Question: I am a 50-year-old self-employed man, my wife is a housewife, and my children live abroad. I have invested in fixed income schemes offered by public sector insurance companies like LIC. I have been thinking of investing in mutual funds for a long time, however, I did not understand the risk rating mentioned in the scheme document of mutual funds. Can you please explain how different mutual fund schemes are assigned risk rating?
Dola Ram Yadav, Pilibhit, Uttar Pradesh
The concept of riskometer – the first method introduced by the Securities and Exchange Board of India (SEBI) in 2015 to indicate the risk associated with mutual funds, is to assign risk to each mutual fund based on the category of mutual funds, effectively all mutual funds in a particular category. They had the same status.
This initial risk rating method was not very popular with the industry or investors because practically all mutual funds of a particular category of mutual funds have the same risk as them. Different investment strategies, asset quality, performance, etc. available in the same category.
In the year In 2020, SEBI issued new guidelines for calculating the risk associated with mutual funds. In a departure from the old methodology, the risk associated with each mutual fund is now independent of the category of mutual funds within it. In the current risk rating system, the risk rating of a particular fund depends on the type of asset. The mutual fund is investing.
For example, in equity mutual funds, mutual fund risk rating is based on market capitalization, volatility and leverage (liquidity).
Below are the key highlights of the new risk rating framework applicable to mutual funds:
1. Riskometer: Under the new scoring framework, Riskometer has the following six risk levels.
- Low risk
- Low to medium risk
- Moderate risk
- Moderately high risk
- High risk
- Very high risk
2. A mutual fund has a legal obligation to allocate the risk level at the time of initiation of a mutual fund scheme/new fund offering (NFO).
3. Mutual fund riskometer rating is reviewed monthly by the mutual fund.
4. Any changes in the riskometer grading of the mutual fund should be communicated to the unit holders through e-mail or SMS at the mutual fund house.
5. The riskometer rating of a mutual fund should be compulsorily displayed on the website of the mutual fund house.
6. On the front page of the first application form, the Scheme Information Document and Key Information Document Risk Rating of Mutual Fund Scheme should be mentioned.
7. Risk analysis of the debt instruments/assets in which the mutual fund has invested has been analyzed according to the following parameters.
- Credit risk.
- Interest rate risk.
- Liquidity risk.
8. Risk analysis of the equity instruments/assets in which the mutual fund has invested has been analyzed based on the following parameters.
- Market capitalization.
- Impact value (liquid parameters).
How important is riskometer rating?
If an investor is trying to understand the risk associated with different categories of debt mutual funds, the Riskometer Rating is very useful. There are more than 16 categories of debt mutual funds, and often investors are confused about the risks associated with different debt mutual fund schemes.
However, when it comes to equity mutual fund schemes, the situation is not so clear, as in the new risk rating framework, almost all equity mutual fund schemes have been categorized as high risk, making it unfair to compare the risk with equity mutual funds. Tracking Nifty 50 (which includes India’s top 50 companies) and small cap mutual fund tracking companies that are not among India’s top 250 companies in terms of market capitalization. This discourages new investors from investing in equity mutual funds.
Does high risk guarantee high returns?
In the case of mutual funds, returns are not guaranteed. Unlike fixed income schemes, there is no certainty or legally binding contractual guarantee regarding your investment. There is a chance that you may even lose your initial investment. A mutual fund’s risk rating does not guarantee any returns, but typically equity mutual funds have the potential to provide better returns than debt mutual funds.
How to use riskometer when investing in mutual funds?
Riskometer can be a useful tool to measure relative risk when investing in debt mutual funds. When you review debt mutual funds, you will find that within each debt mutual fund, most mutual funds have the same investment strategy and hence most have the same risk rating.
For example, variable bond funds are grouped into the “medium” category. You can use it for two purposes: (a) to assess whether a “moderate” level of exposure suits your risk appetite and (b) to evaluate your holdings or potential investments in the same category using “moderate” as a benchmark. If your fund falls into the same category but is labeled as “high risk,” you should probably dive deeper into your mutual fund’s investments and then assess whether the fund in question is a match for you. Investment goals.
The risk rating system in India is currently evolving. It is not a perfect indicator of the risks associated with mutual funds. However, it can help you compare the risk associated with debt mutual funds. If you are thinking of investing in debt mutual funds, you should check the risk level of your choice and its peers in the same category.
Kuvera It is a free direct mutual fund investment platform.
Note: This story is for informational purposes. Please contact a financial advisor for detailed solutions to your queries.
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First published: December 19, 2022, 08:11 am IST