An investor need to invest in various types of investment
avenues based on their risk appetite and profile. The profiling of an investor
can be prepared based on several factors like age, size of the family, ages of
the dependents, medical / hospital requirements, future requirements like
education, retirement etc. An investment advisor can help in creating such a
profile and help in choosing the possible investment avenues. However, this may
not be the case always in India. Most of the investors generally invest based
on the word of mouth, recommendations from Friends, news paper reports and the
expert advice in media. Under such circumstances, it may not be possible for
the investor to know the risk level of a particular investment to match the
same to his / her risk appetite and take an appropriate decision. To mitigate
this factor to some extent, SEBI has directed the Mutual Funds to be colour
coded based on the risk level of the fund.
This colour coding will be compulsory for new as well as existing
schemes.
The colour code has to be mentioned by the side of the name of the
scheme in the application form and advertisements along with a one line
explanation of the objective of the scheme, nature of the scheme, types of targeted
investments and the likely investment levels. A typical one liner may look like
“This product is
suitable for investors who are seeking: safety of the capital and regular
income; investment in money market and gilt edged securities, invests in xxx
rated securities and T-Bills / Bonds; low risk” with a Blue Colur box to be
displayed by the side of the scheme name. As per the guidelines, mutual
funds would also have to include a disclaimer that “investors should consult
their financial advisers if they are not clear about the suitability of the
product”.
The risk levels and colour codes prescribed by SEBI are as
follows
Blue
The blue colour coded box will indicate low risk. Instruments such
as fixed maturity plans, gilt funds and income funds will carry a blue colour
code as these are the safest MF instruments. These instruments are ideal for for
a fixed and safe source of income.
Yellow
The yellow colour coded box will indicate medium risk. All hybrid
products such as monthly income plans (MIPs), balanced funds and unit-linked
insurance plans which typically invest in both equity and debt products will be
given a yellow colour. These instruments are ideal for those who seek
diversification between debt and equity; a possible reduction in risk without a
substantial reduction in the returns.
Brown
The brown colour coded box indicates a high-risk instrument. All
equity funds such as diversified funds, sectoral funds, index funds, large-cap
funds and small-cap funds will carry a brown colour code as these have a
significant risk component and are prone to market fluctuations. The possible returns
from these type of investments could be high with an equal likelihood and
higher losses. At the same time, the
brown colour serves as a warning to anyone who is risk averse.
Colour coding serves the purpose of providing a basic indication
of the possible risk levels of a scheme. However this should not be taken to be
a panacea and a replacement for the investment advice. There are several
aspects of MF investing that cannot be communicated through colours. Due to the
very nature of the available investment options it will be difficult to capture
all the nuances of each scheme’s risk profile. Operational issues like Black
and White printouts of downloaded forms can create a major bottle neck.
Many investors may not be in a position to distinguish between
various classes of mutual funds in the same category. Take the case of Liquid
Funds and Gilt Funds both are rated low risk and will be colour coded Blue.
However the associated risks with these two classes of schemes are different. Also,
both index funds and small-cap funds have a brown colour code; while an index
fund has the least risk among equity funds and a small-cap fund carries the
highest risk. Similarly, in the case of an MIP and a balanced fund, both are
coloured yellow to symbolize medium risk. However, typically Monthly Income Plan has only 5-10%
of its corpus in equity, while a balanced fund can invest 65% of its corpus
into equity instruments. Due to the very nature of the investment options,
colour coding will not be able to capture all the nuances around risk for each
scheme.
All said and done, colour coding should not be completely depended
on for taking a proper investment decision. The investment should be based on
other major factors nature and objective of the scheme and incase of an
existing scheme the track record and current investments and their performance
in the scheme. Overall, the investors
are likely to benefit from this initiative of SEBI as this can reduce instances
of blatant mis-selling of Mutual Fund schemes by distributors as investors will
be more aware of the risks involved.
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