Credit funds’ assets rise 60% in past 10 months

With interest rates likely to remain on hold in the near future, debt funds that look beyond ‘AAA’-rated paper for higher yields are back in the limelight. These include mostly credit opportunity and corporate bond opportunity funds.

In the past 10 months, assets of these funds have grown by nearly ~30,000 crore to ~80,000 crore, data from Value Research show. While the one-year performance of these funds (11.1 per cent) lags duration funds such as gilt and income funds, they have clocked better returns over a three-month period. HDFC Corporate Debt Opportunities Fund is the largest fund in this category with assets of over ~10,000 crore.

The pause in the rate-cut cycle has limited opportunities for funds that rely on duration play since these funds primarily benefit in a declining interest rate environment. Bond prices and interest rates move inversely.

“Since interest rates are not expected to fall further, gains from riding the interest rate curve at this point are limited. One can get higher yields of 100-200 basis points over a normal duration fund by investing in credit opportunity funds,” said Manoj Nagpal, CEO, Outlook Asia Capital.

Accrual funds such as credit opportunity or corporate bond opportunity funds do not play the interest rate game but seek to gain from higher accrual in corporate bonds that do not enjoy high credit ratings. They may also benefit from rating upgrades, which can lead to gains from price appreciation. While these funds may be less volatile than duration funds, they come with a higher risk of capital loss.

MFs do not go below longterm A-rated paper but they can technically go up to BBB, which is considered investment grade. Going below this requires permission from the fund’s trustees.

After the Amtek Auto episode in 2015, investors and funds are taking greater precautions while selecting paper. “The rule of thumb is to avoid stressed sectors like real estate and commodities,” said Dwijendra Srivastava, CIO, fixed income, Sundaram MF. Nagpal added that funds should not just rely on external rating agencies but should do their homework before selecting paper. “The in-house capability is as important as thirdparty ratings and only a few funds have the capability to do proper due diligence,” he added.

Experts said credit opportunity funds were for high-risk investors who understood credit risk. “These are the equivalent of holding a sector fund in an equity portfolio. If an investor has a three-year time-frame and can take such risks, then not more than 10 per cent of a debt portfolio can be exposed to these funds,” said Vidya Bala, head of mutual fund research, FundsIndia.com.

Yields of the 10-year gilt fell about 124 basis points (bps) in 2016 to 6.51 per cent. This year, though, yields have edged up 39 bps to 6.9 per cent. The Reserve Bank of India cut the repo rate by 50 bps in 2016.