Invest in credit funds when spreads are attractive over sovereign and high quality issuers

Jindal Steel & Power’s default on interest payment has highlighted the risk for investors in credit opportunity funds. This fund category, which invest in low- or unrated debt securities, has attracted retail investors with the product returning as high as 11-13% in the last one year.

Wealth managers said investors should study the portfolio of credit funds while investing because they invest in riskier instruments.

“Credit opportunity funds are vulnerable to liquidity and credit risk. Investors should look at a diversified portfolio that does not have high concentration and has a long tail, which reduces risk,” said Lakshmi Iyer, Head (Fixed Income), Kotak Mutual Fund.

In the last few months, mutual funds have been scrambling to cut exposure to companies with high debt. For instance, ICICI Prudential also cut its scheme’s holdings in JSPL’s debt paper.

"Since January 2016, the exposure of various schemes of ICICI Prudential Mutual Fund to the securities issued by JSPL has decreased from Rs.500 crore to Rs.200 crore, which is 0.15% of our total debt AUM and, is also in line with our philosophy of taking less concentrated bets,” said a spokesperson of ICICI Prudential Mutual Fund. He further added that none of the schemes hold any securities in which JSPL defaulted on interest payments on 30 September 2016.

Fund managers believe a diversified portfolio and papers from strong promoter groups helps.

“In such funds we invest in paper of companies which come from groups with a strong track record,” said Kumaresh Ramakrishnan, Head (Fixed Income), DHFL Pramerica Mutual Fund. “Also M&A transactions where promoters are strong are attractive investments as banks don’t lend to such transactions”.

As a rule of thumb, invest in credit funds only when they offer attractive spreads over sovereign and high quality issuers, said Kunal Valia, Director – Investment Products, Credit Suisse Wealth Management. With spreads as high as 150-200 basis points, the risk reward ratio is in favour of investing in these funds.

“Investors need to carry out extra due diligence with regards to the fund’s internal research capabilities in identifying good credits and regularly monitoring such exposures, mix of portfolio quality, concentration and fund size while evaluating credit funds,” said Valia.