Does a mid-cap mutual fund scheme incur high risk or moderately high risk?
The answer to this subjective question depends on your perception of risk. 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.
If you are a conservative investor, a mid-cap scheme will seem like a high-risk proposition compared to the lesser volatile debt schemes. Aggressive investors who may have commodities or other high-risk speculative asset classes in their portfolio, may term mid-cap schemes as moderately high-risk.
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. If you had to choose between a mid-cap scheme and a large-cap or balanced scheme, how can you decide between the two if risk was a criterion?
If someone suggested looking at the Riskometer of the mutual fund, it will be better to look away. It’s similar to a malfunctioning speedometer that indicates you are driving at 60 kmph even though you are going at 100 kmph.
The Securities and Exchange Board of India (SEBI) introduced the Riskometer in July 2015, as a replacement to its earlier colour code labelling (one of SEBI’s many experiments). All mutual funds are mandated to publish a Riskometer at the beginning of all scheme related documents.
The Riskometer provides a visual description of the risk involved in a scheme, ranging from Low Risk To High Risk. The indicator spans five levels in all, including a scale of Moderately Low, Moderate, and Moderately High risk levels in between.
While this may be a simple way to let investors know the risk involved, SEBI, as it usually does, failed to clearly define the five levels. As a result, fund houses applied their own definitions of risk for the Riskometer.
So while Balanced Funds, with an equity allocation under 70%, are Moderately High Risk; in comparison, most equity funds with an allocation of over 90% to equity should be High Risk, right?
Not quite so. When we checked the Riskometer across mutual funds, we found that many Small-and Mid-cap schemes too are classified as Moderately High Risk investments. At the same time, there are certain fund houses that have Large-cap equity schemes categorised as High Risk.
Doesn’t such inconsistent classification create added confusion?
If you had to choose between a large-cap fund of one fund house and a mid-cap fund of another, you simply cannot rely on the Riskometer.
Among the 183 equity-diversified schemes as per ACE MF classification, just 15% of the schemes are categorised as High-Risk, while the remaining 156 schemes are classified as Moderately High Risk.
While this may seem fine, hybrid schemes such as Balanced Funds and even Equity Savings Schemes that have a lower equity exposure are categorised as Moderately High Risk schemes. This is highly inappropriate and gives the wrong impression of risk. The Riskometer puts such hybrid schemes at par with more aggressive equity schemes.
Among the schemes that are marked as High Risk in the equity-diversified category, there are six large-cap schemes, six mid-caps, 14 multi-caps, and just one small-cap.
Faulty Riskometer
Most Mid-cap & Small-cap Schemes at Par with Balanced Funds
Data as on September 29, 2017
(Source: ACE MF, PersonalFN Research)
What’s confounding is, half of the 300-odd debt schemes are categorised just one-notch lower than most equity schemes, at Moderate Risk. This gives the impression that most equity schemes are only slightly more risky than debt schemes.
Riskometer Level of Income Schemes Only a Notch Lower To Equity Schemes
Data as on September 29, 2017
(Source: ACE MF, PersonalFN Research)
Looking at the data, an ideal risk level classification should consider all equity schemes as High Risk, Hybrid schemes tilted towards equity should be marked as Moderately High risk.
However, fund houses refrain from categorising their schemes as High Risk because this terminology has the power to scare away potential investors. In percentage terms, just 22% of equity-oriented 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.
All this happens right in under the regulators nose. Unless SEBI’s does not introduce stricter norms, fund houses will be unhesitant to take advantage of the loopholes. As seen in our analysis, the Riskometer serves no purpose as it can be blatantly manipulated. As you would never rely on a faulty fuel gauge, you should not rely on the Riskometer too.
PersonalFN believes that it is imperative that to check your risk profile taking into account your age, income, expenses, assets, liabilities, number of dependents, and investment horizon. This will help optimise investment returns without disregarding risk. It is best to rely on quantitative risk indicators, while focussing on the risk-adjusted returns as well.
Also by charting a suitable asset allocation, you can optimise investment returns without disregarding the element of risk. For this, you will need a portfolio of winning schemes across asset classes.
FundSelect Plus subscribers get access to SEVEN time-tested, readymade portfolios (both equity and debt) to invest in for steady wealth creation. Here you can invest in the Aggressive, Moderate, or Conservative equity portfolios. Under debt, choose the perfect portfolio out of three, based on your investment horizon. In addition, you get a readymade tax-saving portfolio as well.
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