Credit risk funds top debt returns chart in the past year, shows data

Yet these schemes have run out of investors' favour since April 2020, especially after the Franklin Templeton episode

Credit risk funds have delivered the best returns in the debt category for domestic mutual funds (MFs) in the past year.
 
Such schemes — which invest in riskier paper to generate higher returns — have delivered average returns of over 9 per cent in one year, the data provided by Value Research shows.
 
On the other hand, categories — such as dynamic bond fund, gilt, and money market — have given average returns of 3-5 per cent.
 
Market participants say in the past year the spread offered by some credit risk schemes over similar tenure short-term bond funds was around 150-200 basis points which helped these funds outperform.
 
Schemes — such as Baroda Credit Risk Fund, BOI AXA Credit Risk Fund, and HDFC Credit Risk Fund — have managed to give returns of 12-17 per cent in one year. Of 16 schemes, nine schemes have given returns in excess of 10 per cent. Credit risk funds are debt schemes that take significant exposure (at least 65 per cent) to not-so-highly rated companies (AA and below), with an aim to generate higher returns.
 
“Under normal circumstances when bonds don't go bad, one can expect credit funds to outperform. However, investors need to be aware that this product is highly risky. The ability of the issuer to pay interest need not mean that it is safe,” said Vidya Bala, co-founder of Primeinvestor.in.

 
Industry executives say the steps taken by the government and the Reserve Bank of India (RBI) since the outbreak of the coronavirus have also helped non-AAA-rated corporates improve their financial condition. “Given the central bank's pro-growth commentary and anticipated economic recovery in the years to come, the credit environment may witness improvement,” said a debt fund manager.
 
Since the fall of IL&FS in 2018, credit risk funds have been in focus. On numerous occasions, several credit risk funds have seen markdown on account of defaults on debt papers. But the industry’s conscious move to invest in better quality paper at the risk of slightly lower returns helped stave off defaults over the past year.
 
 “In the credit risk space, the worst has happened over the last few years. As a result, fund managers are doing a lot more groundwork and taking a cautious stance with regards to their exposure,” said Bala.
 
While the category has generated good returns, investors have turned wary of such schemes, especially after the Franklin Templeton episode last April.

 
The data from the Association of Mutual Funds in India (AMFI) shows that since April 2020, credit risk funds have seen net outflows of over Rs 29,000 crore. The average assets under management (AUM) of credit risk funds have shrunk from Rs 58,362 crore at the end of March 2020 to Rs 25,351 crore at the end of last month.
 
Franklin Templeton Mutual Fund’s move to wind up six of its schemes in April 2020, citing redemption pressure and lack of liquidity due to the Covid-19 outbreak, had sent shockwaves across the industry. Credit risk funds saw huge withdrawals between April and October 2020.
 
“This is one of the categories in debt funds which is prone to volatility. Investors should understand the risks associated with such funds and invest accordingly,” said Dwijendra Srivastava CIO-debt at Sundaram Asset Management.
 
These schemes can still continue to generate high returns provided there are no large-scale downgrades or defaults due to the pandemic, especially the second wave.
 
“We have to see how the pandemic plays out. This remains a high-risk category. We don’t know how the repayment capacity of loans will be due to the pandemic,” Bala said.