Risks involved in Mutual Funds

Risks are to investing what students are to teachers — you can’t have one without the other. The basic CAPM formula, which is used to calculate the expected returns considers Beta, which is a parameter of risk. Thus, we can say that any and all investment vehicles are subjected to risks.

Mutual funds being no different are subjected to various types of risks not just the market risks, which you may have heard in the following statement:

“Mutual funds are subject to market risks. Read all scheme-related documents carefully.”

Below are the various types of risks, which mutual funds as an investment vehicle inherit

  • Market Risks: The most known and common risk for any investment vehicle is market risk. Market risk is simply the possibility that the market or the economy will decline, causing individual investments to lose value regardless of the performance.
  • Inflation Risks: It’s the risk of losing the purchasing power. In simple terms, if your mutual funds earn 5% per year and the cost of living goes up by 2%, you are just left with 3% as net returns from your investments. This is also known as the real rate of return.
  • Concentration Risks: Concentration generally means focusing on one thing. Concentrating a considerable amount of a person’s investment in one particular scheme is not a good option. Profits will be huge if lucky, but the losses will be more. Concentrating and investing heavily in one sector is also very risky.
  • Interest Rate Risks: This type of risk is majorly related to debt mutual funds. It deals with the risk of rising interest rates and their effects on bond prices. The commonly known inverse relation between bond prices and interest rates plays a major part here as rising interest rates cause bond prices to fall, thus reducing the capital gains created.
  • Liquidity Risks: Liquidity risk refers to the difficulty to redeem an investment without incurring a loss in the value of the instrument. It can also occur when a seller is unable to find a buyer for the security. In mutual funds, like ELSS, the lock-in period may result in liquidity risks. Nothing can be done during the lock-in period. In yet another case, Exchange traded Funds (ETFs) might suffer from liquidity risks. As you may know, ETFs can be bought and sold on the stock exchanges like shares. Sometimes, due to lack of buyers in the market, you might be unable to redeem your investments when you need them the most.
  • Credit Risks: Credit risk means that the issuer of the scheme is unable to pay what was promised as interest. If a bond issuer cannot repay a bond, it may end up being a worthless investment. Within mutual funds it’s the debt categories, which directly suffer from credit risks as the fund manager might invest in instruments with lower credit ratings in order to generate superior returns.
  • Lack of Control: As much as mutual funds offer the convenience of investing, investors cannot determine the exact composition of a fund’s portfolio, nor can they directly influence which securities the fund manager can buy. The fund may be diversified enough but the investor has no control over the action taken by the fund manager.
  • Country Risks: It’s the risk due to the changes in the foreign economy where the fund has invested. Certain statutory changes or economic instability in the foreign country would affect the returns of the fund. This risk mainly affects overseas funds.

The Investors shall invest only on the basis of information contained in the draft prospectus/KIM’

“The information, analysis and estimates contained herein are based on NBWS Research assessment and have been obtained from sources believed to be reliable. This document is meant for the use of the intended recipient only. This document, at best, represents NBWS Research opinion and is meant for general information only. NBWS Research, its directors, officers or employees shall not in any way be responsible for the contents stated herein. NBWS Research expressly disclaims any and all liabilities that may arise from information, errors or omissions in this connection. NBWS Research, its affiliates and their employees may from time to time hold units of mutual funds referred to herein. This report does not support to be an offer for purchase of this bond issue.”

“Mutual Fund Investments are subject to market risk. Please read the offer document carefully before Investing.”