Monday, June 21, 2021

Should you invest in credit funds?

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Credit-risk funds are the type of debt funds that invest approximately 65 percent of their assets below the highest-rated instruments. Usually, AAA AA debt rated paper. By taking higher credit risk and lending in lower-rated documents, they generate high returns. Such firms grant greater interest rates and offer a capital gain advantage as and when their rating increases. The risk of interest in such funds is small because of their short duration. Generally, these funds can return 2-3 percent more than other mutual funds investments.

Features of credit funds:

  • They are suitable for an investment horizon of at least 2 to 5 years. 
  • High chance of incurring a loss. 
  • These schemes give a better return to investors but take high risk.

Working on credit funds

These funds produce returns in two ways:

  • Interest amount: Investors earn interest income on the securities retained by the funds.
  • Capital Gains: They invest in low-grade securities, and once the security gets improved, the investor also earns capital gains.

There is a high probability that borrowers can default in making their interest payments, and in such cases, the security becomes downgraded. This, in turn, has a huge impact on the fund’s capital gains. 

How to Invest?

There are several methods through which one can invest in credit mutual funds:

  • Offline mode: This is the traditional model of investing, where the investor visits the nearest branch office of the fund house and invest in a suitable scheme. You should provide all the required documents such as Id proof, Address Proof, Cancelled Cheque, PAN Card, Passport size photos, and KYC Document. 
  • Online Portal: This is the easiest mode of investing, where you can easily choose different websites available on the internet. You can select the fund you want to invest in, study the details, and examine similar schemes from other sources.

Steps to invest in credit funds in India

  1. Identify the credit fund you wish to invest in. 
  2. Create an account with the AMC. 
  3. Submit your KYC documents 
  4. Decide the amount you need to invest.
  5. Invest the amount on the chosen dates.
  6. Monitor the performance of the fund always. If the fund’s review is not up to the mark, you can turn your investment into another fund.

Points to Consider While Investing

  • It involves high risk. 

Since these funds are risky, you should have a high-risk appetite. And, you should have enough funds so that you can bear the greater risk in this fund.

  • Role of Fund Manager

Always find a fund manager who is highly compatible with managing the funds. 

  • Asset under Management (AUM) 

Check the AUM of the fund before lending. Usually, when you invest in this type of fund, it should be bigger in size. This is because their higher corpus helps in diversifying risk, and the scope of diversification is better. 

Should you invest in a credit risk fund?

A credit risk fund is recommendable for only those investors who have high-risk toleration. If the issuer of a bond declares its failure to clear its payments, it can promptly begin a liquidity issue for such a fund. As a result, there would be no purchaser for such a bond in the market and, so the fund manager would not be able to sell that holding. Moreover, there is always a possibility that instead of getting up-gradation, a paper possessed by the fund is downgraded. This can vanish the whole capital quickly.

If you have a risk tolerance capacity, you should invest in a credit-risk fund. Always choose a scheme with a large AUM to get a better outcome. This will make the system less sensitive to a few big investor’s immediate redemptions.

Hence, risk-taking investors should mindfully examine the portfolio of the funds they want to invest in while others should stay away.

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