The markets regulator, Securities and Exchange Board of India (Sebi), recently introduced fresh guidelines to determine the place of a mutual fund (MF) on its riskometer tool.
Samie Modak explains the upgraded risk profile depiction system.
What is riskometer?
In 2013, Sebi introduced the concept of ‘product labelling’ for the MF industry.
The move was aimed at helping investors decipher the inherent risk in a scheme through easy-to-understand pictorial depiction.
In the first avatar, the labelling system used three colours - blue (to denote low-risk), yellow (medium risk), and brown (high risk).
In 2015, Sebi tweaked the system, replacing the colour coding system with a graphic called 'riskometer'.
Five years later, the regulator has further improved the system.
The new riskometer will have six levels, up from five.
The labels now range from ‘low’ to ‘very high risk’.
What's the important change in the new riskometer?
Perhaps, the most important change is that the earlier system used to assign a label to the scheme category.
Going ahead, the label will be given to individual schemes.
This mean, two schemes falling in the same category, such as large-cap equity, can have different labels.
The final riskometer reading will be based on the average ‘risk value’ - a reading between 1 and 12, based on various factors.
What will be the key factors to determine riskiness of equity schemes?
Broadly, there will be three factors - market capitalisation, volatility, and impact cost.
Stocks in the large-cap category will have a lower risk value of 5, while those in mid-cap will have 7, and small-cap will have 9.
Similarly, lower volatility and impact cost will mean lower risk value of, say, 5; higher read will mean risk value of 9.
The weighted average of these values will help arrive at the final riskometer reading.
Based on the formula prescribed by Sebi, most equity schemes are likely to fall either in the ‘high risk’ or ‘very high risk’ category.
Under the earlier system, large-cap or equity ETFs fell in the ‘moderately high’ risk profile.
What will be the key factors to determine the riskiness of debt schemes?
The key parameters identified by Sebi that determine the riskiness of debt schemes are credit risk, interest rate risk, and liquidity risk. Under credit risk, government securities have been assigned the lowest risk value of 1; below-investment-grade papers will have the highest risk value of 12.
The interest rate risk will be determined by the duration of the portfolio.
Papers with less than six months of maturity will have the lowest risk value of 1 and as the duration increases, the risk value will increase to a maximum of 6.
For measuring the liquidity risk to schemes, listing status, credit rating, and structure of debt instruments have to be considered.
Sebi has provided a detailed table to assign the risk value based on the liquidity profile.
Irrespective of the debt scheme category, all these parameters will be applied.
The risk value will help determine the final riskometer reading.
What about other asset classes?
Sebi has assigned a relatively low-risk value for gold at 4.
Real estate investment trusts (REITs) or infrastructure investment trusts (InvITs), and investment in foreign securities will have a risk value of 7 - similar to mid-caps.
Cash or net current assets will have the lowest risk value of 1.
Investment in equity derivatives for hedging purposes will not have any risk value.
Excessive investments in derivatives will have a risk value of 5 or 6.
How often will a fund house have to review the labels?
The Sebi circular says the riskometer will have to be evaluated on a monthly basis.
Fund houses will have to label all their schemes within 10 days from the close of each month, along with portfolio disclosure.
Also, any change in the riskometer will have to be communicated to unitholders via SMS or e-mail.
Further, MFs will have to disclose the risk level of schemes at the end of every financial year, along with the number of times the risk level has changed during the course of the year.
This new system will come into force from January 1, 2021.