Capital Markets: Challenges and Developments

Mutual Funds Risk-o-Meter

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Mutual Funds

Mains level : Mutual Funds and associated market risks

The capital markets regulator Securities and Exchange Board of India (SEBI) has made it mandatory for mutual funds to assign a risk level to schemes, based on certain parameters.

Try this PYQ:

Q.Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?

(a) Certificate of Deposit

(b) Commercial Paper

(c) Promissory Note

(d) Participatory Note

What are Mutual Funds?

  • A Mutual Fund is a trust that collects money from a number of investors who share a common investment objective.
  • Then, it invests the money in equities, bonds, money market instruments and/or other securities.
  • Each investor owns units, which represent a portion of the holdings of the fund.
  • The income/gains generated from this collective investment are distributed proportionately amongst the investors after deducting certain expenses, by calculating a scheme’s “Net Asset Value or NAV.
  • It is one of the most viable investment options for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost.
  • All funds carry some level of risk. With mutual funds, one may lose some or all of the money invested because the securities held by a fund can go down in value.

What is the risk-o-meter?

  • All mutual funds shall beginning January 1, assign a risk level to their schemes at the time of launch, based on the scheme’s characteristics.
  • SEBI’s decision on the “risk-o-meter”, characterizes the risk level of the schemes on a six-stage scale from “Low” to “Very High”.
  • The risk-o-meter must be evaluated on a monthly basis.

A compulsory mandate

  • Fund houses are required to disclose the risk-o-meter risk level along with the portfolio disclosure for all their schemes on their own websites as well as the website of the Association of Mutual Funds in India (AMFI) within 10 days of the close of each month.
  • Any change in the risk-o-meter reading with regard to a scheme shall be communicated to the unit-holders of that scheme.

How will the level of risk be assigned?

  • Which one of the six risk levels — low, low to moderate, moderate, moderately high, high, and very high — would apply, would depend upon the risk value (less than 1 for low risk to more than 5 for very high risk) calculated for the scheme.
  • So if the risk value of a scheme is less than 1, its risk level would be low, and if it is more than 5, the risk will be very high on the risk-o-meter.
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