Understanding Riskometer

Understanding Riskometer

Last few years it has been made mandatory by SEBI to display riskometer for every Mutual Fund scheme . The reason behind having riskometer is to make investors aware about the risk associated with that product from the return perspective. The idea no doubt is very good but the way riskometer is displayed needs more clarity so that investors gain confidence and conviction and not get apprehensive or confused .

The riskometer as displayed in the various literatures of Mutual Fund schemes looks as below with ( sample riskometer ) . Interpretation is given on left side ( level of risk ) .

Anyone who invests in any mutual fund scheme has some expectation of return which is either in form of Dividend income and/or capital gain (i.e. profit on invested amount when sold back). It is risk or uncertainty of not getting as per your expectation is what that is displayed .

We find debt funds are usually in low to moderately low category. Very very few might fall in moderate range whereas in equity funds most are in moderate and high and hardly very few in moderate . Equity funds always shown more risky than debt funds so someone who is not so well conversant with equity might fear and not invest in equity fund.

Investors need to understand why and how your principal i.e. amount invested is at risk? But before that lets understand risk.

For most of the new investors risk it means loss or chances of loss. Some think risk means uncertainty in return but that also in downside loss not on upside gain. Risk in investment means uncertainty in return i.e. getting a different return than what expecting.   It could be both upside or downside i.e. in either direction or level from what expected. Here one has to understand expectation has to be realistic and is generally based on past historical average. If someone expecting 15 % based on realistic historical average and gets 7% then there is a risk and if he gets 28% then that is also a risk. So any deviation from realistic expectation is risk whether it is positive or negative.

In investment there are many types of risk and each one of them can affect the assets (debt /equity) and various types of securities within those assets, the performance of the companies and eventually return on investment. The effects can be positive or negative. There are business risk, market risk, economy risk , country risk, currency risk  , credit risk, interest rate risk , inflation risk etc.  The overall impact gets affected in return or performance of the fund.

Riskometer describes Principal at risk . So by above fact it mean principal is more at risk in equity vis avis Debt ? Yes it is true but only in short term. As the time horizon of investment increases and becomes long term (> 5 years) then in fact surety of getting a higher return in equity is more than debt. So one can say Risk in equity is less to zero in long term. In fact if we see performance of equity fund vis avis debt fund on different time horizon say 1 year , 3 year , 5 year , 7year , 10 year ...... one will find that beyond 5 years equity giving better return than debt fund. For a period between 3 to 5 years again most of times equity giving better return than debt. For a period 1 to 3 years it is mix result sometimes equity and sometimes debt has given better return than the other . Yes less than 1 year debt has found be give safe positive return vis a vis equity fund.

In a mutual fund whether it is a debt fund or hybrid fund or equity after doing detailed research money is invested in those companies which are profitable or going to earn good profit soon. Ensuring profitability aspect is the key in fund management. Also while investing whether the security is overvalued or undervalued is also considered and fund manager takes proper care not to go for bargain where there could be identifiable loss. Money is invested in a lot range of companies with a clear objective that the overall portfolio return does not go down. So from where the principal is at risk?

On Asset front return from debt fund is from interest income earned and capital appreciation of debt securities held in portfolio. Similarly in equity fund return is from dividend income earned and capital appreciation of equity securities held in portfolio. Of all these only interest income is fixed and assured. So in a debt fund there is surety of some income definitely coming in fund. The capital appreciation part is affected by interest rate movement so that also is correctly expected by fund managers maximum of time and its likely impact on portfolio is well countered by being in securities with right term to maturity .Equity on other hand is more subject to volatile expectations of investors which reflects in market volatility . The securities held are more subject to steep valuation gain or valuation loss of the security held in the scheme portfolio. The factors causing risk and affecting return are many. Many of them are sudden and bring changes in prices of securities which is difficult to judge in short time. The psychological impact on investors in stock market at times stays for longer period as it takes some times again for confidence building amongst investors . Sometimes the impact is of very short duration. The duration of this psychological impact is also variable  So when principal is at risk here in riskometer means possibility of valuation loss of equity securities are much more than the valuation loss of debt securities in short term. The valuation of securities affect the return and so debt fall under less risky category and equity more but more in short term .

As an investor one should be clear that money is invested in best available companies after thorough research and if the stay is for longer period then investment is equity is less risky i.e. you get return better than debt and as per realistic expectations.