8 questions to ask before you invest in a Credit Fund.
Q1) How much yield should the fund offer?
A) The principle of 'higher-the-better' does not apply to credit funds. Higher yields come with disproportionately higher risks. Funds offering 11%+ are a clear avoid. Thread 1/8
Q2) How diversified is the fund?
A) A fund with higher diversification is less risky. As per regulations, exposure in a company cannot exceed 10%. Well managed funds cap exposure in one company to 5% or lower. Lower exposure means lower hit on return if an accident happens. 2/8
Q3) Does the fund have high exit loads?
A) Usually exit loads ensure that investors allow fund managers time to execute strategies. However, very high exit loads often result in debt-traps restricting investors' exit even when there are glaring mistakes made by fund-managers. 3/8
Q4) How does the 'duration' vary with interest rate cycles?
A) Duration is a measure of tenure risk. If the fund managers vary the duration too opportunistically during interest rate cycles, the investors are exposed to unwanted volatility risk. 4/8
Q5) How consistent have the returns been?
A) Credit funds are all about giving consistent returns over well spread out time periods. If there is too much of a variance in returns, over different time horizons, the fund manager is not doing a good job. 5/8
Q6) Is there enough liquidity cushion in the portfolio?
A) Owing to the liability profile of mutual funds there can be a sudden outflow of size in a scheme. A good scheme has 10-20% of very liquid securities to avoid losses owing to distress sale if large withdrawals happen. 6/8
Q7) Does the fund house have a good team?
A) Managing credit is not a one man show. It is complicated and involves in-dept research and continuous monitoring. Good credit managers have a sizable credit risk team to analyse and monitor. 7/8
Q8) What has been the track record of fund managers?
A) Managing credit is a specialist's job. We should always check fund manager's credit credentials. Further, we should enquire about the history of credit events in the fund and how the fund manager tackled those. 8/8
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