“Be fearful when others are greedy and greedy when others are fearful.” When the Oracle of Omaha speaks, the world stops to listen. Though spoken for equity market, it seems true even for fixed income markets. The current state of the fixed income market is panic stricken and investors are moving out in droves. The current scenario of downgrade and defaults has been in the making for a couple of years. Post demonetization there was very high liquidity in the system.
An increasing number of investors are migrating towards the financialisation of savings, which is of course, a good thing. However, investors must never throw caution to the wind. In an endeavour to provide higher returns/ yields investments were made into lower rated papers with a certain disregard to the overall debt of the firms, their ability to pay and promoter quality. The September 2018 debacle led to a vicious circle of downgrades, credit squeeze and defaults. The last one year has seen more downgrades than ever before. As a consequence, credit risk funds were hit particularly hard. This has led to investors panicking, in some cases rightfully. The knee jerk reaction of investors has been to move out of their fixed income investments.
This brings us to a point where we ask the question - does it make sense to have credit risk funds in one’s portfolio? It definitely merits a spot in the portfolio. More importantly, it makes sense to invest in these funds in the current market situation when others are fearful. The yields and the spreads are high and good quality paper is available at compelling yields. While it is a good time to gain exposure to credit risk funds, one must do their due diligence properly and ensure that the credit risk of the paper held in the fund is commensurate with the overall risk rating of the fund and your individual risk profile.
So, what should the investor look at while investing in credit risk funds. Firstly, investor needs to take a 3-year view while investing in these funds. As most funds have investments in papers with similar maturity. It also provides tax advantage when investing for more than a three-year time frame. Secondly, there would be volatility. Therefore, it is important that the investor is aware and builds a diversified portfolio that can weather this volatility. Additionally, investors should avoid building concentrated exposures and limit investment in any one security to 3-4 per cent. Also, choose to invest in large size funds as they have the capability to absorb redemption related pressures. The vintage and skills of the fund manager is important. If the fund manager is long tenured it is beneficial.
While investors have embraced volatility in equity market, it is important for them to embrace it in credit risk funds too. These funds would provide inflation beating returns with lower volatility.