What Is Credit Risk Fund? Advantages of Credit Risk Fund

What Is Credit Risk Fund?

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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See Also: What is Corporate Bond Fund? Advantages of Corporate Bond Fund

Things to Know While Investing in Credit Risk Fund:

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:

• Do not invest a large portion of your investments in these funds. It is also advised that you seek guidance from a financial advisor before investing in such funds. You may instead use diversified mutual funds to make investments.
• Choose funds portfolios with higher assets as they provide an opportunity for the fund manager to diversify and spreading the risk at all times.
• You must always go with an experienced and professional fund manager who has enough experience in handling such funds.
• First-time investors must invest in funds with lower expense ratio to maximise returns.
• It is also important that your fund manager does not concentrate your portfolio with securities from a single group.
• The risks involved in such investments are high; therefore you must not hold more than 20% of your debt portfolio in such funds.

Why Should You Invest in Credit Risk Fund?

• These are low-rated debt securities whose value may decline due to a sudden downturn. Thus, investors with moderate to high risk-bearing ability must opt for such investments as the risk related are high.
• These are ideal bet for investors who have a sound knowledge about the risks involved in investing in low-rated securities. Credit risk funds are not an ideal option for beginners.
• These funds are not suited for investors who want to generate a steady income while keeping the risk low.
• These funds can prove ideal for Investors belonging to the highest tax slab who are looking for opportunities to save taxes. By investing in this scheme they only need to pay 20% LTCG taxes instead of 30%.

Credit Risk Fund Returns:

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.

How Credit Risk Fund is taxed?

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.

Advantages of Credit Risk Fund:

• Credit risk funds provide an avenue for the investors to expose their investments to risks in the debt sector. Thus investors who are looking for moderate-risk investments in debts can invest in such funds.
• The credit risk funds have the potential to generate better returns when the funds move up. This opens an additional avenue for investors to get better yield along with regular interest income.
• These funds enable the investors to earn returns in the medium to long-investment horizon. Thus these funds are risky investments and are not meant for risk-averse investors.
• They help you to diversify your investment portfolio and invest a portion in risky debt securities.

Risks of Investing in Credit Risk Fund:

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.

See Also: What is Arbitrage Fund? Is It Good to Invest In It?

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