Credit Risk Mutual Fund

Credit risk mutual funds are debt funds that invest a minimum of 65% of their total assets in corporate bonds holding AA and below ratings, excluding AA+ rated corporate bonds. The remaining portion can be invested in other permitted debt and money market instruments, subject to the scheme's mandate.

Because the fund invests in low-rated (AA, AA-, A+, A, A-, BBB) companies, it carries a higher risk of default or delayed payments, so it offers a higher coupon (interest rate) to attract lenders. The fund captured the high yield and passed it down to the investors. Making it an ideal option for those who have a mid- to long-term investment horizon with a good risk appetite.

Credit risk mutual funds are lending portfolios and this is how it works:

• The fund manager identifies bond issuers that pay higher coupons to compensate for the lower credit rating and higher credit risk.
• Next, the manager pools money from multiple investors and builds a diversified portfolio with at least 65% of the total assets invested in corporate bonds rated AA and below. The remaining portion can be invested in higher quality debt or cash equivalents.
• This fund category exists to capture a risk premium. Issuers with weaker credit profiles must pay higher coupons to borrow. Since credit risk funds invest a higher proportion of the portfolio in below highest-rated instruments, the investors are benefited with higher interest rates due to higher credit spreads.
• Returns accrue gradually through coupons (interest) and sometimes from rating upgrades. If sold before immaturity, the bond holding may generate capital gains, if the market value of the bonds rises.

Investors can invest in credit risk mutual funds through Paisabazaar mobile app. Follow the simple steps below to start investing: 

• Go to your Paisabazaar account.
• Click on ‘Mutual Funds’ under ‘Investment Products’ on the homescreen.
• Search for ‘Credit Risk’ fund under ‘Fixed Income’ Category. 
• Pick a credit risk fund or AMC based on your requirement.
• Complete your KYC to start investing in Credit Risk Debt Funds.

A credit risk fund is a category of debt mutual funds. Hence, it follows the exact same rules as any standard debt mutual fund. How your returns are taxed entirely depends on when you acquire the units. 

• On or after 1 April 2023 - If you have invested in credit risk funds on or after this date. All gains are treated as Short-Term Capital Gain (STCG) and taxed at your applicable income tax-slab rate, irrespective of the holding period of the investment (i.e., 6 months or 3 years).
• Before 1 April 2023 - If you have invested in a credit risk mutual fund before this date and hold it for more than 12 months (listed) and 24 months (unlisted), all gains are treated as Long-Term Capital Gain (LTCG) and taxed at 12.5% without indexation benefits.  

Taxation of Dividend Income

If you opted for the Income Distribution cum Capital Withdrawal (IDCW) option instead of growth. The IDCW will be taxed at your standard income tax slab rate. If the gain exceeds Rs 10,000 in a financial year, 10% TDS (tax dedicated to the source) may also apply.