher returns than the other low-risk debt funds.
In credit risk funds the dividends are tax exempt. However, the dividends received by the investors will be taxed as per the applicable tax slabs. The scheme attracts STCG if the holding period of the funds is less than 3-years. Consequently, the investor will have to pay long-term capital gains tax at 20% while getting the advantage of indexation if he/she holds the funds for more than 3 years.
Credit risk funds work to generate returns by receiving regular interest income. They also hope to create additional capital gains if the fund’s security rating is upgraded. Thus these securities carry considerable risk as the credit rating may downgrade due to sudden downgrade. Thus the investor of such funds has to consider taking credit risk to generate returns.
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