Last Updated on December 29, 2021 at 6:17 pm
On June 7th 2021, SEBI introduced a “potential Risk Class Matrix for debt schemes based on Interest Rate Risk and Credit Risk” In this article, we explain what it is and discuss if it helps investors. The new rule comes into effect from 1st Dec 2021 but can be implemented immediately by fund houses if they desire.
We had earlier reported how the new mutual fund risk-o-meter is dynamic in nature: From Jan 2021, SEBI allows mutual fund risk to change each month like expense ratio! According to the June 2021 circular, the risk-o-meter will define the current risk level of the scheme and the newly introduced “potential risk class matrix” will represent the maximum interest rate risk and maximum credit risk a debt fund can take.
Hence we shall refer to this as the debt mutual fund maximum risk matrix. This shall set the bounds within which the risk-o-meter can vary. The matrix will like this to investors.
This refers to a fund with maximum risk levels of C-II. That is high credit risk (class C) and moderate interest rate risk (class II). If the fund revises its strategy such that it falls into a higher risk class, it will be considered a change in the fundamental attribute of the fund.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email! 🔥Enjoy massive discounts on our robo-advisory tool & courses! 🔥
The fund shall be allowed to make the change only after providing advance intimation to the unitholders and offer then a one month window to exit the scheme before the change is effected free from exit load.
For example, a shift from C-II to C-III in the matrix will be considered a change in fundamental attribute, while a change from C-II to B-II will not. Once the initial risk level is set, the scheme is free to lower the risk without informing unitholders.
This logic is a bit baffling. SEBI seems to be ok with unitholders suddenly seeing lower risk (and possibly lower reward) in the scheme and not vice-versa. Why not make both ways a change in fundamental attribute? That is only fair to those who wish to take on more risk.
Interest rate risk thresholds
1. Class I: MD<= 1 year (all bonds in the scheme should mature within 3Y);
2. Class II: MD<=3 years (all bonds in the scheme should mature within 7Y);
3. Class III: Any Macaulay duration (MD); <= New investments in perpetual bonds (e.g. AT1 bonds) can be made only by these schemes.
Classes I and II are reasonably confined, but III is too vague. The Macaulay duration will be the weighted average value based on the AUM allocation to different bond durations. Therefore investors should not go by the I, II or III classification. A scheme can take exposure to 20-25% of long-duration bonds, making the NAV more volatile and susceptible to shart drops or gains. To understand more about Macaulay Duration, please consult, Why you need to worry about duration if your mutual funds invest in bonds.
For a scheme placing itself in Class I (i.e. MD <=1 year), the maximum residual
maturity of each instrument held by the scheme shall be three years. For a scheme
placing itself in Class II (i.e. MD <=3 years), the maximum residual maturity of each
instrument held by the scheme shall be seven years. A scheme placing itself in
Class III can invest in instruments of any maturity.
Credit risk thresholds
This threshold shall be evaluated with a “credit risk value” or CRV.
1. Class A: CRV >=12
2. Class B: CRV >=10
3. Class C: CRV <10
The credit risk value for different bond ratings is given below. The overall CRV of the portfolio will depend on the weights of each bond.
- G-Sec/ State development loans/ Repo on Government Securities/TREPS / Cash 13
- AAA 12
- AA+ 11
- AA 10
- AA- 9
- A+ 8
- A 7
- A- 6
- BBB+ 5
- BBB 4
- BBB- 3
- Unrated 2
- Below investment grade 1
Thus higher the CRV of the portfolio, the better the credit quality. However, because both interest and credit rate thresholds are based on a weighted average, the investor cannot rest easy.
Consider a debt fund with a portfolio CRV of 12. So it would fall under class A. A naive investor might assume the credit quality in the portfolio is “good”. This need not be true.
A portfolio with 80% of govt bonds and cash and 20% of AA- bonds will also have a CRV of 12. That 20% has considerable credit risk. Therfore it is crucial that debt fund investors look carefully into the portfolio history and not just go by the current risk the fund can take (risk-o-meter) or the maximum risk the fund can take (the above risk matrix).
Is the maximum risk matrix for debt mutual funds useful? It is certainly a step in the right direction. It will help uninitiated investors appreciate that that risk in debt mutual funds can be classified into two: interest rate or duration risk and credit risk and provide a ball-park estimate of a debt funds risk positioning is.
It serves as a debt mutual fund 101 but is not enough to commit money in a fund. Because the matrix is based on weighted averages, investors must still carefully inspect the portfolio contents to fully appreciate where their money is being invested.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1,000 investors and advisors use this!
New Tool! => Track your mutual funds and stock investments with this Google Sheet!
We also publish monthly equity mutual funds, debt and hybrid mutual funds, index funds and ETF screeners and momentum, low-volatility stock screeners.
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter using the form below.
- Hit 'reply' to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Join over 32,000 readers and get free money management solutions delivered to your inbox! Subscribe to get posts via email!
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu Gets a Superpower!” is now available!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. - Arun.Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Do you want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or get the Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low-volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish paid articles, promotions, PR, satire or opinions without data. All opinions will be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our YouTube Videos
- Posts feed via Feedburner.
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.Your Ultimate Guide to Travel
This is an in-depth dive into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)