How to read the Mutual Fund Riskometer?

Don't you hate it when your favourite skincare brand is not transparent about its ingredients? Or when food brands print the real deal in tiny fonts to confuse customers? Understanding where you spend your money and how your spending impacts your life is a fundamental right you ought to have. This is why the Securities and Exchange Board of India (SEBI) has mandated Asset Management Companies (AMCs) to indicate mutual funds risk next to their offerings. This allows you to understand how mutual funds work and the volatility and uncertainty you could be exposing your money to when you pick a scheme. 

Let's find out more. 

What is a mutual funds risk-o-meter?

All mutual funds are subject to market risk. But this risk can vary from very high to low. The mutual funds risk-o-meter is a scale that indicates the six levels of risk associated with a particular mutual fund scheme. The risk-o-meter is evaluated every month to complement the dynamic stock market. The results are shared with investors with the portfolio disclosure on the AMC's website 10 days before the end of the month.

AMCs are required to share the new mutual funds risk evaluation with the Association of Mutual Funds in India (AMFI) every month. 

How does the mutual funds risk-o-meter work?

The mutual funds risk-o-meter lets you decide if the said fund is suitable for your risk appetite or not. Here's how you can read it:

1. Low risk: Such a fund will offer low risk and returns but high safety of capital.
2. Moderately low risk: Such a fund carries more risk and has better potential returns.
3. Moderate risk: These funds present medium risk and offer average returns.
4. Moderately high risk: The risk involved is slightly higher than the previous category, and so are the potential returns.
5. High risk: High-risk funds are volatile and can entail high risks. They can also offer a high potential for returns.
6. Very high-risk: This is the highest level of risk with the highest potential for returns. However, there is minimal safety of capital.

There were previously only five mutual funds risk levels as assigned by SEBI. This has now changed to six. So, there is a better explanation of what is in store for you.   

Calculating mutual funds risk on the risk-o-meter

The mutual fund risk-o-meter takes into account multiple factors. The meter also understands the differences between equity vs debt funds and focuses on unique aspects of each type of fund.

So, suppose you are considering a long term investment in an equity fund. In that case, the meter will analyse risk based on the market capitalisation, volatility and impact cost. Impact cost is the cost incurred due to the liquidity conditions in the market while executing a transaction for a predefined order size. For example, the if the average sale price of 3000 shares is Rs. 5.5 and the ideal price is Rs. 6, then the impact cost in this case will be 8.33% (6-5.5/6*100).

If you are looking at a debt fund, the risk-o-meter will bear in mind the liquidity, credit, and interest rate risk. For debt funds, there’s also something known as the Potential Risk Class Matrix. It can help you know the maximum credit and interest rate risk a fund manager can take. This, in turn, can help you make an informed decision.

To sum it up

The risk-o-meter is a more nuanced assessment of mutual funds risk. For example, before the meter was launched, all large cap mutual funds were categorised under the same risk level. This may not be the case now. It is also an excellent tool to use if you are just beginning investing or wish to have a diversified portfolio. And most importantly, it institutes complete transparency between you and the mutual fund house, so you know what to expect.  

An investor education initiative by Edelweiss Mutual Fund

All Mutual Fund Investors have to go through a onetime KYC process. Investor should deal only with Registered Mutual Fund (RMF). For more info on KYC, RMF and procedure to lodge/redress any complaints, visit -https://www.edelweissmf.com/kyc-norms

Mutual Fund Investments are subject to market risks, read all scheme related documents carefully.