Is the SEBIs new Riskometer regulation more investor friendly?

In October 2020, market regulator Securities Exchange Board of India (SEBI) issued a circular detailing a new set of regulations for mutual funds’ investments. Aimed at making mutual funds schemes transparent and more investor friendly, the rules include the new mutual fund Riskometer, changes in Net Asset Value (NAV) calculation, new portfolio allocation rules for multi cap equity mutual funds and changes in the labelling rules of dividend option. After the Franklin Templeton debt scheme fiasco- where the company shut down six of its debt funds suddenly, halting redemptions and creating panic among debt fund investors – the SEBI issued new directions to make debt funds safer. The new SEBI regulations will come into effect from January 1, 2021, thus allowing a sufficient compliance time. Here is a look at SEBI’s new riskometer rules.

History of SEBI’s Riskometer:

Initially, SEBI had provided for color-based code to indicate the risk category of mutual funds. It used three colors: blue yellow and brown to denote low, medium and high category of risks respectively. In July, 2015 the market regulator introduced a new picture-based depiction, which was called Riskometer. The pictorial depiction of risk encompassed five levels: low, low to moderate, moderate, moderately high and high. SEBI fixed the risk level of mutual funds and categorized them accordingly.

Difference between the old and new riskometer rules:

In its circular, SEBI has provided for a detailed procedure through various benchmarks to assess the risk category, besides introducing a scoring system. A key difference is the introduction of a new risk category: ‘Very High.’ In other words, the 5-level riskometer has now been made a 6-level risk assessment tool. The market regulator has also stipulated a wide array of other rules such as:

• The risk level will be recalculated each month based on the fund’s actual portfolio.

• Along with evaluation on a monthly basis, the mutual funds and Asset Management Companies (AMCs) will have to provide the details pertaining to the riskometer along with portfolio disclosure of all mutual funds schemes on their own web portal as well as the website of Association of Mutual Funds in India. This has to be done within 10 days of the previous month’s closure.

• Fund houses have to provide the risk level of various mutual fund schemes on March 31 every financial year. Alongside, fund houses have been categorically asked to furnish details about the changes in riskometer throughout the financial year.

• If there is any change in the riskometer of a particular mutual fund scheme, it has to be communicated to the investors via SMS or email.

What are the benchmarks to determine the riskometer for different mutual fund schemes?

SEBI has detailed various parameters for various categories of mutual fund schemes, including debt mutual funds, equity mutual funds and others.

Additional Read: Investing in different asset classes based on their risk

New riskometer rules for equity mutual fund schemes:

As per the new rules, the risk assessment for equity mutual funds will be calculated based on three key factors: market capitalization, volatility and impact cost or liquidity measure. AMFI’s market capitalization data – published on a half-yearly basis- will be used for evaluating large cap, mid cap and small cap schemes, while the daily volatility of the security prices vis-a-vis the previous two years’ security price will be used for measuring volatility. The impact cost involves measuring the average impact cost of a particular security for the last three months. The risk value will be the simple average of all the three factors.

Additional Read: With the new SEBI rules, are Multi-cap funds worth the risk?

New riskometer rules for debt mutual fund schemes:

The debt funds will be assessed for risk based on calculating the simple average of:

1. Credit risk: The new guidelines have provided for credit risk ranging from 1 (least risk) to 12 (below investment grade).
2. Interest rate risk: As per the new rules, interest rate risk will range from 1 to 6.
3. Liquidity risk: A 14-point scale has been provided after evaluating different variables such as structure of debt instruments, listing, credit, status and so on.

New riskometer rules for other funds:

SEBI has also provided detailed guidelines about risk assessment of other types of funds, including equity derivatives, stock and index futures, index and stock options, Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs), Gold Exchange Traded Funds (Gold-ETFs), foreign securities and so on.

Are the new riskometer rules more investor friendly?

If one wants to opt for mutual fund investments, then it can be safely said that the new riskometer rules have ushered in positive changes. Now, investors can remain vigilant and well-informed about the risk level of their fund portfolios. Fund houses and AMCs have to compulsorily disclose the risk levels each month, besides detailing the entire history of riskometer changes in a given financial year. This, in turn, means that there is no room for fudging and miscommunication of financial facts. The new rules will prevent attempts from fund distributors to sell mutual fund schemes, solely based on returns. One must always remember that a well-informed investor is susceptible to lower market risks.

Conclusion:

Thus, the new riskometer rules have provided for investor friendly mutual funds. One must, however, remember that merely analyzing the riskometer will not provide you the complete picture. You must also have a proper understanding of the various aspects of mutual fund investments, besides having a sound investment strategy. Alongside, you must choose a trusted and reliable fund house/AMC.