How debt funds lead to reduced risk as part of a diversified portfolio
Monday July 29, 2019
While most people no longer hide cash under a mattress, we’d still rather save our money in a bank account than risk investing it. The same applies to small businesses, many of whom would rather keep their capital in the company account than invest. For debt buyers, understanding how risk can be mitigated through diversification, which basically means to assign capital in such a way as to mitigate risk, is an essential part of their business. Debt funds as part of a diverse investment portfolio can yield higher returns and offer less risk than any individual investment in a portfolio.
A debt fund (also called a credit fund or fixed income fund) is an investment pool such as a mutual fund or ETF (exchange-traded fund) that invests in short or long-term bonds, securitized products (such as government securities), money market instruments, floating rate securities or bonds. They are called debt funds because the issuers of these instruments borrow money from lenders against these instruments, which come with different maturities or returns (fixed income rates).
Many corporations also issue debt to raise capital. This debt is often classified by its credit rating. According to Fitch Ratings, investment grade debt is offered by companies with generally stable outlooks and higher credit quality, indicating low to medium risk. Conversely, high yield debt (bonds rated below investment grade) are usually issued from lower credit quality companies with emerging growth prospects, indicating greater risk but potentially higher returns.
Debt funds usually perform differently to equity funds (also called stock funds).When interest rates fall, debt funds appreciate in value due to the lower cost of borrowing. When interest rates rise, bond prices can decrease, leading to decreasing returns on debt funds. Should the investor or debt buyer select uncorrelated debt to match risk appetite, he may be able to generate income in line with prevailing interest rates.
Diversifying a portfolio with debt funds shields it from equity investment volatility and can even be a way for retail investors or corporate investors to park their surplus short-term assets and earn additional returns, thereby managing risk. Debt funds are essential part of any diversified portfolio, allowing the investor or debt buyer to preserve capital, manage risk or generate regular income through dividend distribution.
By providing businesses with clear and concise data to mitigate risk, SCORE helps businesses make informed decisions when purchasing debt. SCORE’s analytical models and risk-based pricing confirms the quality of debt, allowing debt buyers or private investors to confidently diversity their portfolios by purchasing account receivables and investing in debt funds. Contact us today on 647.309.1803 to get the conversation started.