Credit Risk Fund: A Moderate Risk Investment Fund
Every investor invests in various types of funds, according to their risk profile. Some have a high appetite for risk, while other prefer a moderate risk. One such fund for such an investor is credit risk fund. Credit Risk funds are a category of debt funds that invest 65% of their portfolio in AA rated paper. They aim to generate high returns by taking high credit and investing in lower–rated papers. These low papers typically generate two to three percent more returns as compared to risk–free papers.
How does the Credit Risk Fund work?
These funds are ideal for those investors with a higher appetite for risk in the fixed income space should opt for it. They mainly generate income in two ways, first they earn interest income on the securities they hold and secondly, they invest in low rated securities. So, if the securities get upgraded then they have a chance to make a capital gain on those risks. A credit risk fund manager mainly invests in the debt instrument of AA rating (which is highly risky compared to AAA rating). They possibly look upon the potential upgrade on the ratings later in the future or assured returns due to strong fundamentals. Also, if the economy performs better, then there will be an improvement in the finances, which may lead to an upgrade in the bond rating.
Before selecting any credit risk fund, an investor must know that, he must choose a fund manager and fund houses with good experience in managing debt portfolios. Finally, investors should hold no more than 20% of their debt portfolio in such funds, since this category carries higher risk as compared to other debt funds. Apart from that, he should also look upon the fund house size, as most of these funds have high liquidity risk. So, if in case a bond with having a low rating in the portfolio faces a downgrade or default, then it may be difficult for the fund manager to exit the holding. Large asset-based funds act as a cushion against any kind of risk. They should also look out at the fund expense ratio and make sure it is not concentrated with a single sector or any single business group.
One of the biggest benefits of investing in the credit risk mutual fund is dividends are exempt from tax, but the scheme must pay a dividend distribution tax of 28.84%. An investor who invests in three years of investment is treated as short term capital gains and taxed as per your income tax slab. In case, if the investment is more than three years, then they are eligible for long term capital gains tax at 20% with the benefit of indexation.
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*Mutual fund investments are subject to market risks. Please read the scheme information and other related documents carefully before investing.