/Is it the end of the road for credit risk funds?

Is it the end of the road for credit risk funds?

Credit risk funds are fighting for their survival these days. A series of defaults and all the talk of liquidity crisis in the money market are scaring investors away from these funds. After the Franklin Templeton Mutual Fund fiasco, most mutual fund advisors are asking their clients to strictly stay away from the credit risk fund category.

As per the recent Amfi data, credit risk funds have seen an outflow of around Rs 19,239 crore in April.

The credit risk fund category is also offering poor returns these days. The category has offered 3.71% in five years, half of what liquid schemes offered in the same time. The credit risk category has offered 0.69% in three years, -5.31% in one year and -6.18% in the last three months.

BOI AXA Credit Risk Fund, one of the worst performer in the category, has lost around 49.57% in the last one month. In the last three months, UTI Credit Risk Fund has fallen 15.98%. In the last 6 months, UTI Credit Risk Fund has fallen 24.03 % and IDBI Credit Risk Fund has fallen 11.66%. Simply put, investors have lost more than what they earned from investments these schemes.

Is it the end of the road for credit risk funds?
Pankaj Pathak, Debt Fund Manager, Quantum Mutual Fund, believes that credit risk funds, as a category, are flawed. “Regardless of the current situation, the don’t fit well in a portfolio which demands liquidity and stability. The problem is that there is no secondary market for lower-rated securities that these funds can use to tackle redemption pressures. This makes them really unfit for a retail investor’s portfolio.”

In fact, Franklin Mutual Fund had also said that it is forced to wind up six of its debt mutual fund schemes because of poor liquidity in the bond market due to the Covid-19 pandemic. Most investors have turned extremely averse to risk, and there are hardly any takers for lower-rated papers in the bond market.

Gaurav Monga, Director, PxG Consultants, a delhi-based wealth management firm, also says that credit market was already struggling after the IL&FS crisis. “Franklin event has given kind of a knockout punch to credit risk category. It is like a wake-up call for those who didn’t understand the massive risk they take in such schemes. The problem here is that they legitimately take this risk, they are allowed to do it. So, the onus is on the investor to see for themselves,” he says.

That brings us to the risk and reward trade-off in these schemes. Pathak points out that the risk-reward ratio in these schemes is disproportionate. “These schemes at best give you 8-9% returns and the chances of falling to 30–40% is there. I think that’s just too much for a debt scheme. And it is not just credit risk funds, but all the schemes that work on high credit risk,” he says.

Pathak also points out another major problem with these schemes. The credit risk category mostly work in tandem with the equity market. So, they don’t even provide diversification to the investors.

All these factors point to a bleak future for credit risk mutual fund category. As said earlier, most investment advisors are strictly asking their clients to stay away from the category. In fact, many of them even ask them to stay away from most debt mutual fund category, apart from liquid and overnight funds.

Monga says he personally hasn’t been recommending credit risk schemes for a long time now. And he believes that the category is going to face a rough weather in the coming days. “After the lockdown, there might be added issues with redemption and corporate governance which might add to the worries,” he says.

Before the troubles in the debt mutual fund space began, most advisors used to say if someone wants to take the extra risk to earn extra returns, those investors can choose credit risk. However, that is the not case anymore, as most advisors believe the risk-reward factor is not in favour of these schemes anymore. “Until there are some reforms with these schemes, investors need to stay away from them,” says Monga.

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