A speedometer in a car tells you what speed you are driving at. Driving at a right speed is not only paramount for your safety, but can also enhance the performance of your car. Similarly, understanding the risk involved in a product before investing not only helps you get a right mix in your asset allocation, but also provides mental peace.

In 2013, the Securities and Exchange Board of India (SEBI) made it mandatory for the mutual fund houses to use product labels with colour codes to help investors assess the risk involved while investing in a respective mutual fund scheme. It made it obligatory on the part of mutual fund houses to disclose product labels carrying details of the scheme on the front page of initial offering application forms and they also be placed in common application forms and advertisements.

The labels included details of the mutual fund scheme – whether equity or debt – along with the objective i.e. "to create wealth or provide regular income" and also imbibed a time horizon (short/ medium/ long term) indicatively. And along with product labels exhibition of right colour codes for a respective mutual fund scheme was made compulsory. The colour Blue code indicated Low Risk, Yellow - Medium Risk and Brown denoted Highest Risk.

From colour codes to riskometer...
But to help investors understand risk better, SEBI has now replaced mandatory colour codes with a ‘riskometer’. The riskometer would classify risk into five levels, such as....
 

Low -> Moderately Low -> Moderate -> Moderately High -> High
These guidelines would be effective July 1, 2015 for all existing and forthcoming schemes, according to the circular released by SEBI.

Will it work?
PersonalFN is of the view that, the new system may help categorise mutual fund schemes better based on risk involved in them. It more direct as against the usage of colour codes which has in place a few flaws. For example, index funds and sector funds, both being equity oriented funds, use the same colour code (brown) to indicate the risk involve. But in fact index funds can turn to be less risky than actively managed sector funds.

PersonalFN believes that while investing is imperative that you to check your risk profile taking into account your age, income, expenses, assets, liabilities, number of dependents and nearness to financial goals. Also charting a suitable asset allocation, you may help you optimise returns on your investments without disregarding the element of risk. Selecting winning mutual fund schemes for the portfolio involves a deeper study, wherein you should focus on the following aspects amongst others:
 

• Performance (which includes: returns, risk, risk-adjusted returns, etc.)
• Portfolio characteristics
• Fund management style
• Costs (in the form of expense ratio and exit loads)
   

The Indian mutual fund industry should also engage actively in educating investors rightly, as that in the long term can be in the interest of investors as well as the industry.

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