Article: Risk in MFs

#16

This post compares the risk between equity funds and debt funds.

Risk: volatility aka fluctuation in price

Equity

• Equity funds are riskier in the short to medium term
• They have a propensity to swing more intensely in either direction

Debt

• Two aspects of risk: interest risk, credit risk
• Interest risk: 
• Interest rates may move up or down
• Rise in interest rates --> fall in bond prices (and vice-versa)
• A fund comprising long-duration bonds is subject to high risk
• Credit risk:
• Risk of default by the bond issuer
• Debt funds investing in low-rated paper are subject to credit risk

Fund types and their risk grade

Equity funds in increasing order of risk:

• Aggressive hybrid funds (least risky) (35% of assets invested in debt)
• Large companies (don’t fluctuate erratically)
• Mid and small caps 
• Thematic and sectoral funds (undertake theme-specific bets, hence riskiest)

Debt funds in increasing order of risk:

• Liquid funds (least risky)
• Ultra short-duration funds
• Short-duration funds
• Medium-duration funds
• Credit-risk funds
• Dynamic-bond funds
• Long-term gilt funds

How to take risk into account while investing

Solution: Diversify.

• Invest across fund houses and schemes
• This decreases fund-house-specific, fund-manager specific and scheme-specific risks
• Lessen portfolio risk by investing in multi-cap equity funds