Credit risk funds are a category of fixed-income funds with a mandate to invest at least 65% of the assets into ‘AA’ and below-rated corporate bonds.
What are the factors I should look at when investing in credit risk funds?
Credit risk funds are a category of fixed-income funds with a mandate to invest at least 65% of the assets into ‘AA’ and below-rated corporate bonds. These funds aim to invest in lower-rated (riskier) securities as they offer a higher yield to investors (than highly rated securities) to compensate for the risk of default and or/downgrades. These funds also have considerable liquidity risk due to limited liquidity in the low-rated segment in the Indian debt market. Credit risk funds can subject investors to sharp drawdowns placing even their principal invested at risk, as has been witnessed in the recent past with a few credit risk funds even witnessing double-digit drawdowns.
Though these funds offer higher yield compared to other debt categories, one should be cognizant of the risks involved. Investors should restrict allocation to such funds to about 10-25% of their fixed-income allocation in line with their risk appetite. Rather than chasing high yields, investors should select a fund keeping their risk appetite in mind.
While deciding upon a credit risk fund, look to invest into funds which are well-diversified across issuers and sectors. Also look at the underlying holdings and their ratings in detail, such that the portfolio yield is not contributed by a few highly risky securities.
I am 45 and can take risks for another five years. In equity funds, what type of funds should I look at for an investment horizon of 5 to 7 years?
—P H Sunder
Assuming a moderate risk profile given the short horizon of 5 to 7 years, invest with an allocation of 50% to equities and the rest (50%) to fixed-income. As the investment horizon is moderate, the bulk of the equity allocation should be into large-cap equities (80-85%) as they are less risky than midcap and small-cap equities. Though mid-cap and small-cap equities have the potential to deliver higher returns than large-caps, they are more volatile and involve substantial risk. Allocation to the mid- and small-cap segment should be restricted to about 15-20% of the equity allocation depending on your risk appetite.
The writer is director, Investment Advisory, Morningstar Investment Adviser (India). Send your queries to email@example.com