Are SEBI’s New Guidelines Of 'Risk-O-Meter' Helpful?

While one can calculate the risk based on the volatility or standard deviation of returns, the level of risk (high, moderate or low) is often subjective/relative to different asset classes. And in mutual funds the risk is mitigated through diversification and professional management.

Depending on the type of fund, the level of risk differs that is suitable for the individual investor's risk profile -represented by a Risk-O-Meter on the offer document. If you recall, last year I wrote to you about, " Why You Should Not Look At The Risk-O-Meter When Investing In Mutual Funds? " mentioning that usually the inherent risk differed as opposed to the risk represented on the schemes' document cover.

SEBI has observed this disparity as well, hence it has proposed to introduce a new category- "Very High", to the existing five categories - Low, Moderately Low, Moderate, Moderately High, and High.

For better understanding, the market regulator will mandate separate criteria for risk assessment of equity and debt funds, given the distinct features of the two asset classes with scheme specific and score based, to give a better picture to investors for making wise decisions.

Currently the risk is categorised as per the category in which a specific scheme falls, in this somewhere the actual scheme's risk is missed and tends to mislead investors.

But now as per the new norms equity funds will be judged on the basis of three parameters - market capitalisation, volatility, and impact cost. Whereas the debt funds, on the other hand, will be judged on the three parameters--credit quality of bonds, duration of bonds and their liquidity.

Another big reform, as per the sources is that the Risk-O-Meter will have to be computed on real time and displayed in the scheme's monthly fact sheet. As well, any change in the underlying assets will have to reflect in the scheme's risk category.

This is relevant for debt funds, which buy and sell bonds of varying credit profiles. Sometimes at some point, a scheme that falls in the moderately low risk category may carry a very high proportion of AA or less rated papers, contrary to its risk profile and misleading for investors

But with the new score based system, since each bond would be assigned individual scores, any fresh buying or selling of bonds would automatically reset the Risk-O-Meter. In essence, a scheme may carry different risk rankings through its life. So should any scheme require its Risk-O-Meter to be changed, the same has to be expressly communicated to the unitholders.

Lastly in slew of proposed mutual fund reforms is that asset management companies will now have to maintain an annual timeline of how the risk has evolved in each fund. This will help investors to understand the risk style of the fund manager.

Conclusion:

Currently, fund houses refrain from categorising their schemes as High Risk because this terminology has the power to scare away potential investors. Only a few schemes are defined as "High Risk". As fund houses are in the business of asset gathering, no one wants to frighten off investors with "High Risk" mutual funds.

But the new norms will provide a better clarity and the risk -o- meter level properly allotted because it will be a resultant product of various calculations. However, how and who will compute is a question still remains and needs more clarification.

Although it's a great step to finally understand mutual funds risk clearly, concisely, and comprehensively for investment, investors need to do their own thorough research as well. Read through the Scheme information document (SID) for details like allocation of the fund, investment strategy, fund manager's track record and the investment mandate along with the risk-related ratios to make an informed decision.

Besides, it is equally important to understand that whatever fund you choose is as per your:

• Investment goals;

• Investment time horizon;

• Risk profile;

• Financial position;

Watch this short video on selecting mutual fund schemes:

Warm Regards,
Aditi Murkute
Senior Writer

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