A credit opportunities fund is a type of debt fund that seeks to invest in relatively lower quality bonds with the aim of generating higher yields and accrual income. Subsequent to the categorization and rationalization of mutual fund schemes by SEBI, credit opportunities funds have been renamed as credit risk funds. According to new SEBI guidelines, at least 65% of the scheme assets of credit risk funds need to be invested in corporate bonds that are rated lower than the highest rating applicable to these instruments. In other words, they have to be invested in debt securities rated AA and below (below the highest rating of AAA).
Leading Credit Risk Funds with High Returns
The following is a comparison of a few leading credit risk funds across key criteria:
|Fund Name||3 Year Returns (%)||5 Year Returns (%)||AUM (Rs. crore)|
|Franklin India Credit Risk Fund||8.71||9.95||7,116|
|UTI Credit Risk Fund||8.61||9.87||5,321|
|Kotak Credit Risk Fund||8.80||9.60||5,135|
|ICICI Prudential Credit Risk Fund||8.36||9.53||11,452|
|SBI Credit Risk Fund||8.37||9.45||5,388|
*The above returns data is based on scheme NAV as on 17th October 2018 and AUM data is as recorded on 30th September 2018.
Franklin India Credit Risk Fund
One of the top performers in the category, Franklin India Credit Risk Fund featured a Year-to-Date (YTD) return of 5.72% as of 17th October, 2018. The figure looks modest, however the recent correction in bond prices has opened up an opportunity for investors. The scheme had a YTM (Yield-to-Maturity) of 11.22% on 17th October 2018. YTM is roughly the return you get if you hold the scheme for a term that coincides with the average maturity of its debt instruments. This is assuming that there is no major drop in the credit quality of the portfolio.
As of 30th September 2018, the scheme featured AUM worth Rs. 7,116 crores, which makes it one of the largest schemes in the category on this basis. This scheme is currently managed by Santosh Kamath who has been at the helm since April 2014. Franklin Mutual Fund is well known for its expertise in the debt fund category and its management of popular schemes such Franklin India Ultra Short Bond Fund – Super Institutional Plan (AUM Rs. 15,135 crore), Franklin India Short Term Income Plan (AUM Rs. 11,590 crore) and Franklin India Low Duration Fund (AUM Rs. 6,601 crore as of 30th September 2018).
UTI Credit Risk Fund
One of the oldest schemes in the category, the UTI Credit Risk Fund was launched in January 2013. It featured (Yield-to-maturity) YTM of 10.08% on 17th October 2018, due to a correction in bond prices. YTM is roughly the return you get if you hold the scheme for a term that coincides with the average maturity of its debt instruments. This is assuming that there is no major drop in the credit quality of the portfolio.
UTI Credit Risk featured an AUM of 5,321 crore as of 30th September and is currently managed by Ritesh Nambiar who has been in the current role since August 2014. Other popular debt schemes managed by UTI Mutual Fund include the UTI Liquid Cash Fund Institutional (AUM Rs. 33,476 crore), UTI Treasury Advantage Fund Institutional (AUM Rs. 10,851 crore) and UTI Short Term Income Fund (AUM Rs. 9,286 crore as of 30th September 2018).
Kotak Credit Risk Fund
Kotak Credit Risk Fund was launched on the same day as the previously discussed UTI MF scheme. With AUM of Rs. 5,135 crore as of 30th September 2018, it is also one of the most popular in the credit opportunity fund category. As of 17th October, the YTM of this scheme was recorded at 10.25%. YTM is roughly the return you get if you hold the scheme for a term that coincides with the average maturity of its debt instruments, assuming no dramatic deterioration of credit quality.
The current fund manager Deepak Agarwal has been managing the scheme since its inception in January 2013. Some of the popular debt funds managed by Kotak Mutual Fund include Kotak Liquid Fund (AUM Rs. 27,229 crore), Kotak Bond Fund – Short Term Plan (AUM Rs. 7894 crore) and Kotak Savings Fund (AUM Rs. 7,112 crore as of 30th September 2018).
ICICI Prudential Credit Risk Fund
ICICI Prudential Credit Risk Fund was launched close to a decade ago in December 2010 and has witnessed multiple market cycles through the years. The scheme’s AUM was recorded at Rs. 11,452 crore on 30th September 2018, which makes it one of the most popular credit risk funds currently available in India. The scheme featured a YTM of 10.16% on 22nd October 2018 and this indicates the approximate return you can expect to receive from your investment into this scheme if such investments are held for a duration equalling the average maturity of the scheme’s investments. The assumption here is that there will be no substantial deterioration in credit quality during the period.
This scheme is currently co-managed by Akhil Kakkar and Manish Banthia. Other popular debt schemes of ICICI Prudential Mutual fund include ICICI Prudential Liquid Fund (AUM Rs. 47,684 crore), ICICI Prudential Balanced Advantage Fund (AUM Rs. 28,616 crore) and ICICI Prudential Equity & Debt Fund (AUM Rs. 27,342 crore as on 30th September 2018).
SBI Credit Risk Fund
SBI Credit Risk Fund has been around for close to 15 years now since its launch in July 2004. Ranked as one of the top performing schemes in the category, this fund from SBI Mutual Fund has recorded a YTM of 9.80% on 22nd October 2018. This figure represents the approximate returns you will receive by investing in the scheme for a period equal to the average maturity of investments held by the scheme. This of course assumes that the asset quality of the scheme’s portfolio does not deteriorate appreciably during the period.
Mansi Sajeja and Lokesh Mallya are joint managers of the scheme. Other popular SBI schemes are SBI Liquid Fund (AUM Rs. 46,646 crore), SBI Equity Hybrid Fund (AUM Rs. 27,305 crore), SBI Bluechip Fund (AUM Rs. 19,213 crore) and SBI Magnum Low Duration Fund (AUM Rs. 7,485 crore as on 30th September 2018).
Key Features of a Credit Opportunities Fund
The following are key features of credit opportunities fund:
Primary Investments: Credit risk funds primarily invest in corporate bonds (at least 65% of assets). However, these bonds feature relatively lower ratings than the highest credit rating applicable to corporate bonds. Additionally, these schemes may invest a remainder of assets in higher rated corporate bonds as well as various money market instruments.
Higher Accrual Income: By design, lower rated bonds offer higher coupon rates hence accrual income tends to be higher in case of credit risk schemes as compared to other debt schemes. This is a direct result of the potentially higher risk that scheme and its investors undertake when investing in lower rated corporate bonds.
Non-Equity Taxation Rules: Being non-equity investments, these credit opportunity/credit risk funds feature the same taxation rules as other non-equity investments. Therefore you can get indexation benefits on your credit risk fund investments if you hold your scheme units for 3 years or more from the date of unit allocation. Similarly for credit opportunities fund investments held for less than 3 years from date of unit allocation, short term capital gains (STCG) taxation rules are applicable. The applicable STCG is same as the IT slab rate of the individual investor. Know more about non-equity mutual fund taxation rules
Limitations of Credit Risk Funds
The following are the key limitations and risks associated with credit opportunities fund:
Credit Risk: This is potentially the single greatest risk associated with a credit opportunities fund and it arises from the scheme’s investments in relatively low quality securities (65% or more of assets). While lower quality securities such as corporate bonds offer higher coupon rates, they also feature a higher risk of default which is represented through their lower credit ratings. One should thus consider risk to the principal amount invested when choosing a credit risk fund.
Liquidity Risk: Bonds with lower credit ratings tend to find fewer takers especially when such relatively lower rated bonds are downgraded or the bond issuer defaults on its debt obligations. As a result, the main investments of credit risk funds (relatively low rated corporate bonds) tend to feature lower levels of liquidity which is the key source of liquidity risk for these schemes. In order to manage this risk to a certain extent, many credit opportunities fund also invest in highly liquid money market instruments as well as high quality corporate bonds.
High Fund Manager Dependence: A credit opportunities fund is highly dependent on the fund manager and fund management team’s ability to select debt securities that offer high yields while featuring potentially low default risk. What’s more, in an ideal situation, such relatively low quality securities move to higher credit ratings at a later date, which makes these investments even more valuable. Thus, the skill of the fund manager and his/her team to pick the best investment options is a primary factor impacting the scheme’s success.
Factors to Consider When Investing in Credit Opportunities Funds
The following are some key factors to consider when planning credit risk fund investments:
- Credit opportunities funds often feature a higher level of risk simply due to the type of investments they make i.e. the relatively lower rated corporate bonds that comprise a major portion of the scheme’s portfolio.
- Illiquidity risk surrounding such bonds in case of a default by the bond issuer or even the hint of inability by the bond issuer to service their debt obligations.
- Increased illiquidity in case of corporate bonds that are downgraded after the scheme has invested in the already lower rated securities.
Considering the above, you should invest in a credit opportunities scheme if you have relatively high risk tolerance. It is also a good idea to choose a scheme with a large AUM. This will make the scheme less vulnerable to sudden redemptions from a few large investors. The fund should also have diversified investments and a fund manager with a proven track record.