Credit Opportunities Funds are Risky

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Credit opportunities funds continue to rule the bond fund charts and have delivered a healthy 7.3% average return over the past one year. These funds generate returns from interest accrual and typically invest in higher yielding but lower-rated corporate bonds. They also seek opportunities for upgrade in credit rating of underlying securities, which can lead to their price appreciation. 

The higher yield from these funds has attracted huge flows from investors. This category looks particularly tempting now, given that traditional bond funds playing on duration, or interest rates, have been struggling under stiffening bond yields. Experts, however, warn against placing big bets in this space. Although credit opportunities funds have not been affected by unfavourable yield movements, the risk of default in underlying companies is still there. The credit profile of several firms they hold continues to be weak, with many struggling to repay loans on time. 

Worryingly, in a bid to generate higher returns, several credit funds have increased exposure to lower-rated bonds. This exposes investors to high risk, which may not be visible at the outset. "We prefer bond fund investors to play on the safer side. Credit funds expose the investor to unwanted credit risk 

Lower-rated holdings make them risky 
In pursuit of higher returns, these funds have invested in lower rated bonds. 

Investors looking for tactical exposure to this segment may opt for a fund with a cleaner credit quality portfolio—one tilted towards AA or higher-rated securities—rather than an aggressive fund chasing higher yields with a concentrated exposure in very low-rated instruments. Investors should remain selective in the credit space since default risk cannot be efficiently managed given that the domestic corporate bond market remains somewhat illiquid 

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