personal finance

How the new riskometer will alter things for mutual fund investors

Any directive communication, be it the traffic signal or the warning on a packet of cigarettes, is based on a logic. To what extent it is observed and followed by the intended audience is a different question.

For mutual fund schemes, the concept of riskometer, with the arrow pointing to a certain risk level portrayed like the speedometer on a car dashboard, has been there for some time. The risk level shown on the meter, as of now, is somewhat subjective, and is decided by the AMC as per the scheme objectives. We are set for a significant improvement on how the needle is set by the AMC, as per the Sebi Circular dated October 5, 2020. This circular will come into effective from January 1, 2021.

What does it say?

·“Based on the scheme characteristics, mutual funds shall assign risk level for schemes at the time of launch of scheme/new fund offer.” That means this remains the same as earlier.

·“The underlying securities of a scheme shall be assigned a value for each of the parameters based on which the risk-o-meter value will be calculated.” That means it is based on the current portfolio, which is an improvement from the existing dispensation.

·“The risk-o-meter shall be evaluated on a monthly basis.” That means, it is not static, different from the current riskometer.

·“Mutual funds shall disclose the risk level of schemes as on March 31 of every year, along with number of times the risk level has changed over the year, on their website and Amfi website.” The implication is, monthly review may or may not move the needle, but the communication every year ensures that it is not lying static since inception of the scheme.

The scale assigned for the riskometer is that after following the parameters stipulated in the circular, the output will be one single number and the risk level corresponding to that number shall be depicted as the needle pointing to a particular risk level.

There are six levels of risk specified, ranging from ‘Low Risk’ (corresponding number less than or equal to 1) to ‘Very High Risk’ (corresponding number more than 5). To deep dive a bit into the contents of the circular, it states that the underlying securities of a scheme shall be assigned a value for each of the parameters based on which the risk-o-meter value will be calculated. The final output is the weighted average of the risk number assigned to each individual security.

For this purpose, the AUM of the security on the last day of the month shall be considered. For debt securities’ credit risk, there is a scale from 1 to 12, where 1 is the best, reserved for government securities and AAA-rated bonds, 2 is for AA-rated bonds and so on. 12 is for below investment grade. For interest rate risk of debt securities, the scale is 1 to 6. Macaulay duration of the security up to 0.5 year makes it 1, and duration more than 4 years corresponds to risk number 6 on the scale. There is a third category of risk for debt securities, that is liquidity risk. This risk has always been there, but came to the fore after the Franklin Templeton incident. The scale for liquidity risk is 1 to 14. Government securities and AAA-rated PSU bonds are eligible for liquidity risk value 1, other AAA-rated securities are risk value 2 and so on. The highest risk value, 14, is for below investment grade and unrated debt securities. Risk value for the debt portfolio shall be simple average of credit risk value, interest rate risk value and liquidity risk value.

However, if the liquidity risk value is higher than the average of credit risk value, liquidity risk value and interest rate risk value then the value of liquidity risk shall be considered as risk value of the debt portfolio.

For equity exposure, there are three aspects of risk: market capitalisation, volatility and impact cost i.e. liquidity measure. For market capitalisation, the corresponding risk numbers are 5, 7 and 9 where 5 is for largecap stocks, 7 for midcap and 9 is for smallcap stocks. For volatility, there are two numbers, 5 and 6. 5 is for where daily volatility is less than 1% based on price data of past two years and 6 is for volatility more than 1%.

Impact cost risk numbers are 5, 7 and 9 where 5 corresponds to average impact cost of less than 1% for the month, 7 for impact cost between 1 to 2% and 9 for more than 2%. Risk value for equity portfolio shall be simple average of market capitalisation value, volatility value and impact cost value.

Net-net, for investors who are savvy to take note of where the needle is pointing, the underlying calculations will be more structured and more dynamic from the beginning of 2021.

Other investors can take inputs from advisers/ distributors.


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