Table of Contents

General Risk Factors:

  1. Liquidity Risk:
  • Restriction on liquidity due to trading volumes, settlement periods, and transfer procedures.
  • Market liquidity may be impacted by company/sector/general market-related events, causing price impact and potential losses.
  • Settlement delays or problems can lead to uninvested assets and missed investment opportunities.
  1. Interest Rate Risk:
  • Fixed income securities are prone to price fluctuations based on changes in interest rates.
  • Rising interest rates can lead to a decrease in security prices, while declining rates can increase prices.
  • Derivatives are also exposed to price changes due to interest rate movements.
  1. Reinvestment Risk:
  • The risk associated with reinvesting cash flows received from securities at lower rates.
  • The actual rate of reinvestment may be lower than initially assumed, affecting overall returns.
  1. Political Risk:
  • Adverse impacts on investments due to changes in the political scenario at central, state, or local levels.
  • Government actions and policies can affect the economy, businesses, and market conditions.
  1. Economic Risk:
  • Slowdown in economic growth or macroeconomic imbalances can negatively affect investments.
  • Central and state level fiscal deficits can impact the volume of new investments in the country.
  1. Foreign Currency Risk:
  • Foreign investors may experience losses due to currency movements when investing in Indian Rupees (INR).
  • The responsibility to manage or reduce currency risk lies with the foreign investors.
  1. Settlement Risk (Counterparty Risk):
  • Risk of default by the counterparty involved in specific floating rate assets or swaps.

Specific Risk Factors:

  1. Risk related to equity and equity-related securities:
  • Volatility and daily price fluctuations in equity markets.
  • Liquidity restrictions and settlement problems can impact investments and potential losses.
  • Various factors like interest rates, currency exchange rates, changes in law/policies, and economic developments can affect securities.
  1. Risk associated with short selling and Stock Lending:
  • Risks involved in securities lending, including the failure of the other party and loss of rights to collateral.
  • Short-selling carries counterparty and liquidity risks, and covering securities at higher prices can lead to losses.
  1. Risks associated with mid-cap and small-cap companies:
  • Higher volatility and market liquidity risks compared to large-cap stocks.
  • Potential earnings variations and unexpected market changes can adversely affect investment results.
  1. Risk associated with Dividend:
  • Dividends are not guaranteed, and companies may not continue to pay dividends in the future.
  • Variations in company profitability can impact dividend payments and scheme performance.
  1. Risk associated with Derivatives:
  • Derivative products require specialized investment techniques and risk analysis.
  • High leverage and small margin can lead to significant profit or loss compared to the principal investment.
  • Price movements in the underlying securities can impact derivative values and the NAV of the scheme.

Note: The above notes can be presented in a tabular format for better organization and clarity.

General Risk FactorsSpecific Risk Factors
Liquidity RiskRisk related to equity and equity-related securities
Interest Rate RiskRisk associated with short selling and Stock Lending
Reinvestment RiskRisks associated with mid-cap and small-cap companies
Political RiskRisk associated with Dividend
Economic RiskRisk associated with Derivatives
Foreign Currency Risk
Settlement Risk (Counterparty Risk)
Risks Associated with Derivatives
- Counterparty Risk
- Market Liquidity Risk
- Model Risk
- Basis Risk
- Difficulty in executing derivative transactions
- Risks in index futures
- Leveraged nature of derivatives
- No assurance of profitable strategies
- Interest rate risk and liquidity risk in fixed income derivatives
Risks Related to Debt Funds
- Reinvestment Risk
- Rating Migration Risk
- Term Structure of Interest Rate Risk
- Credit Risk
Risks Associated with Floating Rate Securities
- Spread Risk
- Basis Risk
Risks due to Possible Prepayments
- Changes in tenor and yield
Risks Associated with Investments in Securitized Assets
- Risks related to asset class
- Risks related to pool characteristics
- Credit rating and adequacy of credit enhancement
- Limited liquidity and price risk
- Limited recourse to originator and delinquency
- Risk of co-mingling
- Bankruptcy of originator or seller
- Bankruptcy of investor's agent
Risks Associated with Investments in REITs and InvITs
- Price-risk
- Interest rate risk
- Credit risk
- Liquidity or marketability risk
- Reinvestment risk
- Lower-than-expected distributions
Risk Management Strategies
- Managing market liquidity risk
- Managing credit risk
- Managing term structure of interest rates risk
- Managing rating migration risk
- Reinvestment risk management
- Conducting thorough research and due diligence
- Monitoring company-specific factors
- Limiting investments in floating rate securities
- Regular monitoring of equity exposure for favourable taxation
Factors that Affect Mutual Fund Performance
- Different asset classes and strategies
- Risks inherent in asset classes
- Risks taken by fund managers
- Outperformance of benchmark
Difference between Market/Systematic Risk and Company Specific Risk
- Market/Systematic Risk: Impacts entire economy or market
- Company Specific Risk: Impacts individual companies
- Market risk is non-diversifiable, while company risk is diversifiable
- Market risk is also known as systematic risk, while company risk is unsystematic risk
Mutual Fund Investments are Subject to Market Risks
- Mutual fund investments are pass-through vehicles
- Credit risk is the risk of default on investments
- Diversification helps reduce credit risk
- Market-wide price fluctuations are unavoidable
- Diversification can reduce security-specific risk
Drivers of Returns and Risk in a Scheme
- Portfolio composition determines returns
- Asset class, market segment, and investment strategies impact risk and return
- Factors differ for each asset class
Factors Affecting Performance of Equity Schemes
- Returns from equity linked to business earnings
- Risks include business performance and market volatility
- Strategies: security selection and market timing
- Fundamental analysis (business and financials) and technical analysis (price behavior)
Factors Affecting Performance of Debt Schemes
- Risks: interest rate risk and credit risk
- Yields influenced by interest rates and credit spreads
- Duration management and credit quality analysis
- Focus on accrual or interest income, or appreciation
- Money market, ultra-short term, and dynamic bond funds
Factors Affecting Performance of Gold Funds
- Gold prices influenced by global demand-supply balance
- Safe-haven asset, affected by political and economic turmoil
- Rupee exchange rate impacts returns
- Passive funds with no view on gold price movement
Factors Affecting Performance of Real Estate Funds
- Local factors influence real estate value
- Economic scenario, infrastructure development, and interest rates
- Residential, commercial, industrial, infrastructural, warehouse, hotel, or retail properties
- Rental income and capital appreciation
- Portfolio composition and neutral valuation agencies

Measures of Returns

  1. Simple Return:
    • Formula: ((Later Value - Initial Value) / Initial Value) x 100
    • Example: If your investment grew from Rs. 12 to Rs. 15, the simple return would be 25%.
  2. Annualized Return:
    • Formula: (((1 + Return A)^(1/n)) - 1) x 100
    • Example: Comparing returns of two investments with different time periods.
  3. Compounded Return:
    • Formula: ((Later Value / Initial Value)^(1/n)) - 1
    • Example: Calculating returns when compounding is considered.
  4. Compounded Annual Growth Rate (CAGR):
    • Formula: (((Later Value / Initial Value)^(1/n)) - 1) x 100
    • Example: Considering dividends and compounding for accurate returns.
  5. Scheme Returns vs. Investor Returns:
    • Scheme returns may differ from investor returns due to loads, taxes, and other factors.
    • Use actual investment amounts and received/receivable amounts for accurate investor returns.
  6. Holding Period Returns:
    • Calculated for fixed periods (e.g., one month, one year) using CAGR or simple absolute returns.
    • Rolling returns are averaged consecutive returns to eliminate the impact of extreme initial or end values.
  7. Pros and Cons of Evaluating Funds based on Return Performance:
    • Return performance is an important factor but should be considered alongside consistency and benchmark comparison.
    • Risk assessment is crucial, including volatility in returns over time.

It's important to note that these measures provide different perspectives on investment returns and should be used in conjunction with other factors for a comprehensive analysis.

SEBI Norms regarding Representation of Returns by Mutual Funds in India:

  1. Mutual funds cannot promise returns unless it is an assured returns scheme with a guarantor.
  2. SEBI has prescribed the Advertisement Code and guidelines for disclosing performance-related information of mutual fund schemes.

Risks in Fund Investing with a Focus on Investors:

  1. Equity Funds:
    • Price fluctuations are inherent risks, with higher risks in small-cap and focused funds.
    • Small-cap and mid-cap companies carry higher business risks compared to large-cap companies.
    • Liquidity risk should be considered even for long-term equity investments.
    • Investors should align investments with their risk profile and maintain liquidity through liquid funds.
  2. Debt Funds:
    • NAV fluctuations can occur due to changes in interest rates or credit migration.
    • Dividend distributions are not guaranteed, and some schemes may skip dividends in certain periods.
    • Limited liquidity may be experienced in liquid, ultra-short-term, or low-duration funds during gating provisions or segregated portfolios.
    • Remaining investors may face higher risks if others exit the scheme, in the absence of segregated portfolios.
    • Debt funds are not entirely risk-free, and low risk does not mean zero risk.
  3. Hybrid Funds:
    • Distributors should carefully evaluate and select schemes based on the defined asset allocation between equity and debt.
    • Some arbitrage funds may have provisions to invest in debt securities, introducing price movement risks.
  4. Gold Funds:
    • Gold prices provide better pricing transparency and perform well during financial market turmoil and currency weakening.
    • Gold funds carry the risk of loss if the value or price of gold falls.
  5. Real Estate Funds:
    • Real estate investments involve risks such as subjective valuation, illiquidity, high transaction costs, regulatory risk, and litigation risk.
    • Real estate funds are relatively high-risk compared to other scheme types but less risky than direct real estate investment.
    • Family-owned real estate groups may have poor corporate governance standards, further increasing investment risks.

It is important for investors to understand the risks associated with different types of funds and align their investments with their risk tolerance and investment objectives.

Certain Provisions with respect to Credit Risk:

Credit Risk in Debt Markets:

  • Credit risk arises from default, delay in payments, or rating downgrade in debt securities.
  • Mutual funds may face stress if a large part of the scheme is redeemed during a credit event.

Gating or Restriction on Redemption:

  • Restriction on redemption applies during excess redemption requests in overall market crisis situations.
  • Imposed when there are liquidity issues or operational problems affecting the markets.
  • No restriction for redemption requests up to Rs. 2 lakhs; requests above Rs. 2 lakhs subject to restriction.
  • The restriction period should not exceed 10 working days in any 90-day period.

Segregated Portfolio or Side Pocketing:

  • Segregated portfolio creation is permitted for debt and money market instruments affected by a credit event.
  • It is optional and at the discretion of the AMC, with trustee approval and disclosure.
  • Units in the segregated portfolio are distributed to investors and cannot be redeemed or subscribed.
  • Units of the segregated portfolio can be listed on recognized stock exchanges for exit facilitation.

Illustration of Segregated Portfolio:

  • Example demonstrates the creation of a segregated portfolio for a downgraded security and its impact on the main portfolio.
  • Includes valuation, net assets, unit capital, and NAV (Net Asset Value) per unit for both portfolios.

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