SEBI Riskometer

Mint today reported that SEBI has ordered Mutual Funds to classify their schemes in five categories in terms of their risk levels – the risk being of Principal loss. (Link). Currently Mutual Funds follow a Color coding model based on 3 parameters – nature of scheme, investment objective and level of risk, denoted by 3 different colours.

The new scheme while on the face of it seems to have evoked humor among twitter friends, I believe that while the intention of SEBI is good, like  in many cases, this is only the first step with a lot more ground to cover if it really wants to see higher participation in mutual funds by the investing public.

While Mutual funds do not carry as much of a risk as direct investment in equities, there is still a risk of capital loss on the short to medium term and that risk has meant that investors prefer to invest their savings in other asset classes like Gold and Land other than the good old fixed deposit.

Also, when we look at returns from Mutual funds, we tend to ignore the fact that the funds we are seeing are the survivors (Survivor Bias). For some one who invested in say CRB Mutual Funds, the investment was as good as lost and it was only after 20 years they saw closure and the return of a part of their capital that was invested.

Its interesting that just yesterday we launched our own Risk-o-meter by way of analysing how much of one’s savings should be devoted to Equity and how much to debt. (Link). Risk of capital loss exists all the time though it differs from time to time.

A fund that is low risk is very much likely to have a very small allocation to equities while one with exposure to markets will need to be categorised as high risk. All the in-between in a way have no meaning since even balanced funds can take quite a hit when markets tumble as they did in 2008.

Our Asset Allocation model on the other hand is dynamic with monthly resets which ensure that when the markets are at what we consider as the peak, the exposure to markets is lowest and vice-versa. A static model on the other hand and is bound to fail since it looks at risk as one-dimensional (Equities = Risk, Bonds = Safe).

Having said that, if we are unable to educate the investors about the basic concepts of markets and money, no amount of color coding or charts will make him change his mind as to what asset class he prefers investing into.