SEBI's new Riskometer is inconsistent and oversimplified!

From 1st July onwards, SEBI has instructed all amcs to use a riskometer to help investors understand the risk associated with a particular mutual fund. A look at how useful this really is.

The old riskometer

This is how the old risk dial looked (picture courtesy: HDFC amc).

Three settings, each denoted by a color, like a signal. Guess they did not want to use red for brown and green for yellow!

The new riskometer

The new risk dial has 5 settings for the principal, and is in black and white! I have removed the needle in the image below.

Before we look at specific examples, here are some general criticisms.

1) This riskometer does not help goal-based investing!

Those who recognise the importance of beating inflation for long-term goals will/should ignore this setting for equity funds.

The setting is meant to warn investors who wish to use equity funds for short durations.

The point is, the riskometer (terrible name) makes no effort to differentiate between risk and volatility.

The recommend investment duration should be mentioned in the dial setting.

2) How do I differentiate between low and moderately low?

If we define loss from 0% to 100%, then each segment of the above dial is 20% in width.  So does this mean, a 10% risk is low and 30% risk is moderately low?

These divisions are purely subjective. They will claim that they are only indicative. That is more of an excuse.  Product labelling cannot be simplified for the sake of simplification.

3) The labelling appears to be misleading

According to Franklin Templeton,

Franklin India Prima Fund, a mid and small cap fund has

Bluechip and Prima plus also have the same labelling! FT Balanced also has the same label.

So from what I see (at the FT site), all diversified equity funds, including balanced funds are labelled moderately high

Sector funds (concentrated risk) and those that invest in international stocks (currency fluctuations add to the risk) are high

A fund like Franklin India Opportunities Fund which can take concentrated stock or sector exposure is also labelled as moderately high!

All funds labelled moderately high were earlier coated brown (high risk). What has changed now that their risk profile can be downgraded?

At the time of writing ( 5:40 pm July 5th 2015), HDFC had still not bothered to comply with the SEBI deadline of 1st July.

Now have a look at this. DSP BR says their  Monthly Income Plan fund with only 25% max exposure to equity is also labelled as moderately high.

Franklin says its MIP fund is moderate! God help the investors who take this riskometer too seriously.

However, Franklin’s Pension plan which can have up to 40% in equity is labelled moderately high.

The riskometer has no correlation wrt equity exposure in a fund.

By now, it should  be clear to most of you that long-term gilts funds would be labelled as

Dynamic bond funds also fall in this category.

In an earlier post, The key to successful mutual fund investing, I had shown how mutual fund categories can be classified in terms of standard deviation.

This is a plot of 3-year return divided by 3-year standard deviation versus the standard deviation.

Notice that both the x- and y- axis are logarithmic. Only then do the categories line up.

That is, risk is logarithmic and not linear!

The risk associated with a long-term gilt fund can, and should never be placed next to diversified equity funds.

There is a huge gulf in risk between them. The riskometer which is linear (a line placed on a semi-circle) can never capture this.

The previously used color codes also suffered from the same flaw, but somehow that seems better than the new system!

It just gets better and better!

Franklin’s Ultra Short Term Bond fund an accrual based debt fund is labelled moderate!! Unless the investment duration for which the label is valid is mentioned, it makes no sense.

I could go on and on. By now, I hope it is clear to you that this riskometer is more of a legal disclaimer for amcs rather than an aid for investors.

Do not try to reconcile it with VR fund categories. From what I see it is too dependent on fund strategy.

Labelling will work only if it is consistent across a product category. First let SEBI come with a product categtorization. Only then will this labelling work.

Do not take it or anyone who shows  it to you seriously. Please do your own research and choose products suitable for your financial goals.

Ps. Since gold is risker than stocks, guess how gold funds and gold etfs are labelled 🙂