Should you invest in credit risk funds at this point?
On October 5, 2021, the rating agency Moody’s changed the outlook for the Indian government’s ratings from negative to stable and confirmed the long-term ratings of issuers in foreign currencies and local currency as well as the senior unsecured rating in local currency. at Baa3.
The rating agency noted that the downside risks associated with negative reactions between the real economy and the financial system are receding. âWith higher capital buffers and greater liquidity, banks and non-bank financial institutions pose much lower risk to the sovereign than Moody’s anticipated. And while the risks stemming from a high debt burden and low debt accessibility remain, Moody’s expects the economic environment to allow for a gradual reduction in the general government budget deficit over the next few years. years, thus preventing a further deterioration of the sovereign credit profile, âthe agency noted.
Recently, HDFC Mutual Fund advocated for investing in credit risk funds based on the positive green shoots seen in the economy and overall credit ratings as a result of this upgrade. “For India, since the costs of borrowing abroad are linked to its rating and the agencies’ outlook on our country, this upgrade could help reduce borrowing costs for the government as well as the industry. enterprises. Therefore, with the improvement in the credit outlook, one might consider an allocation to credit risk funds, âthe fund house said.
According to CRISIL, the credit ratio (number of upgrades to downgrades) continued to increase in the first half of fiscal year 2022, with 488 upgrades and 165 downgrades. The credit ratio was at a 10-year low of 0.54 (the lowest in more than a decade) in the first half of 2020, which is now at 2.96.
Credit risk funds, which invest 65% of net assets in lower-rated securities, had started to face the heat even before the pandemic due to sporadic credit events and other headwinds that the economy is facing.
Franklin Templeton’s decision to close six debt programs in April 2020 sent investors out of the category in hordes. Out of the total of Rs AUM 27,333 crore from six Franklin Templeton debt funds, the fund house distributed 88% or Rs 23,999 crore to investors in October 2021.
Given the challenges facing the economy, the category has experienced 21 consecutive months of net outflows from April 2019 to December 2020 to the tune of Rs 56,317 crore. As a result, assets in this category fell sharply from Rs 80,756 crore to Rs 25,385 crore in April 2021. As of September 2021, there were eight segregated funds in this category. In total, there are 26 separate portfolios, including eight funds in the Credit Risk category.
Net outflows from this category have eased and the category is experiencing a gradual revival. In the last five consecutive months (May 2021 to October 2021), credit risk funds have recorded cumulative net inflows worth Rs 1,504 crore.
Credit Risk Funds generated double-digit returns in 2014, 2015 and 2016. These funds started to face the heat from 2018 with the onset of the IL&FS crisis. It should be noted that some funds experienced drawdowns of more than 50% in 2020.
With the economy showing signs of recovery, these funds generated an average return of 8.92% over the current financial year as of November 8, 2021. Some funds such as UTI Credit Risk, Nippon India Credit Risk, IDBI Credit Risk, Nippon India Credit Risk and Baroda Credit Risk yielded double-digit returns. Advisors attribute the current year double-digit returns to these funds due to the accumulation of funds that have been discounted.
What Should Investors Do?
With these positive indicators, is it time to get into Credit Risk Funds at this point?
Dev Ashish, founder of StableInvestor, says that when considering investing in this category, he recommends that investors go with funds with shorter durations. âThere is of course a risk of rising interest rates. If this happens, credit risk funds with a relatively high portfolio duration may be affected a little more than those with a shorter portfolio duration. So even in the credit risk space, programs with a shorter duration are better placed at the moment. “
Dev says investors with a low appetite for risk should simply avoid this category. For others with a higher risk appetite and larger portfolios, he recommends that credit risk funds still not be an integral part of their debt portfolios. Instead, the exposure should be limited to 10-25%. And investors should go for funds that have a good track record. âWhen choosing funds in the category, stick to well-managed funds (with a relatively lower maturity profile) with large assets under management from only the best AMCs. Don’t chase after table tops or AMC small bottoms. Also make sure that the fund’s portfolio is not too concentrated (on a few instruments and / or issuers).
Dev says investors with a low risk appetite can avoid this category.
Dhaval Kapadia, Director – Portfolio Specialist, Morningstar Investment Advisers India, says the best time to invest in credit risk funds was 12 to 15 months ago, when spreads widened due to the FT problem . âThe returns of credit risk funds and other debt funds have fallen over the past 6 to 9 months due to the high liquidity of the interbank market. The interest rate cycle appears to have bottomed out and given the expectations of a rate hike over the next 6 to 12 months, it is advisable not to invest in these funds at this time. Instead, he recommends bank funds and PSUs or corporate bond funds to investors at this point.
Bengaluru-based RIA Basavaraj Tonagatti says debt funds should be used to diversify his portfolio from equity volatility and given the risk involved in this category, he recommends investors avoid such funds. âWe all know the risk involved, I would avoid such a tactical call especially in the debt portfolio. The reason is that we invest in debt when our time horizon is short or to diversify the risk of investing in debt. Therefore, in either case, the main objective of investing in debt is not to maximize the high returns of risky bets like credit risk funds. Therefore, my suggestion is to avoid such fund categories.
In summary, advisers recommend looking at debt funds from an asset allocation perspective to amortize your portfolio in the event of a stock market crash and build a corpus to meet short-term goals. If one is willing to take the risk, keep the allocation to credit risk funds minimal.