The product labelling of mutual funds is based on the concept of 'Riskometer' and this meter depicts the level of risk in mutual funds.
By Vishwajeet Parashar
In order to ensure that the investor invests in mutual fund schemes that correspond to the investor’s risk profile, the markets regulator Securities and Exchange Board of India (SEBI) has a system of product labelling in place. Presently, the product labelling of mutual funds is based on the concept of ‘Riskometer’ and this meter depicts the level of risk in any specific mutual fund scheme denoting five risk areas – Low, Moderately Low, Moderate, Moderately High and High.
Going by the recent news reports, the SEBI may be considering to add one more level of risk-category in the labelling system of mutual funds – ‘extremely high risk’. The move, as and when it gets implemented, is a welcome step as it will help the investor to take a more informed investment decision.
As the fund houses are not allowed to provide any assurance of zero-risk to principal invested or a guaranteed return in mutual funds, the investor gets a fair amount of idea about the risk to the capital invested based on these five risks:
i. Low : Principal at low risk
ii. Moderately Low : Principal at moderately low risk
iii. Moderate: Principal at moderate risk
iv. Moderately High: Principal at moderately high risk
v. High: Principal at high risk
Picking the right mutual fund scheme for one’s portfolio goes a long way in determining the final returns for the investor. Also, important is to look at the nature of risk that the specific MF scheme carries. This is because the risk that a fund carries need to be aligned to the risk profile of the investor.
Broadly speaking, the riskiness in the mutual fund scheme is a function of the underlying assets. While equity as an asset class is inherently a volatile asset, the debt asset is not prone to such volatility, especially over the long term.
And, then there are schemes which have a mix of both. Balanced funds or hybrid funds, for example, can fall in the moderately high category or the Moderate category depending on the allocation in the two assets. Similarly, ELSS and large-mid-cap funds can make the moderately high or the High-risk category. The risk also arises depending on the allocation of funds into concentrated assets. The funds that cater to specific themes or sectors fall in the high-risk category.
Largely, there are three major categories that investors fall in – Conservative investors, Moderate Investor and Aggressive Investor. Once an investor identifies his or her risk-profile, picking the right fund within the category becomes easier and well-aligned with one’s long term goals.
The choice of the right mutual fund scheme depends on the long term performance of the scheme over different business cycles and which has consistently beaten its benchmark over the long term. Product labelling helps investors to choose such schemes from within each category so that it matches with one’s own risk profile. Make sure to go through the objectives and labelling as per the Riskometer of the fund to bring out the most from the investment.
(The author is Chief Marketing Officer, Bajaj Capital)