Credit Risk Fund is a category of debt funds. A debt fund is a long/short term bonds investment tool for example mutual funds (MFs) in which core holdings are fixed-income investments. Credit Risk Funds offer 2% more returns over long-term or overnight funds.
Credit Risk Funds invest at least 65% of their portfolio in bonds with less rating than ‘AA’. There is more credit risk in lower rating bonds. By raising this risk, these funds generate more returns. Companies issuing such bonds offer higher interest rates. Capital gains benefit when their ratings increase.
Who should invest in CRFs?
Fixed income investors with a high-risk bearing capacity
In the field of fixed income investors who can take more risk, they should invest in credit risk funds. They make returns in many ways. They have interest income from securities included in the portfolio. Now, since the funds invest in instruments with a low rating, therefore, there is a capital gain if the rating improves.
How do investors choose credit risk funds?
There is a high risk of liquidity with credit risk funds. With the lowest rating of bonds included in the portfolio, defaulting to bonds, it is difficult for the fund manager to get out of this. Because of this, the financial planner advises investors to look at the size of the fund.
Large asset size gives the fund manager the chance to spread risk. Investors should also see that the portfolio is not very concentrated in one of the business groups. This category has more risk in comparison to other debt funds. Therefore, in these funds, investors should not invest more than 20% of their debt portfolio.
Dividend distribution tax (DDT) in CRFs
There is no tax on dividends from credit risk funds, but the scheme has to give dividend distribution tax (DDT) at the rate of 28.84%. There is short-term capital gains tax on returns earned over three years. It will be at the rate at which you come in the tax slab. Keeping them for more than three years, there is a long term capital gains tax with 20% indexation.