From 2021 onwards, the new mutual fund risk-o-meter will have six levels of risks for mutual funds based on the credit score of the portfolio at the end of each month – low risk, low-to-moderate risk, moderate risk, moderate-to-high risk, high risk and very high risk

Furthermore, the risk-o-meter places all equity-based schemes in the category of either high or very high (on the basis of the lowest scores provided to any equity instrument). This makes it difficult for investors to assess and compare the level of risk for different equity-oriented schemes in the same category on the basis of product labels. Digging deeper into the approach, we find that it is expensive and laborious for mutual funds to source the data required for calculating the risk scores for their portfolio, as many data points used in the same are not available in the public domain.

The risk-o-meter also provides a standard approach to risk management for all types of portfolios irrespective of the investment strategy or risk management approach of different fund managers. Further, it fails to address the change in risk on the basis of a changing macro environment, which goes against the concept of dynamic risk management.

Although a step in the right direction, we believe that we are still far from reaching a standardised approach that can help us assess the risk of all types of portfolios in the industry. Each fund house and each fund manager have a different approach when it comes to managing a portfolio. A standardised approach like this may prove to be counterproductive in cases where fund managers rely on more detailed and complicated models of dynamic risk management.

Given these limitations, the new guidelines fail to achieve the primary objective of helping investors make informed decisions. In fact, they may create more confusion by complicating the risk assessment process without achieving the end result. Thus, we do not believe that investors can solely rely on the risk score of the new risk-o-meter. They still need to understand and evaluate various other risk parameters to compare and pick the right fund which suits their risk appetite.