Credit risk funds have earned a bad name for themselves in the last year. Many of these schemes are offering negative returns, but some schemes are doing very well. Kotak Credit Risk Fund is one such scheme that has offered 9 per cent in the last year. Shivani Bazaz of ETMutualFunds.com spoke to Deepak Agarwal, fund manager, Kotak Credit Risk Fund, to find out the secret behind the impressive performance, also what is in store for the category. Edited Interview.

At a time when the credit risk fund category is barely out of the negative territory, Kotak Credit Risk Fund is offering around 9 per cent returns in one year. What is the strategy behind this stellar performance?
We maintain the average rating of the portfolio between AA/AA-. Adequate credit research and due diligence and continuous monitoring of the credits held in the portfolio. We have a diversified credit portfolio. We also have an active duration management at tail-end when needed.

Credit risk funds have been badly hit in the last one year. However, many market pundits believe that the credit spread looks good at this point. What is your outlook for these schemes?
We believe that there is more of confidence crisis. However, there are certain stressed credit and these are isolated cases and they would be resolved without impacting the entire credit market. We believe the current spread of 200-250 bps of AA assets over AAA assets is attractive. Incremental credit deposit ratio is down to 90 per cent. Due to the slowdown, we believe the credit demand has also reduced and hence credit concerns in the market abate over a period of next six month to one year. We expect these spreads to compress. We would also advise investors to invest in credit risk funds with a three-year investment horizon.

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In such uncertain markets, how do you select your bets? Are there rules that you follow to stay safe from defaults and downgrades?
We will continue to evaluate credit the way we have done in the past. Any stress events in the market, gives us opportunities to learn and implement strategies to avoid such stress events. We will have to keep improving our due diligence process and increase market intelligence with respect to credits in our portfolio. In any market scenario, we have to be clear of one thing that we are taking credit risk (debt risk) and not equity risk under the garb of credit risk. If we continue to follow the above points, largely we should be able to ward off potential defaults and multiple downgrades.

It has been one year since IL&FS defaulted on payments and that was followed by a series of defaults and uncertainty in the market. How do you see the last one year and how much has changed in the market?

Post IL&FS, in October to December Quarter, market was worried about the ALM mismatch of NBFC/HFC. Starting January 19, the assets side risk also started surfacing, due to decline in value of assets and slowdown expectation in certain sectors of the economy. NBFCs which have been doing real estate lending and promoter funding have scaled back their lending since market risk perception of these NBFCs had increased and they were finding it difficult to raise funds. Hence cost of funding of real estate players and promoter funding has gone up and they are monetising their assets and reducing their debt. Post media reports of allegation on a few NBFC and few manufacturing companies (cash being shown in the balance sheet). The trust deficit in the system has increased, leading to cost of borrowing for low rated credit and widening of spreads. However, we believe that there is more noise and less news. Also, there are few isolated stress cases (which needs to be resolved) and all credit lenders would have to increase due diligence/ seek additional security. Over the course of next 6 months, we expect credit concern in the market to gradually abate.

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Many debt mutual fund investors wanted to get out of the credit risk funds. The AUM of the category is also down. Do you think credit risk as a category is too risky for debt mutual fund investors?
Apart from a few credit funds, AUM of credit risk fund is down by average 5-7 per cent from April 2019 till date, which is not very alarming. We believe in spite of heightened credit risk concerns in the market advisors /investors have stayed invested in credit risk funds, because of their relatively better experiences in the past. We believe well diversified credit risk funds should continue to be part of the investor debt investment bouquet.

What is your advice to debt mutual fund investors at this juncture?
Let us not assume that there is a generalised credit crisis. The credit market is stabilising as the government is proactively taking steps to reduce stress in multiple sectors. RBI is also proactively monitoring the system and has infused substantial amount of liquidity in the system. Over a period of next six month to one year, we expect the current credit spread to compress. We believe with 200-250 bps credit spread of AA-rated assets above AAA is too attractive and investors should take advantage of the same by investing in well diversified credit risk fund.





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