Do Mutual Funds Need One More High-Risk Category? Know Here

November 2, 2023 Mutual Fund

Last week, the capital market regulator, the Securities and Exchange Board of India (SEBI), proposed to introduce a new ‘high-risk’ category of mutual funds in its letter written to the Association of Mutual Funds in India (AMFI).

This proposal, which is at the very nascent stage of discussion within the Indian mutual fund industry, will assess whether there should be an instrument for investors looking for an intermediate investment product between mutual funds and PMS (Portfolio Management Service).

Currently, the perception is that mutual funds are for retail or small investors, whereas the wealthy and/or high-risk investors are attracted to Portfolio Management Services (PMS), where the minimum investment usually is Rs 50 lakh.

But a fact is, certain High Net worth Individuals (HNIs) and Ultra High Net worth Individuals (Ultra HNIs) are also currently investing in mutual funds. These investors are playing an increasingly important role in the growth of the Indian mutual fund industry.

This brings us to an important question: Do mutual funds really require one more high-risk category instrument?

If we consider the ‘high-risk’ category, i.e., mainly the equity-oriented mutual fund schemes, at present, there are 12 sub-categories (including the Aggressive Hybrid Funds):

(Source: As per SEBI’s categorisation norms; data collated by PersonalFN Research) 

So, there are enough options to choose from depending on one’s risk profile. The regulatory guidelines make it binding on fund houses to review the risk-o-meter of the respective schemes in the product basket monthly and disclose the reviewed risk-o-meter along with the portfolio disclosures for all their respective schemes.

In the last couple of years, in the endeavour to clock higher returns, it is mainly the small-cap and mid-cap segments that have witnessed higher inflows. Notably, the returns clocked by these subcategories have been higher than other equity-oriented funds.

But now SEBI is worried that in the endeavour to earn even higher returns, many investors could be lured to PMS, perhaps being influenced by unregistered advisors or what someone else is doing with his/her investments.

The rationale behind SEBI’s proposal is that if mutual funds launch such a ‘high-risk’ product, investors, particularly those who are wealthy and can afford to take high risks, would be more likely to stick with mutual funds rather than getting swayed to another product.

While SEBI has not pronounced where the proposed high-risk category of mutual funds can and cannot invest, typically, we may find them investing in momentum stocks, micro-caps, and small-caps, perhaps even using derivatives, and following an aggressive investment strategy.

The industry body, AMFI, has clarified that such a product cannot be compared with PMS and AIF (Alternative Investment Fund). However, it believes that prudential norms applicable to mutual funds are higher, as compared to other investment instruments, where prudential norms are flexible in line with the ticket size of investment.

In my view, the proposed high-risk category of mutual funds is surely not suitable for everyone — at least not for retail investors. To keep retail or small investors away, the capital market regulator has proposed that the minimum or threshold investment should be high (maybe similar to PMS and AIF). The fund houses have been asked to recommend the minimum investment size for this proposed fund.

Investors should keep in mind that for every level of high returns you seek, there is risk. In other words, risk and returns are two sides of the same coin. It is important to set your risk-return expectations right when you invest in mutual funds or any market-linked investment avenue, for that matter.

“The essence of investment management is the management of risks, not the management of returns,” says Benjamin Graham, the father of value investing in his legendary book, The Intelligent Investor.

Thus, you must be mindful of the risk involved — and not invest blindly going by just the returns. Only going by the returns offered by any mutual fund scheme or other investment product is stupid; it may be detrimental to your health and wealth.

Similarly, it’s pointless getting carried away with how someone else invests. There is no one-size approach when it comes to investing. Remember the adage: one man’s meat is another man’s poison. Investing is an individualistic exercise.

You need to pay attention to your financial situation, personal risk appetite, the broad investment objective, the financial goals you are addressing, the time in hand to achieve those envisioned financial goals, and make investments accordingly – and not looking at just the returns. This thoughtful and sensible approach shall pave the path to wealth creation and be in the interest of your long-term financial well-being.

Happy Investing!

This article first appeared on PersonalFN here