Credit risk funds top league table with 8.4% returns, shows data

This is thanks to economic revival, improving upgrades to downgrades ratio, say experts

Over the past year, even as returns of most debt fund categories have slipped below 5 per cent, credit risk funds – which invest in lower-rated papers – have generated returns of 8.4 per cent.
 
A revival in the economy, better corporate health, and improving upgrades-downgrades ratio have aided returns, said experts. The mutual fund industry has not seen any major defaults in the past year since the IL&FS and YES Bank episodes, which hit these funds from 2018.
 
“The yield-to-maturity (YTM) of credit risk funds was always higher than the regular funds. So, as long as there is no default the accrual level is anyways higher,” said Joydeep Sen, consultant with Phillip Capital fixed-income desk.
 
According to Vidya Bala, founding partner and head of research and product at PrimeInvestor, the net asset value of such funds had been hit significantly a year back because quite a few of them were impacted by the downgrades and the liquidity crisis.
 
“These funds are operating from a low base and the returns a year on may look optically higher,” said Bala.
 
She added that the accrual of credit risk funds is much higher than corporate bond funds and in a shrinking rate scenario, higher quality bond yields have reduced much more than the credit risk category. So, the YTMs are quite high.
 
All the other categories either have low-yielding quality bonds or hold long-duration papers that are not able to deliver in a low interest rate environment.
 

The upgrade-downgrade ratios have seen an improvement in the last six months to a year. The non-performing assets (NPA) numbers for banks for the quarter ended June reveal a fair bit of pressure on asset quality, particularly in the retail and MSME sectors. MFs, however, do not have any exposure to MSMEs and that is a positive.
 
“Investors who have the appetite and understanding about what a credit risk fund stands for can look at the category, provided they are comfortable with names in the portfolio and preferably in the funds that survived the last cycle without any major accidents," said Sen.
 
According to Bala, credit risk funds appear to have learnt from past mistakes. Many of them no longer go too far down the credit risk path in their portfolio and maintain a much higher liquidity buffer by holding shorter tenure, low-risk papers or quality bonds that are more easily traded.
 
“Credit risk funds are not for those who want to use debt as a hedge but for select, high-risk investors with a five-year timeframe,” she said.
 
Credit risk funds came into the limelight after the default of IL&FS in 2018. Until last year, several funds saw a markdown on account of defaults on various debt papers.
 
The worst seems to be over for these funds, with the category seeing inflows over the past few months. Such funds had witnessed limited interest after the pandemic’s outbreak as investors fled to the safety of ‘AAA’-oriented funds, despite the high YTMs on offer at the time.
 
The category saw outflows in excess of Rs 5,000 crore each in March and May last year, and had posted record outflows of Rs 19,239 crore in April. Outflows gradually reduced in the second half of 2020.
 
Net assets of these funds stood at Rs 26,511 crore as on July 31.