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Are mutual fund colour code labels a true indicator of risk?


 

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SEBI has initiated the system of colour coding/ product labeling for mutual fund schemes, wherein the mutual fund application forms, brochures and all advertisements in newspapers and magazines will have a product label of a specific colour to indicate the level of risk associated with the investment. This came into effect from 1 July 2013 and will help investors understand the risk profile of the fund before considering investing.  The MFs have been divided in to three broad categories and assigned specific colours-

The blue colour label indicates low risk – liquid funds, fixed maturity plans, income funds and gilt funds will display this code.

The yellow colour label means medium risk – balanced funds, monthly income plans would have a yellow label.

The brown colour label indicates high risk- All the equity mutual funds-diversified, sector, index would carry this label.

This move will surely help curb mis selling of mutual funds by agents and at a preliminary level help the investor understand what category of risk a particular scheme falls into, give the highly misleading names of some of the mutual fund schemes. For example, HDFC multiple yield fund and Birla sun life dividend yield plus- The former is an MIP with medium risk hence has a yellow label; while the latter is an equity fund with high risk and hence has a brown label. Similarly, Birla short term opportunities fund and  HSBC India opportunities fund may sound similar but have completely different risk profiles- while the former is a pure short term debt fund with a blue label, the latter is an equity fund with high risk and displays a brown colour product label.

But, as stated earlier, these codes only work at the preliminary level. It is important to know that even   schemes listed under the same risk category/product label significantly differ from each other with regard to the investment objective, risk and volatility. The product label coloured blue has very low risk, low return schemes like cash funds and liquid funds suited for parking funds temporarily for less than a year and also funds like gilt funds which are highly volatile and carry a high interest rate risk and in the past have given negative returns during rising interest rate scenarios. The medium risk blue coded hybrid schemes too vary from a 10 % equity, 90 % debt  to a 70 % equity , 30 % debt composition. Similarly, the high risk schemes consist of the passive index funds to the highly aggressive equity funds to the high risk sector funds.

In addition to this, ‘risk’ is a relative term whose definition depends on the investor’s age and overall profile. For a 25 year old or 30 year old investor earning a stable decent salary, investing in equities with a long term perspective cannot be considered high risk, while it certainly will, if the investor is 55 or 60 years old, retired or on the verge of retirement. On the contrary, for a 30 year old, not investing in equities is a higher risk – risk that his savings will not grow enough to even beat the combined effect of inflation plus taxes!

So, use these codes for reference, but also do your own research or seek advice from a certified financial planner before deciding to invest.

 

 

 

 

 

 

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