Colour Coding of MF Products – Risk Identification
Introduction
In the old days, mutual funds used colour codes (Blue, Yellow, Brown) to indicate risk. That system was vague. Today, SEBI mandates a standardized "Riskometer"—a graphical meter that looks like a speedometer— to clearly depict the risk level of every single scheme. This ensures that a 60-year-old doesn't mistakenly buy a high-risk Small Cap fund thinking it is safe.
The Riskometer (6 Levels)
Since January 2021, the Riskometer has 6 distinct levels of risk. It must be displayed on the front page of every Scheme Information Document (SID) and all marketing material.
| Risk Level | Meaning | Typical Fund Category |
|---|---|---|
| Low Risk | Principal is very safe. | Overnight Fund, Liquid Fund |
| Low to Moderate | Slight interest rate risk. | Ultra-Short Duration, Arbitrage Fund |
| Moderate | Moderate fluctuations. | Short Duration Debt, Conservative Hybrid |
| Moderately High | Significant fluctuations possible. | Aggressive Hybrid, Large Cap Equity |
| High | High volatility expected. | Flexi Cap, Mid Cap |
| Very High | Extreme volatility / Capital erosion possible. | Small Cap, Sectoral Fund, Credit Risk Fund |
How is the Riskometer Calculated?
Previously, the risk level was static (assigned by category). Now, it is Dynamic.
- It is calculated monthly based on the actual portfolio held by the fund.
- Parameters evaluated:
- Credit Risk (Quality of bonds).
- Interest Rate Risk (Macaulay Duration).
- Liquidity Risk (How fast assets can be sold).
- Example: If a Liquid Fund (usually Low Risk) suddenly buys risky bonds, its Riskometer will shift to "Moderate" or "High" immediately next month, alerting investors.
Why is Product Labeling Important?
It is part of the "True to Label" philosophy.
- Prevention of Misselling: An agent cannot sell a "Very High Risk" Sector Fund to a pensioner by claiming it is "Safe like a Bank FD." The Riskometer on the brochure will scream "Very High Risk."
- Investor Awareness: It forces the investor to pause and ask, "Am I okay with this level of risk?"
Exam Notes: Writing the Answer
Question: "Explain the concept of Product Labeling in Mutual Funds using the Riskometer." (10 Marks)
Model Answer:
Concept: Product Labeling is a regulatory mandate by SEBI to ensure that the risk level of a mutual fund scheme is visually communicated to the investor in a simple, standardized manner.
The Riskometer: It is a graphical representation depicting 6 levels of risk:
- Low
- Low to Moderate
- Moderate
- Moderately High
- High
- Very High
Dynamic Nature: The risk level is not fixed. It is reviewed monthly based on the fund's portfolio attributes (Credit, Liquidity, and Market Risk). If the portfolio quality deteriorates, the risk needle moves up, alerting existing and new investors.
Summary
- Visual Tool: Speedometer design.
- 6 Levels: Covering the spectrum from Overnight Funds to Small Cap Funds.
- Dynamic: Updates monthly based on actual portfolio handling.
- Mandatory: Must be shown in all advertisements.
Quiz Time! 🎯
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