Investing in credit risk funds

Credit and risk management process is of paramount importance

Johncy Jacob Johncy Jacob

CREDIT RISK FUNDS are a category of debt mutual funds that invest primarily in securities with lower ratings. Credit-risk funds have at least 65 per cent of their investments in AA and below-rated papers. This category of funds, over the past several years, had been popular among the investors because of their potential to earn double-digit returns.

However, since IL&FS defaulted on its payments, this category has come under pressure. Many of the funds from several fund houses that had exposure to troubled papers saw their NAVs crash in a single trading session, leading to a concern among the investors.

However, amid this, it is also important to note that a few of the fund houses were left unaffected by these negative developments. This was such fund houses did not have any exposure to the troubles papers. What did these fund houses do differently? The logical answer would be their risk management processes. Data shows that investors have moved to fund houses with quality names and robust processes in the past few months.

So, the question for an investor now is, how does one choose a credit risk fund? The answer lies in the practices followed by fund houses like ICICI Prudential AMC that have time and again performed well in terms of generating returns and successfully kept themselves away from bad debt papers.

The process followed by such AMCs

Investment philosophy: The investment team seeks to achieve safety, liquidity and returns, in that order, for managing fixed income schemes.

Robust investment process: The strong processes followed when it comes to credit research, portfolio construction and portfolio monitoring have helped these funds perform.

Strong credit selection process: The presence of an independent research team, which works on a self-origination model, has ensured that each of the debt paper which forms a part of the portfolio is thoroughly scrutinised and is approved by the risk management team. The external credit rating is just an input and not the sole deciding factor in the decision making process.

Better risk-adjusted return: To achieve the objective of providing a good investment experience, it is imperative to ensure that risks emanating from liquidity, credit, duration and concentration are properly managed.

Things to remember for an investor

Unlike duration funds (which generate returns through events resulting in interest rate reduction), for accrual funds to generate return two things are important—risk-adjusted rate of return and the time period of investments. Considering that the upside in any debt investment is capped, it is better to invest in schemes with robust risk management teams. Last but not the least, do not chase yield-to-maturity (YTM) as the sole metric.

Author is managing director of Thirukochi Financial Consultants Pvt Ltd



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