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Decoding the new riskometer

Adhering to SEBI's new product-labelling guidelines, AMCs have started disclosing the new riskometers for their funds. Here's what it means for you

Decoding the new riskometer

Introduced in 2015, riskometer for mutual funds was a simple method to assign risk levels (Low, Low to Moderate, Moderate, Moderately High and High) to funds based on their individual categories. The risk level of each official SEBI category was fixed by SEBI and each fund in that category was simply assigned that risk level automatically. But in that form, the entire method turned out to be not-so-useful, as different funds in the same category actually differed significantly on risks based on their underlying portfolios but they were assigned the same risk level.

Recognising this shortcoming, SEBI came out with fresh guidelines to calculate risk grades in October 2020, and these guidelines came into effect in January 2021. The first set of riskometers based on the revised guidelines is now out. In this article, we have delved into what has changed, how to use it and where you can find its disclosures.

What has changed?
Unlike the earlier fund-category riskometer system, the revised one is a genuine system where the risk grade is based on actual underlying holdings of a fund. The riskometer methodology of equity funds factors in three parameters - market capitalisation, volatility and impact cost (liquidity) to assign risk grades. A risk score is assigned to each of these parameters. For example, a fund investing a higher portion of its assets in mid caps and small caps will earn a higher risk score on the market capitalisation parameter. Similarly, funds whose underlying investments are more volatile and less liquid will attract higher risk scores on those two parameters, respectively. These three risk scores are then aggregated through a simple average to arrive at the fund's overall risk score, which forms the basis of bucketing it into one of the six risk labels (Low, Low to Moderate, Moderate, Moderately High, High and Very High). Likewise, for debt funds, risk factors comprise credit risk, interest-rate risk and liquidity risk.

So, the new methodology captures all the relevant parameters from where potential risk can come in both equity and debt asset classes. And unlike the past, different funds in a category can have different risk grades if their underlying portfolios differ significantly. Earlier, there was no standard and objective measure to compare their risks but the new riskometer attempts to fill that void.

Not only that, since fund houses need to update it every month, one can monitor how the risk grade of a fund changes over a period of time, which will help one get a timely alert about rising risk levels.

Where can you find it?
Fund houses are mandated to disclose the riskometer, along with the portfolio disclosure, for all their schemes on their respective websites and on AMFI website within 10 days from the close of each month.

Users of Value Research Online can get it on the fund page of each scheme (see image: Riskometer). Soon, you will also be able to view the riskometers in our fund listings on the Fund Selector tool under the Risk Stats tab. This will facilitate easy comparison of funds based on these metrics.

Decoding the new riskometer

How useful is it?
In its new avatar, the riskometer ticks some of those right boxes in terms of providing a standard, objective and easy-to-understand way to assess the risk level. It is meant to facilitate a comparison of the risk levels of different funds within the same category, which is particularly needed on the fixed-income side, especially in light of various adverse events in the last couple of years. And importantly, regular updates would ensure that the riskometer of a fund changes, along with the changing complexion of its holdings, to aid the ongoing decision-making.
The impact of new changes in riskometer on investment decision-making will be clearer in the coming time. Early impressions indicate that the underlying methodology may need some tweaks to make it more useful. For instance, we have observed that practically all equity funds, ranging from passive large-cap index funds to sector-focused and small-cap funds, are labelled as 'Very High' on risk under the new methodology. This seems inappropriate and one would expect the riskometer to be able to make some degree of distinction between the risk levels of a fund investing in the Nifty 50 basket as against the one investing only in small caps. Therefore, the regulator may need to fine-tune the approach further so that it is able to achieve its full potential. So, while the upgrades to the riskometer are a step in the right direction, one needs to wait before saying the last word on its utility for investors.