Best Credit Risk Mutual Funds

Here are some features of credit risk mutual funds:

Asset allocation: According to the Securities and Exchange Board of India (SEBI) guidelines, credit risk mutual funds must allocate at least 65% of the fund corpus in corporate bonds with a rating below AA+. 

Risk-reward ratio: The underlying low-rated corporate bonds have the potential to generate higher returns than debt securities with a better credit rating. Moreover, the top credit risk mutual funds involve lower interest rate risk when compared to the other debt funds.  These schemes benefit when ratings of these financial instruments are upgraded. Fund managers of top credit risk mutual funds control the average credit quality of these schemes to minimise the chances of default. 

Short-term Capital Gains Tax: If investors redeem their units before 3 years, the returns they earn are added to their taxable income and taxed per their slab rate. 

Long-term Capital Gains Tax: When investors sell their units after a holding period of 3 years, the returns are known as long-term capital gains. A tax rate of 20% is applicable on these gains, and individuals are eligible for indexation benefits.

Since credit risk mutual funds invest in corporate bonds with a low rating, they’re associated with a high risk of default. If the underlying securities are upgraded, these schemes generate returns via interest income as well as capital gains. However, there’s a high possibility of a downgrade in credit rating due to non-repayment of principal amount or delay in interest payment. In such cases, the performance of these funds is severely impacted. Hence, even the best credit risk mutual funds may not be suitable for investors with low-risk tolerance. Nevertheless, there are certain aspects apart from the risk profile that investors need to consider before allocating their savings to any of the best credit risk mutual funds 2023. 

Investment goals: Credit risk funds aim to generate higher returns than other types of debt funds by investing in securities that are of low quality. The financial goals of all investors are not the same. Investors with a moderate to high-risk appetite may want to earn higher returns than what these schemes can generate. In such cases, they may opt for other options. Hence, it’s vital that investors identify their financial goals before parting with their savings. 

Assets under management (AUM): Funds with a high AUM can diversify their portfolio as much as possible, thereby minimising the risk. Hence, it is vital for investors to consider the AUM of different schemes besides other essential factors when choosing which is the best credit risk mutual fund for them.

Fund manager: Fund managers of the best credit risk mutual funds are responsible for formulating effective investment strategies to achieve the scheme objective efficiently. They use various risk management techniques and carry out thorough research and analysis to take prudent buy-and-sell decisions that can maximise the portfolio return of investors. A fund manager with a proven track record and many years of experience have the potential to produce the best possible results. Hence, one must make sure to check a fund manager’s previous performance.

Expense ratio: The expense ratio is a maintenance fee that asset management companies (AMCs) levy on investors to finance a scheme’s operating and administrative expenses. It is a small percentage of a fund’s total assets. The higher the expense ratio, the lesser will be the returns. Hence, investors must consider the expense ratio when allocating their funds to a credit risk fund. 

Fund history: When browsing the best credit risk mutual funds, investors must check their historical returns. A fund that has been able to deliver consistently since its inception is likely to offer the best possible results. Hence, one must consider that past performance does not guarantee future performance. It just gives us an idea of how has the fund performed to various economic conditions in the past.

Exit load: Exit load refers to a penalty fee levied by a fund house if investors sell their units, fully or partially, within a specific period from the date of purchase. This penalty is charged to discourage investors from withdrawing from a scheme prematurely. The exit load of all credit risk funds is not the same. Investors must know the exit load of a scheme before investing in it. 

Direct or regular plan: Direct plans are what investors directly allocate their funds to; they do not involve any broker or distributor. One has to facilitate the transaction via third parties if they choose a regular plan. In the case of a direct plan, fund houses do not need to pay any commission to brokers and distributors as opposed to regular plans.  Hence, they feature a lower expense ratio and report a higher NAV than regular plans of the best credit risk mutual funds.

Here are some advantages of investing in credit risk mutual funds:

High returns than other debt funds: These funds invest in debt securities that have a low credit rating. Accordingly, they are associated with default risk. Nevertheless, to compensate for the high risk, the underlying corporate bonds have a premium coupon rate. 

Tax benefits: STCG earned from a credit risk mutual fund is liable for taxation per the investor’s tax slab. However, LTCG is taxed at a flat 20% rate + indexation benefits. This contrasting tax treatment between STCG and LTCG is particularly beneficial for investors in the highest tax bracket since they have to pay only 20% tax on their gains, saving 10% in tax outgo. 

Investment route: One can invest in the best credit risk mutual funds via two ways, namely Systematic Investment Plan (SIP) and lump sum. By choosing the SIP mode, investors can allocate their funds in a scheme by paying fixed monthly/quarterly/yearly instalments. Contrarily, the lump sum mode allows investors to buy scheme units by making a one-time payment.