Investing in debt funds? Have a look at these red flags

Debt funds are often considered to be a safe option when compared with equity, witnessed credit and liquidity events. This calls for watching out for red flags before investing in debt funds. Read on to find out more. 

Debt mutual funds when compared with equity mutual funds are assumed to be a safe option. However, it is quite unreasonable to call them risk-free. Debt funds do carry risk, although it is relatively lower when compared to equity. In this article, we have listed the top red flags to watch out for while investing in debt funds. 

High concentration in one issuer

If the debt mutual fund is more tilted towards a single issuer, then that is a red flag. Investing in different instruments issued by the same company exposes debt mutual funds to company-specific risk. And if such a company is not in a position to honour the payments, then this would put that mutual fund at great risk. Even one or two downgrades would have an overall impact on the fund’s performance.

High concentration in low-rated securities 

Debt funds usually invest in low-rated securities to generate higher returns. Although such instruments provide higher interest rates, they carry higher credit risk. Although, having a subtle approach towards them is fine, at times debt funds go heavy on investing in these securities which makes the overall portfolio risk. Therefore, before you invest in any debt fund, make sure that you are fully aware of the risk undertaken for the returns that they generate.

Ratings under review 

Credit ratings is one of the tools that help you in gauging the risk of particular debt security. Looking out for securities which are under review status by the credit rating agencies makes sense. This is the time when credit rating agencies re-assess the credit profiles of the securities and decides whether to upgrade, downgrade or keep the status quo. You can check the recent developments happening with the issuer to understand its impact. However, it is not necessary to check each and every paper. Check only those having higher allocation.