Credit Opportunities Funds

• 25 April 2017 | 1375 Views | By Mint2Save

It hasn’t been long since debt funds have started to compete with conventional banking products such as fixed deposits and recurring deposits. 

Companies have also realised the potential of these funds and are issuing debt based securities such as bonds at a rapid rate. Since there are many issuers of debt based securities, the rating and returns of these securities have a wide variation. Interestingly, rating and returns follow an inverse relationship.

This means that if a company has been rated AAA or A1 or A+++, its debt security would be issued with a lower rate of interest. On the other hand, if a company has a BBB or B- rating, its bonds would tend to issue a higher interest rate. The investor can have a wide variety of risk based returns to choose from.

In this thought provoking game, debt based mutual funds have struck gold with Credit Opportunities Funds. In the recent times, the returns of these mutual funds has surprisingly been high and some of them have even matched with the equity based funds.

 Though, you must be surprised with an idea of how such credit risk can be utilised by debt mutual funds. So, these Credit Opportunities Funds are new types of funds that might utilise and market the credit opportunity. Credit opportunities funds take up the growth strategy to provide the best and high return. Credit risk is taken by them for the sake of generating high yield.

They are also known as corporate bond funds as they invest in corporate bonds with the objective of giving higher returns to the investors by acquiring credit spreads of lower rate bonds. Credit opportunities funds hold bonds till their maturity to limit interest rate risk.

Important points about Credit Opportunities Funds:

1. Credit Opportunity funds or the CROP funds are debt mutual funds which invest in investment category debt securities with a lower than AAA credit rating.
   
   2. They take credit risk for generating higher yield as lower the credit rating of a debt, higher would be the interest rates paid by the issuer.
   
   3. If there is any improvement in financial performance of the company then the credit rating of its paper might get improved. In such a position the value of the bonds also rise up.
   
   4. If these funds are reduce or default due to the lower-rated paper then there might be a loss in value and this might impact the liquidity of the fund.
   
   5. Credit opportunities funds are appropriate for investors who are keen to take on credit risk for a better higher return and provide a good diversified opportunity as compared to invested directly in such bonds.

There are two types of opportunities for a fund manager that offers better returns, one if he is holding the low rated corporate bonds and another is, if a company performs better then the same credit rating agency may grade it higher. Then in such circumstances the price appreciation will positively effect into a better return from such funds.

Ideally, fund managers are not only looking for a present credit rating but also at the health or status of a company. If the company has a great opportunity to grow or diversify then it turns to be the best choice for a fund manager.

A few categories in which these funds do invest are:

In case of long term capital gain more than 1 year then return will be tax based on indexation which carries income tax of 10% without indexation and income tax of 20% after indexation. In other words, if you sell your investments in credit opportunities funds within a year of investment then your profits are legally responsible for income tax as per your tax slab, with the capital gains being added to your individual income for the financial year.
If you cash in your fund after keeping it for more than one year then you are liable to pay tax at the rate of 20% subsequent to indexation on the capital gains.

Risk Factors involved in Credit Opportunities Funds are:

There are mainly two types of risks in fixed income.

1) Credit Risk:

Credit risks occur when the bond issuer is not in the position to make interest payments to the bondholders. Though, the price of the bond will fall if the bond issuer fails to pay on interest or principal payments.

2) Interest Rate Risk:

When interest rate falls, bonds price will increase and when interest rate risks occur than bonds might go down. Though, interest rate risk becomes irrelevant to the investor, if an investor holds a bond till its maturity as irrespective of the market price of the bond, the investor will persist to receive interest payments and the face value of the bond at maturity. Credit Opportunities Funds keep bonds till the time of their maturities. Therefore the interest rate risk is limited in these funds and they can give fair and equitable returns.

Credit opportunity funds for the Young Investors:

If you are a youthful investor who is ready to take risk then you could think to expand your portfolio by investing in credit opportunity funds. In beginning, invest with a minimum of 2 to 3 years time period. This investment of more than 2 years let the credit opportunity fund to provide better returns than the other investments including even fixed deposits (FDs).

So, opting for credit opportunity funds can be a very good idea if you have the resources to ride over irregular or instability in bond markets.

Here is a list of some top class credit opportunity mutual funds along with returns: