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Reliability of the risk-o-meter

Ashutosh Gupta discusses the relevance of the revised risk-o-meter

How reliable is the risk-o-meter, considering the fact that it failed to catch the risk in the debt funds of Franklin, which are now under winding up?
- Rakesh Prasad

Yes, the previous version of the risk-o-meter was not effective enough to identify the additional risk in the Franklin funds that are now under winding up. That's because that version of the risk-o-meter assigned risk grades at a category level and all funds within that category used to get the same risk grade, irrespective of the underlying differences in their risk profile. Now, typically, if you look at debt funds, most of the debt-fund categories by regulatory mandate have a restriction on either the kind of duration that they can maintain or the kind of credit quality.

So, for instance, if we talk about short-duration funds, the regulations mandate that these funds have to maintain a duration in the band of one to three years, while the credit quality is left to the discretion of fund managers. So, you see that often funds differ significantly in terms of the credit quality of the bonds that they invest in and therefore, their underlying risks differ substantially. The earlier version of the risk-o-meter was not capable of identifying and calling out this kind of nuance. But that has changed with the revised risk-o-meter methodology, which came into force from January this year.

Now, the risk grades are assigned on the basis of the underlying holdings of a fund. We did a detailed study on this. In fact, we published that in our monthly magazine Mutual Fund Insight in February and our study has found that the new risk-o-meter is effective in identifying and highlighting the additional risks in some of the funds in certain categories. In fact, there are a lot of categories where funds straddle across three risk grades and in some categories, the funds are spread across even four different risk grades. So, clearly to that effect, the new version of the risk-o-meter has been much more effective. And I believe had that been in force earlier, sometime last year when the Franklin episode happened, it would have been effective in highlighting those additional risks in the Franklin funds. But now that this new risk-o-meter is available, the onus is on investors to take note of it, monitor it regularly and ask questions to their fund companies if they see the risk in their funds rising. And this information one can easily get on the Value Research's website in the fund listings under the risk stats section.

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