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Always look for well diversified credit risk funds and check holdings in …

Assuming a moderate risk profile given the short horizon of 5 to 7 years, invest with a 50% allocation to stocks and the rest (50%) to bonds.

What factors should I consider when investing in credit risk funds?
—Arvind Shekhawat
Credit risk funds are a category of fixed income funds mandated to invest at least 65% of assets in “AA” and lower rated corporate bonds. These funds aim to invest in lower-rated (riskier) securities because they offer a higher return to investors (than well-rated securities) to offset the risk of default and / or downgrading. These funds also present considerable liquidity risk due to limited liquidity in the low-rated segment of the Indian debt market. Credit risk funds can subject investors to large drawdowns, even putting their invested capital at risk, as has been observed in the recent past with some credit risk funds even experiencing double-digit drawdowns.

Although these funds offer a higher return than other categories of debt, you should be aware of the risks involved. Investors should limit their allocation to these funds to around 10-25% of their fixed income allocation, based on their risk appetite. Rather than looking for high returns, investors should choose a fund with their appetite for risk in mind.

When choosing a credit risk fund, look to invest in funds that are well diversified across issuers and sectors. Also examine the underlying positions and their ratings in detail, so that portfolio performance is not affected by a few high-risk stocks.

I am 45 years old and I can take risks for another five years. In equity funds, what type of fund should I look for with an investment horizon of 5 to 7 years?
—PH Sunder
Assuming a moderate risk profile given the short horizon of 5 to 7 years, invest with a 50% allocation to stocks and the rest (50%) to bonds. Since the investment horizon is moderate, most of the equity allocation should go to large-cap stocks (80-85%) because they are less risky than mid- and small-cap stocks. Although small and mid-cap stocks have the potential to generate higher returns than large caps, they are more volatile and carry substantial risk. The allocation to the small and mid-cap segment should be limited to about 15-20% of the equity allocation, depending on your risk appetite.

The author is Director of Investment Advisory at Morningstar Investment Adviser (India). Send your questions to fepersonalfinance@expressindia.com

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