The one-year category average return of credit opportunity funds is currently the highest among all mutual fund categories at 8.70 per cent (as on February 16, maximum 9.69 per cent and minimum 6.49 per cent), according to the mutual fund rating agency Value Research. This has no doubt been aided by the downturn in equities, and the fact that interest rates have not declined significantly over the past year, so duration-oriented funds have not outperformed. Before investors rush out to invest in credit opportunity funds for their returns, they should understand how these funds work and the risks they carry.
In a credit opportunity fund, the fund manager includes lower-rated paper with the expectation of garnering higher returns. A debt instrument that is rated lower than AA may be looked upon as risky. However, according to Renu Pothen, research head, fundsupermart.com, "Ratings should not be treated as sacrosanct. If the fund management team has done its work and is convinced about the instrument, it may add the bond to its portfolio." Fund managers also bet on lower-rated paper in anticipation of an upgrade in rating, which boosts its price.
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