In a transfer that can assist buyers to make a extra knowledgeable funding determination, capital markets regulator Securities and Trade Board of India (SEBI) has made it obligatory for mutual funds to assign a threat degree to schemes, primarily based on sure parameters.
SEBI’s determination on the “risk-o-meter”, which it introduced on October 5, 2020, got here into impact on January 1. In its round issued on October 5, the regulator made it obligatory for mutual fund homes to characterise the danger degree of their schemes on a six-stage scale from “Low” to “Very Excessive”.
How will the risk-o-meter work?
As per the October 5 round, all mutual funds shall, starting January 1, assign a threat degree to their schemes on the time of launch, primarily based on the scheme’s traits.
The danger-o-meter should be evaluated on a month-to-month foundation. Fund homes are required to reveal the risko-o-meter threat degree together with the portfolio disclosure for all their schemes on their very own web sites in addition to the web site of the Affiliation of Mutual Funds in India (AMFI) inside 10 days of the shut of every month.
Any change within the risk-o-meter studying with regard to a scheme shall be communicated to the unit-holders of that scheme, SEBI has stated.
How is that this totally different from the older class threat degree?
There was a sort of risk-o-meter for mutual funds since 2015; nonetheless, the schemes merely confirmed the danger degree of the class that they belonged to. They didn’t mirror the riskiness of particular person schemes and their respective portfolios.
Subsequently, all giant cap schemes — or some other class of schemes — throughout fund homes, carried the identical threat degree (one among 5 dangers ranges) that was assigned by SEBI to the class to which they belonged.
This has modified with impact from January 1 this 12 months. Fund homes should now assign a threat degree out of six out there ranges — the “Very Excessive” class is new — after calculating their threat worth from their respective portfolios.
Because the threat worth and threat ranges could be arrived at after bearing in mind vital parameters comparable to credit score threat, rate of interest threat, and liquidity threat in case of a debt scheme, and parameters comparable to market capitalisation, volatility, and influence price in case of an fairness scheme, trade consultants really feel that the risk-o-meter will now present a extra goal evaluation of the riskiness of a specific scheme to potential buyers.
Many really feel that the sooner class risk-o-meter was in a manner deceptive — the class risk-o-meter had no reference to the schemes, and two schemes of two totally different fund homes in the identical class would mirror the identical threat degree, although that they had very totally different portfolios and riskiness profiles.
Now, if in the identical class, one scheme is producing a better return than others, buyers will be capable to determine whether it is, in truth, taking a better threat than others for producing these superior returns. In impact, this provides one other layer of data to make an funding determination.
How will the extent of threat be assigned?
Which one of many six threat ranges — low, low to reasonable, reasonable, reasonably excessive, excessive, and really excessive — would apply, would depend on the danger worth (lower than 1 for low threat to greater than 5 for very excessive threat) calculated for the scheme. So if the danger worth of a scheme is lower than 1, its threat degree could be low, and whether it is extra the 5, the danger can be very excessive on the risk-o-meter.
How will the danger worth be calculated?
For an fairness portfolio, the danger worth could be a easy common of market capitalisation worth, volatility worth, and influence price worth.
Whereas market cap worth of a portfolio can be primarily based on the weighted common of the market capitalisation values of every safety (5 for big cap, 7 for mid cap and 9 for small cap), the volatility threat worth of the portfolio would be the weighted common of the volatility worth of every safety (5 for every day volatility of as much as 1, and 6 for better than 1).
As for influence price worth, which is a measure of liquidity, the worth could be the weighted common of influence price values of every safety (5 in case of common month-to-month influence price of as much as 1; 7 for that between 1 and a pair of; and 9 for that above 2).
The danger worth for the debt portfolio could be a easy common of credit score threat worth, rate of interest threat worth, and liquidity threat worth. Nevertheless, if the liquidity threat worth is larger than the common of credit score threat worth, liquidity threat worth, and rate of interest threat worth, then the worth of liquidity threat shall be thought of as threat worth of the debt portfolio.
Whereas the credit score threat worth of the portfolio could be assigned 1 for AAA rated and 12 for devices beneath funding grade, the rate of interest threat can be valued utilizing the Macaulay Period of the portfolio (1 for period beneath 0.5 years and 6 for these with period of over 4 years). (Macaulay Period is the weighted common time for which a bond needs to be held so that the overall current worth of money flows obtained matches the present market value paid for the bond.)
For measuring the liquidity threat of schemes, itemizing standing, credit standing, and construction of debt devices is taken into account (1 for Gsec and AAA-rated PSUs, and 14 for beneath funding grade and unrated debt securities).