Wary of rising rates? Investing in short-term debt funds can help mitigate interest rate risk. But if you are up for some risk, park some of your surplus in credit risk funds that invest in lower-rated corporate bonds that can offer attractive returns.

SBI Credit Risk Fund is one such fund that capitalises on interest receipts than gains from bond prices.

The fund in its earlier avatar (before SEBI’s directive on categorisation and rationalisation of mutual fund schemes), named SBI Corporate Bond Fund, had been investing 55-65 per cent in AA- and below-rated corporate bonds. Nothing much changes post the SEBI directive, except for the rigid investment mandate.

As per SEBI’s categorisation, a credit risk fund has to invest a minimum of 65 per cent in corporate bonds of below highest-rated instruments. Since the fund has been following the mandate, there is unlikely to be much change in the portfolio or performance.

The fund has delivered healthy returns across time-periods. Over three- and five-year periods, it has delivered 8-9 per cent returns.

While this may be relatively lower than a few other funds within the category, given the varied exposure of different funds in lower-rated bonds, it is difficult to do a like-to-like comparison based on returns alone.

Franklin India Corporate Bond Opportunities Fund (now Franklin India Credit Risk Fund), for instance, has delivered 1-2 percentage points higher returns at times. But the fund’s higher exposure to low-rated papers pegs up the risk. It has been investing nearly 90 per cent in AA- and below-rated corporate bonds.

For investors who have moderate risk appetite, SBI Credit Risk Fund offers a good risk-return trade-off. It has been maintaining an average maturity of up to three years. Investors with a two-three-year time horizon can invest in the fund

Accrual strategy

Some debt funds invest in bonds with different ratings, betting on the credit risk to earn higher interest. Since these funds bet on the credit risk of the underlying bonds in the portfolio, a wrong credit call can cost dear.

Hence, higher the risk (lower rating), higher the interest rate the bond offers. Debt funds that follow the accrual strategy, hence, profit from interest receipts rather than interest rate movements in the economy that impact bond prices.

Since these funds carry credit risk, investors need to assess their risk appetite and the fund’s track record before picking a fund. While higher exposure to low-rated bonds can spice up returns, it also increases the risk.

Good track record

SBI Credit Risk Fund has delivered consistent returns across all rate cycles. In 2016, for instance, a good year for bond markets, the fund delivered a healthy 10.5 per cent return. It managed to deliver 9.7 per cent return in 2015 as well — a lacklustre year for most gilt funds (betting on interest rate movements) that delivered 4-5 per cent returns. The year 2017 was tepid for bond markets. SBI Credit Risk Fund, too, delivered a lower 6.9 per cent return, slightly underperforming other funds in the category, possibly on account of its relatively lower exposure to low-rated bonds.

Top holdings of the fund in low-rated bonds include Muthoot Finance (AA rated), Dalmia Cement (Bharat) (AA), AU Small Finance Bank (AA-) and Tata Realty and Infrastructure (AA).

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