If you are an investor of debt mutual funds, you must have come across the word credit opportunities fund. Sometimes investors consider investing in these funds to try out new options or to diversify their portfolio. What many of them don’t know is that though they are a category of debt funds, credit opportunities fund comes with a considerably higher risk. Before proceeding further, let’s discuss a few basics of credit opportunities funds.
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As the name suggests, ‘credit opportunities’ funds are debt mutual funds that are known to take credit risk in order to generate a high yield. In order to provide better returns, these funds adopt an accrual strategy which means they consider a buy and hold strategy and hold the assets till maturity. The main objective of these funds is to generate an interest income by purchasing the securities of a company with lower credit rating, with the hope that its ratings would go up in future.
Thus the fund manager adds the papers of lower-credit rated securities that are rated below “AA” to these mutual fund schemes. Thus these securities carry a considerable amount of risk and are not for the faint-hearted. As such credit opportunities funds have the potential to fetch 2-3% higher returns than risk-free debt funds.
The credit opportunities fund is an ideal bet for investors who have a fair idea of the risk factors involved while investing in low-rated securities. A default or fall in the rating of the scheme’s portfolio holding may impact the NAV of the scheme badly. In the past, many such schemes of AMCs have badly suffered when the ratings downgrade.
Investors must have the knowledge of the risk posed by these funds and thus it can be said that these investments are not suited for risk-averse investors. Investors looking to generate steady income while keeping the risk low must stay away from such investments. However, Investors belonging to the highest tax slab who are looking for opportunities to save taxes can opt for credit opportunities fund. By investing in this scheme they only need to pay 20% LTCG taxes instead of 30%.
See Also: Debt Mutual Funds - A Complete Insight
The credit opportunities funds are mainly known to generate returns in the following ways:
As already discussed, credit opportunities funds adopt accrual strategy to generate high returns. They take credit risk and are thus risky investments. They usually invest in securities with low credit rating (less than “AA” rated), thus there are chances that they might degrade. Consequently, investors with high to moderate risk-appetite can invest in such funds. Listed below are some of the things you must remember while investing in these funds:
The mutual fund schemes investing in credit opportunities fund are bound to pay a 28.84% Dividend Distribution Tax. However, the dividends are tax-exempted in the hands of the investors. These schemes attract STCG as the returns earned from such schemes within a period of 3-years are subject to STCG and are evaluated based on the investor’s tax slab rates. But if the investor remains invested for more than 3 years then he becomes eligible for LTCG tax with indexation benefit.
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