Mutual Fund investments are subject to market risks, read all the scheme-related documents carefully - everyone has read/heard this disclaimer, but how many of us know what these risks that the organisations talk about are? Mutual funds invest in various types of securities like equity, Government Securities, Gold, international securities, corporate bonds, and many more. The prices of these securities fluctuate owing to various micro/macroeconomic factors, which in turn changes the NAV (Net Asset Value) of a mutual fund scheme, which is nothing but the per-unit cost of the scheme.
Here are some risks that all investors should be aware of-
Volatility risk- Equities/stocks trade in the stock market and the bonds trade in the bond markets, while at varying degrees, both the markets are subject to volatility, the former is relatively riskier than the latter. This volatility is the fluctuation in the per unit price of the security being traded, like shares, bonds, etc. This price fluctuation can be due to the companies’ performances, change in government policies, regulatory changes, RBI policies, etc. The more a scheme belongs to a niche segment, the riskier it can get. For example, a sectoral scheme can be riskier than a large-cap equity scheme. This is because the scope of diversification when the portfolio is limited to a particular sector is much lesser than a large-cap scheme that diversifies its investments.
Liquidity Risk- This refers to the difficulty in being able to redeem an investment because of lack of liquidity of the assets in the scheme or because there is a sudden flood of redemption demands for a scheme which the fund is not able to cater to. The fund manager, in such situations, may not be able to quickly buy or sell assets.
Interest rate risk- The prices of the bonds fluctuate based on the change in the interest rate or the speculation of change. The two are negatively correlated, which implies when the interest rate increases, the bond price falls and vice versa. This movement in the price of the bonds constitutes for the interest rate risk associated with the bonds, and in turn, with the mutual fund schemes invested in these bonds. The longer the maturity period of a debt scheme, the higher will be the interest rate risk and vice versa.
Credit risk- The credit risk associated with a company defines the likelihood of it being able to repay the debt/credit. The credit rating agencies rate them in the range of AAA to D, wherein AAA is the highest rating implying the company has a very high likelihood of repaying the debt, and likewise, D is the lowest. The mutual fund schemes investing in these companies will be exposed to the credit risk as well.
In conclusion-
Every type of mutual fund scheme may have multiple types of risks associated with it; it is for you, as an individual, to decide how much of an appetite do you have for different kinds of risks. You can understand the risks associated with a scheme by going through its scheme information document (SID). Based on that, you may go ahead with your customised asset allocation and build a portfolio which is in line with your investment objectives, and risk level.
Mutual Fund Investments are subject to market risks, read all the scheme related documents carefully