Credit Risk Funds | 25 Apr 2020

Recently, Franklin Templeton Mutual Fund (one of the largest fund houses in India) has decided to close its six credit risk funds.

The reason behind the step was severe market dislocation and illiquidity caused by the Covid-19 pandemic.
A fund house is a company that invests the pooled money of investors to buy financial securities like stocks, mutual funds, equities, etc.

Definition: Credit-risk funds are debt funds which have at least 65% of their investments in less than AA-rated (i.e. in lower-rated) papers.
- Debt funds aim to generate returns for investors by investing their money in avenues like bonds and other fixed-income securities.
- Investment grade refers to the quality of a company's credit. Anything below 'BBB' rating is considered a non-investment grade.
They have the potential to offer 2-3% higher returns compared to risk-free higher rated papers.
Return: Credit-risk funds make returns in two ways:
- One, they earn interest income on the securities they hold.
- Secondly, since they invest in lower-rated securities, if the rating of a security is upgraded, they have the potential to make capital gains.
Risk:
- Liquidity risk: Credit-risk funds have a higher liquidity risk. If a bond with a lower rating in the portfolio defaults or faces a further downgrade, it may be difficult for the fund manager to exit the holding.
- Concentration risk: If the portfolio is concentrated or has high holdings in any single business group, then even a single default by business group will affect the entire portfolio.