How to manage credit risk in your portfolio?

In the past three years, credit risk has acquired a reputation of being ambiguous which has scared the investors. Credit risk funds recorded net redemptions worth Rs. 35,703 crore in CY2020, as per the data released by the Association of Mutual Funds in India. While corporate bond funds – schemes primarily investing in AAA-rated good quality papers delivered 9.48%, credit risk funds that invest in low-quality bonds in search of high returns lost 0.46% in CY2020. This underlines why investors need to manage credit risk better. A clear understanding of credit risk can help investors manage it well.

Wealth management companies in India can help you to grasp the extent of credit risk in your portfolios. Credit risk simply means the possibility that the money lent or invested in a bond will not be paid back with a pre-defined rate of interest according to the pre-determined timelines. Sometimes, it is termed as the possibility of a default by the bond issuer.

Selecting bond issuers who will offer a higher rate of interest and return your money on the due date is a challenge. When an investor chooses to invest in a government bond, the credit risk is low. The government is highly unlikely to default on its loan obligations. Given low credit risk, these bonds offer low-interest rate. If the investor wants to pocket more returns, then s/he has to lend her/his money to private companies. Since there is default risk involved, they tend to pay more in most cases. The credit rating of issuers can offer some help to investors. AAA-rating is the highest credit rating for corporate bonds with the least chance of default. However, one can’t rely blindly on these AAA ratings.

Wealth management services can help investors identify issuers that honour their obligations if investors are keen to buy individual securities. Some wealth management companies in India run bond desks to help their clients with fixed income investments at relatively low risk.

The key aspect investors need to understand is it is not only just about due diligence when it comes to managing credit risk, but also about building a diversified portfolio of issuers from different industries. Earlier, investors used to contact wealth management services to do so. However, over a period of time, mutual funds have emerged as an efficient mechanism to build such bond pools in the form of bond funds.

Investors should avail wealth management services to ascertain their risk appetite and then match it with the risk-reward associated with bond funds of different types, before taking investment calls. These wealth management companies in India customise investment solutions for investors based on their risk-taking capacity by explaining the credit risks involved in various fixed income offerings. Availing wealth management services can help investors in making informed decisions which will help balance their credit risk and returns.