Best Credit Risk Mutual Funds

Credit risk funds (essentially debt funds) are mutual funds that invest in low-rated corporate debt securities. These funds hold an objective to generate higher returns by investing in securities that provide a higher yield than high-rated funds. High-rated corporate or government securities hold a lower risk profile. 

In simpler words, they are debt funds investing in debt assets that are of low credit quality. They invest in low-quality instruments and have a higher credit risk. The securities with a low credit rating usually offer high rates of interest; each of these debt instruments is ranked in an alphabetical code. 

The securities with a credit rating below, 'AA' are known to have a high credit risk. Therefore, to boost the overall rating, the fund manager would choose other highly ranked securities among credit-risk debt funds. This balance provides a positive NAV. 

Some top credit risk funds are listed in the table below.

Individuals most suitable for credit risk debt funds are:

1. Investors Who Have a Medium-Term Investment Horizon: If your investment horizon is for a period of 2 - 3 years, then these funds can be suitable for your investment choice. However, you will also have to consider having a greater risk tolerance. 
2. Investors Who Look for Better Returns from Fixed-Income Investments: A credit risk fund could be a good choice for your investment objective if your motive is to earn comparatively greater returns than other fixed-income investment vehicles.
3. Investors with a Higher Risk Appetite: Credit funds are relatively riskier. Therefore, you will have to invest in them only if you have the appetite to tolerate the risk. If you choose to invest in low-risk and stable schemes, other forms of debt funds would suit your requirements.

The major factors one needs to consider while finding the best credit risk funds for their portfolio are-

1. Financial Goal: These funds are suitable for investors with a moderate risk tolerance and look forward to portfolio diversification. It can assist them to look forward to more ways of earning a fixed income. 
2. Expense Ratio: It is essential to understand the expense ratio of the fund and understand how much of your final returns would be delivered. 
3. Exit Load: Before making investments, you will have to consider the exit load of the fund.
4. Historical Data: It is easier to evaluate the performance of a fund through the historical data available. Therefore, you will have to note the past performance of the fund in detail.

Here are some advantages of investing in credit risk mutual funds:

High returns than other debt funds: These funds invest in debt securities that have a low credit rating. Accordingly, they are associated with default risk. Nevertheless, to compensate for the high risk, the underlying corporate bonds have a premium coupon rate. 

Tax benefits: STCG earned from a credit risk mutual fund is liable for taxation per the investor’s tax slab. However, LTCG is taxed at a flat 20% rate + indexation benefits. This contrasting tax treatment between STCG and LTCG is particularly beneficial for investors in the highest tax bracket since they have to pay only 20% tax on their gains, saving 10% in tax outgo. 

Investment route: One can invest in the best credit risk mutual funds via two ways, namely Systematic Investment Plan (SIP) and lump sum. By choosing the SIP mode, investors can allocate their funds in a scheme by paying fixed monthly/quarterly/yearly instalments. Contrarily, the lump sum mode allows investors to buy scheme units by making a one-time payment.

The risks that are associated with this kind of funds are:

1. Low Liquidity: There is low liquidity in these funds. Since they contain lower credit quality through the underlying bonds, they can't be instantly sold in the market. This makes credit risk funds have liquidity limitations when compared to other funds, especially the ones that invest in high-credit quality papers. 
2. High Credit Risk: According to SEBI's regulations, credit risk funds invest 65% of their assets in bonds that are rated below AA. As these kinds of companies carry a relatively higher credit risk, your investment in these schemes will be subject to a certain level of risk.