Imagine the excitement of a white water rafting trip and the adrenaline rush as you race through the waves and finally reach your destination. However, before embarking on the adventure, a responsible tour guide will usually inform individuals about potential risks and safety precautions. It also ensures that people are equipped with life jackets and become aware of necessary survival skills.
Investing in mutual funds is quite similar; To overcome these risks, it is crucial to understand the associated risks and mitigation processes. Riskometer can serve as one of the important tools of investors in this journey and enable investors to make smarter and more informed decisions.
History of riskometer
One of the first things you will see when you open a document related to the scheme is a semicircle with an arrow indicating the ‘Risk’ levels associated with that fund. In 2015, SEBI introduced ‘Riscometer’ as a risk metric in the said scheme. Before this, fund houses would color risk with blue, yellow and brown codes to indicate low, medium and high risk respectively.
However, the risk meter introduced then could not capture the detailed risks associated with mutual fund schemes. So SEBI further developed this to define and classify the risk into low, low to moderate, moderate, moderately high, high and very high risk based on their individual categories.
The main circular determined risk based on a fund’s actual underlying assets, taking into account market capitalization, volatility and liquidity in the risk meter. Over the years, it has worked well on both the equity and debt side, promoting transparency among investors.
A riskometer is a standardized tool used by mutual fund houses to communicate the risk levels of individual funds. It provides a visual representation of a fund’s risk profile, using a needle (like a compass) to represent different levels of risk:
Low risk: Investors investing in funds classified as ‘Low Risk’ can expect their principal to be subject to Low Risk. Investments in this category are suitable for investors who want to take minimum investment risk.
Moderately Low Risk: Investors who invest in funds classified as ‘Low to Medium Risk’ can expect their principal to be exposed to minimal market risk. This category is suitable for conservative investors.
Medium Risk: As the name suggests, ‘Medium Risk’ funds are suitable for semi-conservative investors who want to take limited risk on invested capital with the aim of creating wealth.
Moderately High Risk: Plans in this category are typically exposed to equity-oriented risks on the principal invested. These are suitable for aggressive investors with a medium to long-term investment horizon (3+ years).
High risk: ‘High Risk’ programs are suitable for aggressive investors who want to invest for the long term (>5 years). Principal invested in these schemes may be subject to high risk and high market volatility.
Very High Risk: These invest predominantly in equities, which have higher relative risk profile schemes compared to the highly volatile stocks of other funds. It is suitable for very aggressive investors. Here, the principal invested is subjected to the highest risk in the mutual fund spectrum with the goal of creating long-term wealth. This fund category includes sectoral/thematic/international/midcap/small funds.
From an investor’s perspective
Riskometer acts as a useful guide for investors, helping them understand the risks of investing in mutual funds. By familiarizing yourself with Riskometer’s categories and adjusting them based on their comfort level, goals, and investment duration, investors can make informed decisions and effectively manage risks to achieve their financial goals.
For example, typically gilt funds and ultra-short-term funds have maturity periods of less than 90 days, attributing low risk to them. Because these funds provide relatively low risk-return utility, they may be suitable for risk-averse investors looking for a steady income stream with low-risk, low-return growth.
On the other hand, investors who have a relatively higher risk appetite, are willing to wait patiently, and are willing to invest in the market for the long term may consider investing in high-risk funds for long-term goals such as retirement or their child’s higher education. .
Moderately high risk funds, travel, lifestyle improvement etc. It can be considered by those who plan for such goals. because these funds usually invest in companies with large market capitalization or multi-cap funds, allowing them to choose between large, mid-cap or small-cap companies. Medium-risk funds offer great opportunities for medium to long-term investment and are suitable for investors who want to commit to an investment period of 2 to 3 years, earning moderate profits while accepting a moderate level of risk.
As a result, the Indian mutual fund industry has experienced a dynamic transformation in the last few years, accelerated by the integration of technology and rapid growth of digital channels. The reality of this industry today is far beyond what could have been imagined when it started taking root in India almost 30 years ago! Much of this tremendous growth can be attributed to the rigorous risk control mechanisms established by the regulatory body aimed at protecting the best interests of investors.
It is crucial to consider factors such as risk tolerance, investment goals, investment horizon, and asset allocation. Armed with this knowledge, investors can begin their investment journey with confidence, striving towards a prosperous financial future.
Ashwin Patni is Head of Products and Alternatives at Axis AMC.
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