Looking for extra return in debt funds? Know what you’re signing up for. Debt mutual funds are often seen as safe, stable, and predictable. But not all debt funds are the same.

Credit Risk Funds, in particular, promise higher returns than traditional debt options—but in exchange, they take on more risk by investing in lower-rated bonds.

If you’ve ever wondered why some debt funds offer 8–9% when others cap at 6–7%, you’re likely looking at credit risk funds.

Let’s explore how they work, what makes them different, and—most importantly—when (or if) they belong in your portfolio.

1. What Are Credit Risk Funds?

Credit Risk Funds are debt mutual funds that invest at least 65% of their assets in bonds rated below the highest safety category (i.e., below AAA).

This includes:

• AA-rated corporate bonds

• A or lower-rated instruments

• Emerging companies with lower credit ratings but higher interest payouts

The idea is to earn higher yields by lending to borrowers with slightly higher credit risk.

2. How Credit Risk Funds Differ from Regular Debt Funds

3. Why Investors Are Attracted to Credit Risk Funds

✅ Higher Yields

Investing in AA or A-rated bonds fetches higher interest rates—boosting fund returns

✅ Better than FDs (on paper)

Returns of 7–9% often look attractive compared to bank FDs, especially for high-tax individuals

✅ Debt Fund Taxation

If held over 3 years (before April 2023), eligible for indexation benefits

Post-April 2023: Taxed as per income slab, like other non-equity mutual funds

4. But Here's the Flip Side: What Makes Them Risky?

Credit Risk Funds are called that for a reason.

⚠️ Default Risk

If a bond issuer fails to repay on time, it impacts fund NAV. In extreme cases, side-pocketing or write-downs occur.

⚠️ Downgrade Risk

Even if a company doesn’t default, a rating downgrade causes market panic and value erosion.

⚠️ Liquidity Risk

Lower-rated bonds are harder to sell during market stress—redemption pressure can force distress sales.

⚠️ Concentration Risk

Some funds may take larger positions in a few high-yielding issuers—amplifying single-event impact.

5. When (and If) to Consider Credit Risk Funds

✅ You have a higher risk appetite and want to enhance debt returns

✅ You understand that returns are not guaranteed

✅ You can stay invested for 3+ years, preferably through a full credit cycle

✅ You’re working with a financial advisor who regularly monitors fund credit profiles

✅ You want a small tactical allocation—not a core debt holding

⛔ Not ideal for:

• Emergency corpus

• Retirement income

• Risk-averse or first-time investors

• Short-term parking

  
  

6. How to Evaluate a Credit Risk Fund

🟢 Portfolio Quality

Check the percentage of AAA, AA+, AA, A-rated holdings

(You’ll find this in the fund factsheet)

🟢 Issuer Concentration

Ensure no single bond makes up more than 5–7% of the portfolio

🟢 Past Credit Events

Does the AMC have a history of managing defaults gracefully?

🟢 Fund Manager’s Track Record

Look for seasoned managers with a conservative credit approach—even in risk funds

🟢 Fund Size

Smaller funds may struggle to manage liquidity during stress periods

7. Alternatives for Safer Yield Enhancement

If you want better-than-FD returns without full credit risk, consider:

• Banking & PSU Debt Funds

• Corporate Bond Funds (AAA-rated only)

• Target Maturity Funds (low credit risk)

• Short Duration Funds with mixed profile

TL;DR — Too Long; Didn’t Read

• Credit Risk Funds invest in lower-rated corporate bonds to earn higher yields

• They offer 7–9% return potential—but carry default, downgrade, and liquidity risk

• Suitable only for high-risk investors who understand the structure and can stay invested long-term

• Never use them for short-term goals, emergency funds, or low-risk portfolios

• Safer alternatives include Banking & PSU Funds, Corporate Bond Funds, and Short Duration Funds

  
  

📩 Want help reviewing if credit risk funds are right for your profile—or finding safer ways to boost returns? Let’s map your investment goals to the right debt fund strategies.