Mutual Fund Risk Profiler and Riskometer

Investment risk in mutual funds refers to the possibility of returns getting impacted due to factors such as market volatility, economic changes, unforeseen events or poor investment decisions.

The main types of risks are market risk (fluctuations in the market), interest rate risk (changes in interest rates affecting funds), credit risk (default by issuers), liquidity risk (difficulty in selling assets), inflation risk (eroding purchasing power), business risk (uncertainties and potential hazards that may encounter), price risk (the risk on value of a security or investment), etc.

Market risk is the primary risk affecting equity funds. It is the risk of loss in value of securities due to a variety of reasons that affect the entire stock market. These can be attributed to many factors like macroeconomic trends, global economic crisis, geopolitical tension, regulatory changes or any other factors. Apart from the above sources of market risk, equity funds can also be prone to currency risk which could be relevant to funds that invest in companies having operations in multiple countries. Equity funds can also be impacted by unfavourable development around a company like say a change in management or company policy. This is referred to as company specific risk. Equity risks cannot be eliminated but mitigated through diversification.

It’s a misconception that Debts Fund have no risk just because they don’t invest in equities. Even though debt funds carry relatively lesser risk compared to Equity Funds that doesn’t mean Debt Funds guarantee that your money will never face any loss. Debt funds invest in debt and money market securities that are prone to different kind of risk factors as compared to equity funds that invest in stock market. Debt Funds are exposed to various risks including interest rate risk, credit risk liquidity risk, that are quite different from the stock market risk we all are familiar with. Hence investing in most of the Debt Funds may be relatively less risky as compared to Equity Funds but not completely risk-free.

Riskometer is a graphical representation of the risk a mutual fund scheme carries. The risk categorisation in the graph is defined by SEBI in its Master Circular dated May 19, 2023. It resembles the speedometer of a vehicle and displays 6-levels of risks. The six levels of risk ranging from low, low to moderate, moderate, moderately high, high, and very high have been linked to various categories of mutual funds depending on the level of risk in their portfolio.

Every investment we make involves a risk, only its nature and degree vary. The same applies to Mutual Funds too. Different funds carry varying levels of risk. Equity funds generally have higher risk due to stock market volatility, while debt funds might have relatively lower risk but still face interest rate, credit and other risks.

While there are many risk indicators like Standard Deviation, Beta, and Sharpe Ratio provided in the factsheet of every scheme, product label is the most basic thing to look for. The riskometer in the label shows the risk level of the Mutual Fund scheme. This riskometer is a mandatory requirement by SEBI and represents the underlying risk associated with the Mutual Fund Scheme. The six levels of risk ranging from low, low to moderate, moderate, moderately high, high, and very high have been linked to various categories of mutual funds depending on the level of risk in their portfolio.

No investment is entirely risk-free. Even diversified mutual funds are subject to market fluctuations. However, diversification might help in managing and mitigating risks.

In a Mutual Fund, a typical portfolio holds many securities, thus offering diversification. In fact, diversification could be one of the biggest benefits of investing in a Mutual Funds.

The level of risk you're comfortable with depends on your investment goals and risk tolerance. Low-risk funds might provide stability, but they might not offer the potential returns required to meet goals.

Mutual Funds invest in securities and the nature of securities depends on the scheme’s objective. Company shares are bought and sold through the stock exchange, which is part of the Capital Market. Similarly, debt instruments like Government Securities, can be traded through a platform at the Stock Exchange or through specialised systems called NDS.

So, the entire process of buying and selling, and price determination is done by the ‘market’. The price of any security is dependent on ‘market forces’, and the market acts on any news or development, making it difficult to predict the direction of the market.

Thus, every investor should know that there always exists a certain risk to security price from an all-important entity known as the ‘Market’.

Investments in Mutual Funds require the appropriate time horizon. Having the right time horizon, lowers the risk in the investment. The risk here is the volatility of investment performance, as well as chances of eroding investment capital. Staying invested over the long term tend to average out the negatives and positives in the market. Therefore, one may stay invested for long term to whether the volatility. The time horizon differs for every asset class as well as Mutual Fund category. One must consult a financial expert and read the scheme-related documents before making an investment decision.

Mutual Funds invest in securities, be it equity or debt, whose values fluctuate along with market movement. The NAV of the fund is calculated considering valuation of individual security held in the fund’s portfolio. But since most of the mutual funds invest in securities across different sectors, they diversify this market risk. Thus, it is true that mutual funds diversify risk, but they don’t eliminate it.

When you invest in Mutual Funds, depending on your risk-taking ability, you should choose a fund with the right kind of diversification that might suit you.

Market conditions, such as economic downturns or recessions, can increase overall market volatility, impacting the performance of mutual funds and potentially leading to higher risk.

Index funds generally have lower fees and less active management risk, but they're still exposed to market fluctuations. Actively managed funds depend on the fund manager's decisions, which can lead to potential outperformance or underperformance.

Your investment horizon (how long you plan to stay invested) affects your ability to ride out short-term market fluctuations. Longer horizons can help mitigate the impact of market downturns.

If ‘risk’ is measured as either, probability of loss of capital or as swings and fluctuations in investment value, then asset classes like equity carry high-risk, and a government bond carry relatively low-risk.