not all mutual funds carry the same level of risk. two funds in the same category can have completely different risk profiles . the difference comes down to what the fund holds, how it is managed, and how sensitive it is to market movements.
the riskometer is a visual tool introduced by sebi to help investors compare risk levels across funds . it ranges from low to very high, with colour coding from green to dark red . but the riskometer is only the starting point.
asset allocation. the biggest factor
what the fund invests in determines most of its risk.
equity funds. these carry the highest risk. they invest in stocks, which are volatile by nature. small-cap and mid-cap funds are riskier than large-cap funds because smaller companies are more sensitive to economic downturns . sectoral and thematic funds are even riskier because they are concentrated in one area .
debt funds. these carry lower risk but are not risk-free. they invest in bonds and other fixed-income instruments. the risk comes from interest rate changes and the creditworthiness of the issuer . longer-duration debt funds are more sensitive to interest rate changes than shorter-duration ones .
hybrid funds. these sit between equity and debt. the risk depends on the equity-debt mix. a fund with 70% equity is riskier than one with 30% equity .
the riskometer. six levels of risk
sebi categorises mutual funds into six risk levels :
| risk level | typical funds | colour code |
|---|---|---|
| low | overnight funds, liquid funds | dark green |
| low to moderate | ultra-short duration funds, money market funds | light green |
| moderate | corporate bond funds, banking and psu funds | yellow |
| moderately high | equity savings funds, credit risk funds | orange |
| high | sectoral funds, international funds | red |
| very high | small-cap funds, mid-cap funds | dark red |
two funds in the same category can have different riskometer ratings. for example, two gilt funds can have different risk levels because of differences in portfolio composition . one may hold more cash, reducing its risk.
concentration risk. putting all eggs in one basket
a fund that holds a few stocks or is heavily weighted in one sector carries higher risk. if that sector underperforms, the entire fund suffers.
multi-asset allocation funds show this clearly. of 34 such funds, only one was rated low risk. five were rated high risk. the remaining 28 were rated very high risk . the difference came from portfolio mix. the low-risk fund had 60% in debt and 48% in cash. the very high-risk funds had much higher equity exposure .
credit risk in debt funds
debt funds face credit risk. this is the risk that the bond issuer defaults on interest or principal payments . funds that invest in lower-rated bonds offer higher returns but carry higher credit risk. funds that stick to aaa-rated bonds are safer .
interest rate risk. the bond price equation
bond prices move inversely to interest rates. when rates rise, bond prices fall. debt funds with longer duration are more sensitive to rate changes . short-duration debt funds are less affected.
liquidity risk. getting stuck in a fund
liquidity risk is the difficulty of redeeming units without affecting the price. closed-ended funds and funds that invest in illiquid securities carry higher liquidity risk . during market stress, this risk becomes more apparent.
what to check beyond returns
returns are not the whole picture . two funds with the same returns can have very different risk levels.
standard deviation. measures how much the fund’s returns have varied from the average. higher standard deviation means higher volatility .
beta. measures how much the fund moves relative to the market. above one means more volatile than the market. below one means less volatile .
sharpe ratio. measures the return per unit of risk. higher means better risk-adjusted returns .
frequently asked questions
1. which mutual fund category carries the highest risk ?
small-cap and mid-cap funds carry the highest risk. sectoral and thematic funds also carry high risk because they are concentrated in one area.
2. are debt funds completely safe ?
no. debt funds carry credit risk and interest rate risk. the risk is lower than equity funds but it is not zero.
3. what is the riskometer in mutual funds ?
the riskometer is a sebi-mandated visual tool that shows a fund’s risk level from low to very high. it is based on the fund’s portfolio composition, credit quality, and interest rate sensitivity.
4. can two funds in the same category have different risk levels ?
yes. portfolio composition varies within the same category. one fund may hold more cash or higher-rated securities, reducing its risk.
5. how should investors use the riskometer ?
the riskometer helps match the fund’s risk level with the investor’s risk tolerance. investors should check the riskometer before investing.
