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Does the new risk-o-meter render star ratings redundant?

While the risk-o-meter provides a broad indicator of the riskiness of a fund, VRO's rating system gauges performance on a risk-adjusted scale, says Dhirendra Kumar.

What is your take on the newly announced risk-o-meter mandated by SEBI for mutual funds? Will it make the star ratings provided by Value Research and others redundant?
- Ashok

Risk-o-meter is a pictorial depiction of the risks inherent in a mutual fund. It has now been enhanced. Compared to five levels of risk provided earlier, it will now provide six levels of risk, ranging from Low, Low to Moderate, Moderate, Moderately High, High and Very High Risk. Earlier, risk-o-meter was linked to the category and used to be the same forever. Now, it will get revised periodically based on the characters of the portfolio. So, risk-o-meter is a broad indicator of a fund's riskiness.

However, the rating is a little different. It is a relative gradation of funds in a particular category based on the risk-adjusted performance over a defined time period. So, the objective of the rating is to find out which funds have done better on a risk-adjusted scale in a particular category. Now, risk-o-meter is going to tell you how risky the fund is. The guidelines for the risk-o-meter are quite elaborate. I feel fund companies will now make sure that their funds don't frequently change on the risk-o-meter. This will also modify their behaviour, i.e. the way they will be building their portfolios. So, I don't see any conflict there.

Risk-o-meter is meant for a naive investor. Here, SEBI's objective is to ensure that there should be no mislabelling of a fund. If a fund has a certain kind of risk, then that risk should be clearly stated. On the other hand, the rating is trying to tell you which funds have performed well or poorly relative to others in their respective categories.

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