Understanding the new risk-o-meter for mutual funds

The market regulator, Securities and Exchange Board of India (SEBI), has launched a new risk-o-meter for mutual funds. Funds houses will have to carry it in their key fund related documents, and in their advertisements from January 1, 2021.

- Sudipta Mitu

What’s new about it

A risk-o-meter for mutual funds existed earlier also, but it was not widely used by investors or their advisors. This was chiefly because asset management companies enjoyed discretion in deciding a fund’s risk level. It was decided mostly on the basis of the category to which the fund belonged.

Now, Sebi has provided a clear formula based on which a fund’s risk level will be determined. In the case of debt funds, for instance, it will be based on the credit risk, interest-rate risk and liquidity risk present in a fund’s portfolio. The final score will be the average of all the three types of risks after which the fund will get categorised into one of the six risk levels. In the case of equity funds, fund houses will have to use the following three criteria: market capitalisation, volatility, and impact cost.

Thus, the methodology for determining a fund’s risk level has been completely standardised. Nothing has been left to the discretion of fund houses for determining a fund’s risk grade, which will depend on its portfolio constituents, rather than the category to which it belongs.

Another difference between the new risk-o-meter and the old one is that the former has six levels of risk whereas the latter had only five levels. Now a risk level called ‘very high’ has been introduced, whereas the earlier one only went up to ‘high’.

What is good about it