In the recent policy review by the RBI Monetary Policy Committee (MPC), the policy rates were not changed. As such, the interest rates on traditional investment avenues continue to stay lower. However, owing to the developments in the financial sector, the yields in the debt market have risen sharply over the past month and continue to stay elevated. As such, debt funds are emerging as a smart investment choice for you as you can be benefited with the potential to earn higher tax-efficient returns.
Over the past month, credit risk premiums have increased significantly and much of it can be attributed to defaults by IL&FS, an AAA-rated NBFC till July 2018. This created a lot of panic on the liquidity comfort in the financial systems and also led to a spike in the spread in the yield of AAA-rated securities which used to earlier quote at a spread of 50-65 bps from the G-Sec. Presently, such spreads for AAA-rated entities itself have increased to 90-105 bps for varying tenors, as the investors now begin to perceive the risk within the debt securities and thus expect higher yields in compensation of the higher risks.
In line with the spikes in the AAA credit spreads, the credit risk premium for the below-rated entities have also gone up. As such, the yields of the existing debt securities in the markets with different credit ratings have also increased. Hence, considering the current economic scenario, the credit risk funds are presenting an interesting investment opportunity for the investors. The Govt. and the regulators have been actively monitoring the current situation, showing their commitment to easing the liquidity concerns if any.
Credit Risk Funds invest 65% or more in the debt securities, which are rated at least one rating below the highest credit rating. Thus, such funds are able to generate higher yields on their investments, as well with a potential for capital appreciation in case of a favorable credit rating upgrade or a decrease in yields.
What is exactly a Credit Risk?
Credit risk refers to the probability that the issuer company may not be able to service its debt obligations including principal and/ or interest. Every company will have a specific credit risk attached to it. Just like an individual’s credit risk gets reflected through his credit score and credit report, the credit risk associated with the issuer company and the debt instrument gets reflected through credit ratings issued by credit rating agencies in several grades ranging from AAA to D and AAA conveys the highest level of safety with respect to payments by the issuing company.
Thus, considering the higher credit risk premium for the increase in credit risk, a bond issued by an ‘AA’ rated company will typically be issued at a higher coupon rate than a similar interest-bearing bond issued by an ‘AAA’ rated company. In other words, if there are two different securities with same coupon and same maturity, the bond issued by AA-rated company will be quoted at a lower price in the debt market, as against a similar bond issued by AAA-rated company.
While the word ‘credit risk’ may be making you feel nervous before making an investment decision, it can be effectively managed by proper and adequate research and by maintaining a well-diversified portfolio of debt securities. Credit risk funds make the job easier as the investment decisions are taken by professional fund managers and backed by timely and proper research by the team of analysts. As a part of the risk mitigation strategy, such funds also carry internal limits for exposure to a single security or a single issuer.
Further, such funds do not only rely upon the credit ratings of the Companies to decide the securities to invest in but also keep a regular watch on the existing and potential investments to make the most of the investment opportunities available.
Special tax rates for long-term capital gains from debt funds, including the credit risk funds also make it attractive for the investors, helping the investors generate tax-efficient returns. As per the current tax laws, if the money is kept invested in credit risk funds for 3 years or more, the investors are liable to pay tax at a preferential rate of 20% after indexation benefit instead of regular tax rates applicable to the individual.
As such, Credit Risk Funds can certainly be considered for investment by the investors aiming to generate reasonable returns in the volatile market, considering the presently elevated yields in the debt markets and also due to the possibility to generate better returns from the subsequent cool-off in the yields that have spiked exceptionally within a short time.
Edelweiss Partners offers you an online platform wherein you can check out the details and apply in the public issues of various debt securities including NCDs, bonds etc. It also provides access to the online transaction platform, secondary market quotes related to the existing NCDs/ bonds and financial planning tools to help you achieve your financial goals.