Credit risk fund outflow reduces as yields rise on rally in rates

Offer significant spread over 'AAA' corporate bond funds over 3-yr period

The worst seems to be over for credit risk funds, with the category seeing outflows of just Rs 205 crore over the past two months. They witnessed limited interest after the pandemic’s outbreak as investors fled to the safety of ‘AAA’-oriented funds, despite the high yield to maturity (YTMs) on offer at the time.

The category saw outflows in excess of Rs 5,000 crore each in March and May, and posted record outflows of Rs 19,239 crore in April. Outflows gradually reduced in the second half of 2020. Net assets of these funds stood at Rs 28,482 crore as on December 31.

After a sharp rally in rates, the relatively higher YTMs offered by credit risk funds has started to attract investor interest, albeit gradually, according to industry observers. Over a three-year investment period, credit funds offer a significant spread over conventional AAA corporate bond funds. This provides a decent cushion against any accidents or possible defaults in the future, according to some experts.

“While headline portfolio YTMs of credit risk funds do indeed offer a relatively higher spread today over AAA oriented funds, one must dig deeper to understand its constituents. An in-depth security-wise analysis of the category shows that a significant part of the excess portfolio YTM is contributed by a small portion of high yielding securities,” said Arvind Subramanian, fund manager and head of credit research, IDFC AMC.

“The spread offered by some of the credit risk schemes over similar tenure short-term bond funds is 400-600 basis points right now, which is attractive. Having said that, the category’s appeal is limited to a set of niche, discerning investors willing to take the extra risk,” said Dwijendra Srivastava, chief investment officer—fixed income, Sundaram MF.

He added that the credit market has not fully stabilised and there are several weaker companies that have just about managed to keep their heads above water, owing to regulatory forbearance.

According to market watchers, the credit market has witnessed a sharp divergence in performance between the haves and have-nots. While the acceptable corporate borrowers belonging to strong promoter groups and resilient sectors have witnessed sharp spread compression, the bonds of perceivably weak corporates have continued to languish owing to issues like weak perception of corporate governance and sectoral issues. This latter category has limited access to the mutual fund market today and also happens to constitute the bulk of the ‘high yield’ (defined as securities with yield greater than 9 per cent) category, said Subramanian.

“It is instructive to note that less than 5 per cent of today’s ‘high yield’ issuers have managed to raise fresh bonds via primary market from mutual funds in the current financial year. This is probably indicative of weak investor appetite to take incremental exposure or inability of the borrower to raise money at a competitive rate or both,” he said, adding that future headline portfolio YTMs can get diluted if and when these ‘high yield’ securities mature or schemes get significant inflows without commensurate replacement or fresh purchase.

Some industry observers believe that alternative investment funds are better suited to run credit strategies because of their close ended nature and ability to match asset-liability profiles better.