Are you aware of these invisible mutual fund risks?

Published: October 24, 2020 at 11:12 am

Last Updated on October 24, 2020 at 11:12 am

The “mutualfundsahihai” ads are into their second innings and this time around, the young earners who dreamt of big returns appreciate that big risk comes first! So much so that AMFI now includes a line “MFs are for those who wish to understand risks” (and hopefully don’t*). There is more to mutual fund risk than the NAV going up and down each business day. These are some invisible risks that can affect your investments.

* First-time investors will never buy MFs if they knew about risks vote 78% netizens! This poll was conducted in Nov 2019, months before the crash when investors thought all they had to do was to invest each and the returns will automatically “come”. Mutual funds (or any product/service for that matter) can only be sold if investors do not stop to learn about all the risks.

Invisible risk here refers to factors that investors typically do not pay attention to or take seriously. They are visible but we choose to ignore them as we are busy with a covenient truth All these risk factors (and more) are clearly included in the scheme information document that no one reads, which makes it our first entry. This list is a mixed bad: behavioural risk, technical risk, entity risk etc.

1:  Just give me returns risk: I will not reach scheme documents, I will do not do any kind of analysis, I will not invest with specific needs in mind. I will get on Google and ask, “which are the best mutual funds for 2021?”

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2:  Enticement risk: Mutual funds talk about special strategies and technologies to pick stocks and bonds in their portfolio. If you look carefully, many or at times none of these fancy statements would be present in the scheme document (the only legally binding entity)

3: Credit risk: You might think, nothing new, everyone now knows about these after so many defaults. Not so fast. To this day, you will find investors choosing debt mutual funds by their star rating; To this day you will find investors believing a portfolio with only A1+ or AAA rates bonds has no credit risk; banking and PSU bond funds are “safe” from credit risk;

4: Mass redemption risk: When unitholders collectively lose faith in the portfolio, the fund manager will have a tough time selling securities. The Franklin Fiasco was not triggered by credit risk but by the fear of credit risk. Not quite the same. In hindsight, imagine what would have happened if FT had temporarily closed the fund with SEBI’s special permission; Imagine what would have happened if SEBI had ordered the immediate shut down of the funds without the vote? If there was no litigation? Investors would have had access to a reasonable chunk of their money by now. Perhaps mistaking one risk (collective loss of faith) for the other (credit quality) is a risk in of itself! What happened to a debt fund can also happen to an equity fund.

5: Safety risk(!!):  When an investor seeks a “safe option” it almost always means they have not considered all angles. Those choosing gilt mutual funds because the govt will never default fail to appreciate that the market value of GOI fluctuates day to day and can result in big losses.

6: Reinvestment risk Perhaps a type of “safety risk”. Investors who want to avoid both credit risk and market risk (as in no 5), prefer liquid funds and money market funds. Is there no risk here? Of course, there is: Invest in these for years then as interest rates gradually head lower, gains from these funds will also decrease. There is always a price to pay: sometime you see it day to day and sometimes you have to look real close.

7: Concentration risk: The active or passive fund we invest in is partial to a sector or one/two stocks. The new government is ahem less favourable to the topmost stock or they lost an antitrust lawsuit.

8: Expense ratio risk: We have seen several instances of mutual funds tactically lowering TER to invite AUM only to jack it up or at specific months in a financial year. See: Why SEBI should stop frequent mutual fund expense ratio changes

9: Riskometer risk(!!) Bizarre as it sounds, SEBI allows mutual fund risk to change each month like expense ratio!

Perhaps the regulator is as much a risk to investors as fund houses, banks, sales guys and the market. This is because “protecting the interest of investors” is not their only mandate 🙁

10: Resource risk: Be it advisors (registered or otherwise), sales guys, influencers, websites like this, media, YouTube channels etc. everyone in this game is living and learning and many do with conflicts of interests. Unless investors do their own research and take responsibility for their actions, these invisible risks will remain so. Perhaps some risks has been left out; perhaps new risks will get added in future.

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