Credit-risk funds have emerged as the best-performing debt mutual fund category over the past three years, delivering 8.97% returns. According to reports from Mint, the category benefited from a favorable credit cycle where corporate balance sheets strengthened, leverage declined, and profitability improved, while concerns around defaults moderated. Nehal Meshram, senior research analyst at Morningstar Research India, noted that credit-risk funds have benefited from this favorable credit cycle over the past three years. The category also continued to earn relatively high accrual income because of its exposure to AA and below-rated securities, with the spread between this yield and the repo rate widening from around 1.6% in mid-2023 to approximately 2.8% currently.
As reported by Mint, credit-risk fund portfolios have an average exposure of around 55-59% to AA-rated bonds and a yield to maturity of roughly 8-8.4%. Nirav Karkera, head of research and fund manager at W by Groww, explained that the category's three-year performance was driven by three factors: credit spread earned on lower-rated securities, duration gains during the interest-rate easing cycle, and the absence of major defaults or downgrades. The Reserve Bank of India cut the repo rate by 125 basis points through 2025, allowing funds to benefit from mark-to-market gains on bonds. Average modified duration was around 2.3 years in late 2024 when the category entered the interest-rate easing cycle.
According to Mint reports, credit-risk funds are required to invest at least 65% of their portfolio in corporate bonds rated AA and below, making the strategy explicitly designed to take additional credit risk in return for potentially higher yields. The category's yield to maturity is currently around 8.1%, roughly 60-120 basis points above a clean banking & PSU or corporate bond fund. However, experts caution that with spreads this compressed, the extra yield is thin relative to the risk. Credit-risk funds can experience sharper NAV movements when an issuer is downgraded or defaults, with investors needing to be prepared for occasional volatility even though the underlying investments are debt securities.
The strong performance of credit-risk funds reflects a broader trend among lenders becoming more selective about where they take risk exposure. As reported by The Economic Times, banks are increasingly backing segments through intermediaries rather than taking direct exposure themselves. For NBFC-MFIs, this means taking on more direct lending while continuing to rely on banks for funding. This risk management approach becomes particularly relevant as the era of falling rates and expanding credit comes to an end, forcing lenders to reconsider their pricing models and risk tolerance. The trend suggests that lenders are moving away from direct exposure to segments like microfinance, preferring to maintain control over risk while still supporting lending growth.
