I have invested in HDFC and ICICI credit risk funds. Both have 5-star ratings from Value Research. After the Franklin crisis, is it advisable to discontinue these funds and switch to other debt funds?
- Umakanta Mishra
Credit risk funds are a higher risk-higher return strategy, somewhat similar to what small cap funds are on the equity side. At best, you can look to have a limited exposure in a supplementary role in your fixed income allocation to provide a kicker to your fixed income returns. But for the majority of investors, these funds can be avoidable and there are a couple of reasons for that.
One is that generally, fixed-income investors have very low tolerance for any negative returns in their fixed income portfolio. Even small negative returns can be very disappointing for them. So that's why such allocations can be avoided. Second is that by investing in other mainstream categories like short-duration funds, investors do get some degree of exposure to less than top-rated papers. That's why a separate exposure to credit risk funds can be avoided.
As things stand today, credit risk funds would tend to have meaningfully higher yields than the likes of short-duration funds. And at least in the near term, one can reasonably expect credit risk funds to deliver superior returns. But as I said, that does come with additional risk. Now when it comes to fixed income, risk is something which materialises once in a while but when it does, it hurts and it's painful. Even if one or two among top holdings go bad, it can potentially wipe off an entire year's worth of gains. And the bigger issues happen when because of a default or a downgrade, majority of investors start redeeming from the funds and the funds are not able to create enough liquidity to honour the redemptions.
So, these are some potential risks that one has to be knowledgeable about and one should factor in while deciding to invest in a credit risk fund. Having said that, if you decide to go ahead and keep some allocation in credit risk funds, then both the funds - HDFC and ICICI credit risk funds rank among the better ones and are the largest in this category. So, from that perspective, they are certainly worth considering.