Barring a couple of schemes in the category, most credit risk funds have delivered reasonable returns in the last three years.

We had the worst ever corporate credit default cycle in history, starting with the IL&FS group in August 2018, and continuing through early 2020. More than 20 companies defaulted. But by counting these companies as business houses / groups, the number is much lower. As per data compiled by CRISIL, from July 2018 to February 2020, the impact of defaults on debt MFs (mutual funds) is Rs 17,719 crore. This is across 11 business groups, of which the major ones are ADAG (Rs 4,334 crore), DHFL (Rs 4,315 crore), IL&FS (Rs 4,155 crore), Yes Bank (Rs 3,597 crore), Altico (Rs 499 crore) and Essel (Rs 498 crore). The impact was across fund categories, from Liquid to FMPs to Arbitrage. But the fund category that took the maximum hit was obviously credit risk. Here is a status check of things as they stand.

How credit risk funds fared

We will look at the performance of credit risk funds.  The returns generated by credit risk funds would be representative of the impact of the defaults mentioned above. We will look at three-year returns, as the period starting from May 2018 covers the entire default cycle till date. As of May 14, 2021, the basket of 17 credit risk funds, on an average, delivered three-year annualized return of 1.83 percent (regular) and 2.65 percent (direct) across the two options. That is, returns are positive even after incidents of default.

BoI AXA Credit Risk Fund, with (-) 32 percent annualized return is the outlier in the data set. This fund had the dubious distinction of facing the maximum number of defaults in its portfolio and losing investors’ money to that extent. The next in the list is UTI Credit Risk Fund with (-) 10.18 percent and (-) 9.35 percent annualized in the regular and direct plans, respectively.

Without these two outlier funds, the average three-year annualized return from the other 15 funds is 4.89 percent and 5.76 percent annualized in the regular and direct plans. This is not bad, considering the significant default cycle the category went through. And there are the bright spots as well.

The funds in this category that showed healthy performances are HDFC Credit Risk Debt Fund with 8.83 percent / 9.39 percent, ICICI Prudential Credit Risk Fund with 8.54 percent / 9.31 percent, Kotak Credit Risk Fund with 7.28 percent / 8.32 percent, SBI Credit Risk Fund with 7.44 percent / 8.16 percent and IDFC Credit Risk Fund delivering 7.17 percent / 8.2 percent in the regular and direct plans, respectively. That is, there are funds that escaped the wave and are showing sanguine results.

Medium duration funds too took a hit. These schemes had the next-highest exposure (next to credit risk funds) to less-than-AAA rated papers. The three-year average return in this category, till May 14, 2021, comprising 15 funds, is 5.11 percent annualized in the regular option and 5.87 percent annualized in the direct option.

Outlook

There was a phase in 2019 when there was negative news flow every other day relating to defaults or delays or corporates being in trouble. We now find that there are laggards, and there are the bright spots – funds with better credit risk management. In future, there may be incipient stress in the system due to the COVID-19-induced economic slowdown. We are better-placed currently, than we were in April-June 2020, when GDP growth dipped nearly 24 percent. From the Oct-Dec 2020 quarter, GDP growth has turned positive. In the second wave of the pandemic, GDP growth projections are being revised downward. But it is relatively less severe. The restrictions are localized, as against the prevalence of a nation-wide lockdown.

Even after the downward revisions, GDP growth projections for the current financial year, by various agencies / houses, are in high single digits. The smaller entities, the MSMEs, have borne the brunt as they have relatively lesser resilience to face bad times. Fortunately, at least in the mutual fund space, exposures are to the larger corporates, the relatively better and resilient ones. Even if we go through further incidents of default, hopefully, they would be less severe. The rationale is that the cycle from August 2018 to early 2020 was a clean-up, when the pent-up stress came to the fore. In the slow-down challenge, businesses in the less-impacted sectors that are resilient, will survive.

Source: https://www.moneycontrol.com/news/business/personal-finance/credit-risk-mutual-funds-may-have-turned-the-corner-6916711.html