Risk Involved in Mutual Funds
Unlike FDs and RDs, investment in mutual funds is associated with some different types of risks. Growth in Mutual Funds always fluctuates in the same proportion as of the performance of the invested companies and some other related factors. In order to diversify their portfolio, Mutual Funds invest the money to various financial assets such as bonds, equities, debt, government securities and many others so they can be associated with a number of risks. To make the investors aware of the level of risk, SEBI, a statutory regulatory body, says that every mutual fund must disclose the level of risk that is associated with the mutual fund and to make it possible Risk-o-Meter is introduced which gives a fair enough idea of the risk.
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So, it is clear from the above statements that mutual funds are closely associated with the risk due to which investors can lose their money too. But it is also true that investors can minimize this risk. We are not going deeply about how to we can handle the risk in this post, but we will going to understand that what are types of risks accompanying with mutual funds here..
Types of Risks in Mutual Funds
Broadly there are 2 categories of risks in mutual funds.
- Systematic Risk – these are not in out control and impact most of the assets like change in Government policy
- Unsystematic Risk – these are specific to the company and impact a particular asset or company like workers strike in a company.
Equity Funds Risks:
- Risk of Volatility: Equity based mutual funds always impact by the volatility of the market. These types of funds invest the money from the investors in the companies which are listed in the stock exchange. The growth of the companies is totally based on their performance in the market. It may be analyzed majorly by the growth of the revenue and profit margins. There are microeconomics factors like changes in Government policy, Economic cycles and many others involved also.
- Risk of Liquidity: There are also some categories where it is must to block the money for specific period of time like in ELSS type of mutual funds we have a lock in period of 3 years that causes liquidity risk. So, with these types of funds, we cannot do much like will not be able to liquidate the invested amount when we are in lock-in period. ETF is another type of funds with associated with the same nature of issue as trade volumes are very low and sometimes it is difficult to search for buyer in the market.
Debt Funds Risks:
- Interest Risks: RBI(Reserve Bank of India), who is responsible to change the interest rates in India, will analyze the market conditions and may revises the interest rates time to time which again may impact our investments.
- Credit Risks: It is a kind of defaulters. It is inability of the issuers to pay the interest amount which is promised at the time of issuing the bonds. It is the responsibility of the fund managers to analyze the situation and eliminate the risk. To eliminate the risk the rate the securities in context of credit risk.
- Inflation Risk: Increase in inflation plays an important role in investing in any of the asset. It also impacts the returns which you will get on your investments and investors always look at the history of the investing instruments and analyze if it beats the inflation or not. For example: if there is a fund whose return is 8% and the rate of inflation at that time is 5%, then the effective return will be 3%.
- Concentration Risk: It is just the opposite of the diversification. This type of occurs when investors invest their all money into a single sector or fund. Recently many of the investor invested their money into the Technology funds which are sectorial funds and portfolio is mostly comprises of technology companies and this is because at that time they saw a massive growth in technology companies shares.
- Currency Risk: There are funds which will invest their money in the foreign companies in dollars and currency fluctuation will impact them the most. A decrease in the exchange rate may reduce the gains of the investors.
- Management Risk: This is one of the biggest challenge investors can face. Performance of the mutual fund is dependent on the fund managers to a very large extent. If the assigned fund manager will underperform and will not meet the expectation, then there is risk to the returns what we expect.
