Spotting risk in a mutual fund is vital for investors to know what they are getting into. Although equity investments are risky by nature, investors are supposed to evaluate the size of risk these schemes carry.
And when they are apprised of the quantum of risk, it can be referred to as ‘conscious’ or ‘calculated’ risk.
So, to be able to take a calculated risk, it is important for mutual fund investors to first go through the risk indicators revealed in the factsheet before they take a plunge.
Although there are a number of risk indicators that are shared by fund houses in their schemes’ factsheet, the most elementary thing to look for is the riskometer.
Before we proceed, let us first understand what exactly is a risk-o-meter.
What is a risk-o-meter?
It is mandatory requirement put in place by SEBI and represents the underlying risk associated with the fund. It a graphical representation of the risk a mutual fund carries. It derives its name from ‘speedometer’ of a vehicle.
The risk-o-meter divides risks into six levels. These include low, low to moderate, moderate, moderately high, high and very high depending on the level of risk in their portfolio.
Spotting risk in a mutual fund is vital for investors to know what they are getting into. Although equity investments are risky by nature, investors are supposed to evaluate the size of risk these schemes carry.
And when they are apprised of the quantum of risk, it can be referred to as ‘conscious’ or ‘calculated’ risk.
So, to be able to take a calculated risk, it is important for mutual fund investors to first go through the risk indicators revealed in the factsheet before they take a plunge.
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Although there are a number of risk indicators that are shared by fund houses in their schemes’ factsheet, the most elementary thing to look for is the riskometer.
Before we proceed, let us first understand what exactly is a risk-o-meter.
What is a risk-o-meter?
It is mandatory requirement put in place by SEBI and represents the underlying risk associated with the fund. It a graphical representation of the risk a mutual fund carries. It derives its name from ‘speedometer’ of a vehicle.
The risk-o-meter divides risks into six levels. These include low, low to moderate, moderate, moderately high, high and very high depending on the level of risk in their portfolio.
All mutual fund schemes are meant to categorize similar kinds of funds into the same risk category.
Metaphorically speaking, higher the speed of the vehicle, higher the risk of an accident. Similarly — higher the risk of a mutual fund, riskier the investment
What are the other risk categories?
Since the riskometer only gives a sketchy view of the size of risk, one can also go through more specific risk indicators by looking at different risk ratios. Some of the key ratios include:
Standard Deviation: It shows how much the return from your mutual fund portfolio is deviating from the expected return, based on the fund’s historical performance
It measures the range of a fund’s return. When a mutual fund scheme has a higher standard deviation of return, it means its range of performance is wide, and has a greater volatility.
Beta: This measures a fund’s volatility with regards to the market. When Beta is greater than one, it means the fund scheme will be more volatile than the market.
On the contrary, less than one of beta means it’ll be less volatile than the market. And beta of one indicates the scheme will move in alignment with market volatility.
Sharpe Ratio: This measures the excess return provided by the fund per unit of risk undertaken. It is seen as a fair indicator of risk-adjusted return of mutual fund scheme.
So, the next time you are set to invest into a mutual fund, make sure to first evaluate the scope of risk in the scheme based on these parameters.
