Speaking at the sixth annual seminar on mutual fund industry, Aditya Birla group director SK Mitra said, "Investors have suffered in the last six months both in debt and equity funds." He added, "The three corners of risks in a mutual fund business stem from the plan sponsor, investment manager and custodian or registrar. The primary risk areas involved are regulatory risks which arise due to non-compliance, changes and limitations. Investment risks are equally present in the debt and equity market. Limited hedging products along with little scope for futures, options is only adding to the risk.

There are also operational, marketing risks and risk arising from wrong valuation and accounting."

As part of the risk management business, mutual funds must clearly define the risk policies, organisational structures and adopt risk-adjusted return measures. Lastly, due diligence has to be paid on policy compliance and guideline monitoring and also on comparison of managers' strategies to compensation and investment activity, independent review of methodologies, models and systems.

Talking on internal and external risks, Mr Mitra added that the former involves recognition of specific risks as market volatility, trade settlement, share registration and periodic illiquidity. The latter involves poor knowledge of mutual funds among the investors fraternity, short-time investment horizon of the investors, restricted business operation and low risk taking ability of the investors.

In a typical mutual fund business, there is a marketing challenge of fund mobilisation, the investment management challenge of investing the collected funds and the risk management challenge of protecting the targeting return.

According to UTI Institute of Capital Markets Professor Uma Shashikant, "Risk in mutual fund portfolios has been measured and used extensively in the context of performance evaluation. Over the past 40 years, techniques for performance measurement have been sharpened to include performance attribution and style analysis, among others."

Speaking on the immediate steps to be taken in risk management of portfolios, Mrs Shashikant added that mutual funds could initiate internal processes that measure the relative risk of their portfolios with respect to a benchmark and using a simplified value at risk approach to compute the sensitivity of their portfolios to market risk.

Mutual funds can begin to clarify the mandate they are seeking by moving to specific mandates. This would clarify the fiduciary responsibility they have for the risk of the portfolio, and the risk that are borne by the investor. Benchmarks which enable the evaluation of such clearly mandated portfolios should be disclosed in the offer documents.

Risk measurements should move away from traditional variance-based models that are counter-initiative, to measures that focus on the downside risk of the portfolio. In this context, the issue of multiple benchmarks in the minds of investors should be tackled. Fund managers may not be able to beat multiple benchmarks that investors set for them. It would be useful if industry standards on disclosures to investors about expected performance and downside risks are developed.