Credit Risk Funds - In Depth Guide 2025
A credit risk fund is a kind of debt mutual fund which primarily invests in low rated corporate bonds and in most cases even lower than the highest credit quality. These funds are more risky than most of the traditional debt funds, and they have a higher potential to generate better returns. The credit risk funds have gained prominence in the Indian mutual fund market in 2025, as they are capable of giving high returns in a developing and vibrant economy.
The credit risk funds accumulate funds of different investors and invest them in fixed income securities with moderate or low credit rating. These comprise AA and rating below securities. In contrast with the liquid or ultra short term funds that emphasize on the very high quality short term papers, credit risk funds are calculated risk taking by investing in lower rated instruments to obtain additional returns- also referred to as credit premium.
The regulatory scene has transformed over the past few years with SEBI (the Securities and Exchange Board of India) coming out with stronger norms to protect the investors following previous credit events in the NBFC space. As a result of this, there is increased transparency and due diligence in the way these funds are run in 2025.
People also ask
Credit rating in credit risk funds?
Credit risk funds take risks in terms of investing in bonds that are graded as lower than the highest rating i.e. AA, A or even lower by credit rating agencies such as CRISIL or ICRA.
What are the reasons and why investors should use credit risk funds?
The credit risk funds are primarily attracted by the fact that it may yield higher returns than the other conventional debt funds. This out performance potential is achieved through the acquiring of extra credit risk which when well managed can lead to higher yield particularly in a situation where the interest rates are stable or declining.
Investors are interested in credit risk funds in 2025 because some of the reasons include:
- Possess the opportunity to make better returns than bank fixed deposits or highly rated debt funds.
- Mutual fund debt portfolio diversification.
- Good in case of medium or long-term investment (at least 3 years).
- Capital gains tax benefits in holding of 36 months or above.
It is important to remember that credit risk funds are not capital secured. Bond downgrade or default risk is a reality and investors cannot afford to invest without knowing that.
What are the Major Characteristics or attractions of credit risk funds?
Due to their uniqueness, credit risk funds are different among debt funds, as they have the following standout characteristics:
- The latest categorization of SEBI stipulates that minimum 65 percent of the assets have to invest in the less than AA rated corporate bonds.
- More likely to experience greater returns in their portfolios because of their exposure to credit risk.
- Exposed to the credit events like defaults or downgrades in companies invested in.
- Labels: demand active credit analysis by fund manager.
- Appropriate to moderately risky investors who are more aggressive.
- Open ended funds which are mostly liquid and yet have some exit load on short holding.
Did you know?
Credit risk funds in 2025 now have a portfolio risk-o-meter on monthly factsheets that tell precise credit quality and risk profile to make better informed decisions by the investor.
How Do Credit Risk Funds Works?
The concept that guides credit risk funds is that greater interest should be paid on lower rated bonds so that investors are attracted. The fund managers will select these bonds strategically in order to get a better spread over the less risky securities to achieve higher returns without risking duration (interest rates).
By way of illustration, although in the case of 2025 banks are typically paying interest of about 6.25 percent to 7 percent on a 3-year deposit, portfolio yields of credit risk funds could range between 8 percent and even 10 percent basing on the quality of the paper used and the market condition.
Fund managers need to carry out thorough credit research, conduct periodic review of portfolio issuers and re-adjust portfolio holdings when negative trends occur. They can also diversify investments in more issuers and industries in order to reduce concentration risk.
People also ask
Are credit risk funds safe?
The credit risk funds are risky compared to other debt funds, however, they are typically less risky than stock investment. It is very important to diversify and choose funds properly.
Whom should Invest in Credit Risk Funds?
Credit risk funds will not be appropriate to all investors. They are best matched for:
- Patients with medium to high tolerance to risk.
- Investors possessing a 3 year time horizon and above.
- Anyone who wants higher returns than FDs and who is able to put up with interim fluctuations.
- Individuals who wish to have their portfolio diversified partly by not staying in equities.
- Investors that are able to track reviews and performance on a regular basis.
These are not fitting to the conservative retirees who cannot take volatility or those who require guaranteed protection of the capital.
What are the Advantages and Disadvantages of Credit Risk Funds?
It is also important to know both the pros and the cons before putting your money into it. This is a fair analysis of the advantages and disadvantages:
Pros
- Potential to make greater returns as compared to most debt mutual funds.
- Profits of declining interest rate case, when utilized efficiently.
- Capital gains is charged as long term when it is taxed over 3 years with indexation benificence.
- There is diversification in investment in several companies/issuers.
Cons
- Risks; probability of default or rating downgrade of bonds.
- In case of bad credit event NAV (net asset value) may decline significantly.
- Senior and harder to comprehend than risk-averse funds.
- Volatility in returns may make them unsuitable in parking emergency or short term funds.
Experts’ Insight
Investors must only think of investing in credit risk funds once they have their own risk profile and financial plan completely comprehended, and once they have evaluated the finer credit risk details of the monthly factsheet of the fund.
Rahul Desai, Senior Debt Analyst, Mumbai.
Comparison Table Credit Risk Funds vs Other Debt Funds
| Characteristic | Credit Risk Fund | Corporate Bond Fund | Liquid Fund |
|---|---|---|---|
| Main Investment | AA and less bonds | AA+ and more bond, T bills, CPs | |
| Yield (2025 average) | 8% - 10% | 7.2% - 8.2% | 6% - 6.7% |
| Risk Level | Medium-High | Low-Medium | Low |
| Exit Load | Applicable in most cases | Mostly none | Usually none |
| Appropriate To | 3+ years horizon | 2+ years | To 6 months |
| Ideal Investor | Moderate risk | Conservative | Ultra safe |
| Exposure to Loss | Moderate | Low | Very Low |
People also ask
Are credit risk funds able to supply monthly income?
Others provide the option of SWP (systematic withdrawal plan) though payout is not assured as in monthly income scheme.
Late Performances and Trends in 2025
Indian credit risk funds have seen a recovery following the credit market unrests in 2018-2021. Strictened SEBI rules have enhanced transparency and the fund houses are more sensitive on single issuer exposure and sector caps.
Depending on individual credit calls and market rates, most of the leading funds have recorded averages of 8 to 9.5 per cent in the past one year. The volatility still exists and there still are some minor defaults but much less than the previous years.
The average profile of the investor is changing: younger accumulators of wealth and the HNI (high net-worth individuals) are selectively investing in credit risk funds that they believe will yield the same or be downward trending in India.
What are the factors needed to be considered Before investing in credit risk funds?
In deciding on a credit risk fund in 2025, consider the following before making a decision:
- History of the fund and fund house to manage the fund.
- Sector and single issuer exposure capping.
- Existing portfolio credit rating (AA, A, BBB etc).
- Experience and strength of credit research of fund manager.
- Past credit event liquidity management policy and communication.
- Magnitude of the fund (larger funds have greater diversification opportunities).
- Exit load and expense ratio.
It should not be over-concentrated (greater than an average of the peers) in one or two issuers nor record a unstable history.
Did you know?
The highest rated funds in this category now make their exposure to single issuers voluntary with a 7 percent limit or even less restrictive than the necessary 10 percent limit (2025) imposed by SEBI.
Credit risk funds and taxation in 2025
The taxation of credit risk funds has been reformed in 2023 with the definition of long-term capital gains having been altered. As per rules prevailing in 2025:
- Gains on capital on assets held below 3 years are included on income and are taxed at your slab rate.
- The tax on gains on units of over 3 years is at 20 percent with indexation benefit.
- Any dividend (in case of choice) will be taxed as per investors slab following the repeal of the dividend distribution tax.
- TDS which is applicable on interest/dividend income according to the Indian taxation law.
This renders the 3-year horizon as ideal since after indexation performance may be productive to investors in the high income group.
People also ask
What should I do to lower tax on returns of credit risks funds?
The growth option and holding more than 36 months provides the option of indexation thus a decrease in the tax of the long term gains.
What are the Secret to Select the Best Credit Risk Fund in 2025?
In India, there exist more than 18 fund schemes on credit risk, of different size and strategy. To choose the best suited scheme:
- Compare 3 and 5 year rolling returns with category average.
- Determine the existing and previous credit quality profile.
- Examine consistency of returns not just peak performance.
- Check cost ratio (would like to see less than 1.25 percent).
- Take into account fund manager track record of default avoidance.
A disciplined SIP strategy as opposed to lump sum investment cuts timing risk within the credit markets which are volatile.
Ordinary threats of credit risk funds
The general risks of credit default funds are not the only specific risks that credit default funds have to deal with:
- Credit default risk (issuer does not repay the principal / interest).
- Downgrade risk (rating is lower, and the value decreases).
- Liquidity risk (impossibility to sell papers at appropriate price in the panic).
- Concentration risk (heavy weight to less number of companies).
It will be wise to be conscious of these and scrutinize portfolio statements every month to prevent having to be caught up in a rough scenario.
Experts’ Insight
Do not allocate the debt allocation of more than 20 percent to credit risk funds despite the attractive yields. The most important ones are prudence and diversification.
Preeti Ghosh, CIO Fixed Income, Kolkata.
How to Invest in Credit Risk Funds in 2025
The majority of credit risk funds that are most popular can be bought by:
- News websites or mobile investment apps of the AMCs.
- Mutual fund distributors and financial advisors registered.
- Groww, Zerodha, Kuvera, Paytm Money, and others on the internet.
- Demat accounts involve banks and brokers.
Every transaction is paperless, and folios are created instantly and optional e-KYC. The most popular form of investment is SIP (Systematic Investment Plan) and there can also be lump sum.
People also ask
Is credit risk fund investment obligatory KYC?
Yes, in India all investments in mutual funds that are in the form of credit risk funds are subject to KYC checking.
Investing in Credit Risk Funds Best Practice
Of the best practices and habits, consider these ones to hold on to in 2025 in case you are planning to invest:
- Just divide a portion of your portfolio but not the entire fixed income corpus.
- Periodically (monthly) monitor fund portfolio quality and monthly factsheet.
- Should not be short run, maintain at least 3 years of investment horizon.
- Follow the trends in your industry that your stock is best invested.
- Ask a SEBI-registered investment advisor in case of doubt.
- Sell off when you notice any radical change in fund quality or continued defaults in portfolio.
TLDR or Quick Recap
Debt mutual funds that invest in lower-rated corporate bonds to greater extent to achieve higher returns are credit risk funds that have higher credit and volatility risks. They are effective on averagely aggressive investors and have a 3+ year horizon, and will not be suitable on investors with a need to be fully cautious. They are now more transparent in 2025 with the changes of the SEBI rules and additional monitoring. This category will require a disciplined approach, proper due diligence and periodic review in order to benefit.
People Also Ask FAQs
Q1: Am I able to lose my entire money in credit risk funds?
A1: Complete loss is uncommon except in cases where a fund experiences huge multiple defaults simultaneously. This risk is capped through proper diversification though losses will be incurred in the case of credit events.
Q2: Does 3 years credit risk fund outperform equity fund?
A2: During a 3 year horizon, the credit risk funds tend to be more risk-adjusted with moderate aggressive investors, whereas the prospective excess growth is more apparent with equity fund of higher risk.
Q3: Is credit risk funds appropriate with retirees or older citizens?
A3: No, the capital protection is more significant than yield at this point and the retiree should look at less risky short-term or overnight funds.
Q4: To what extent are credit risk funds liquid?
A4: This is an allowance of most funds, which can be redeemed within 1-3 working days but exit load can be incurred when redeemed prematurely (typically over 12 months).
Q5: Is it possible to invest in credit risk funds in India by NRI?
A5: The majority of credit risk fund schemes will be available to credit NRIs based on country of residence and KYC requirements.
Sources
- SEBI Funds Regulation Changes.
- AMFI India - Mutual Schemes Categories definitely explained.
- Best Credit Risk Funds - Value Research.
- Morningstar India credit funds analysis.
