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Credit Risk Funds

  • 25 Apr 2020
  • 2 min read

Why in News

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.

Key Points

  • 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.

Source: IE

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