1. KIM of scheme summarises the specific risk factors of a scheme
  2. SID mentions that the past performance of the mutual fund does not guarantee future performance but yet investment in mutual funds is not a gamble.
  3. Portfolio Liquidity –If the scheme has invested in assets which are liquid then the Fund Manager can easily encash them whenever he needs the funds.
  4. SEBI has set a ceiling for illiquid assetsOpen-ended mutual fund schemes require more liquidity. Hence the ceiling of illiquid assets that the open-ended scheme can hold is lower.
  5. Liquidity is required if the fund manager thinks the market is over heated and he is looking for an entry point. Liquidity may also be required for upcoming dividend payment or for heavy re-purchase (redemption).
  6. Liquid assets generally give lower return but they provide safety of liquidity.
  7. As per SEBI norms, exposure to Corporate Debt is limited to maximum exposure to a single issuer– 10% of NAV (can be increased to 12% with prior approval of trustees), to a single Corporate Group – 25% of NAV and to a single sector – 25% of NAV
  8. As per SEBI regulations, the restrictions regarding scheme’s liabilities towards leveraging are that :

a. Scheme cannot borrow more than 20 percent of its net assets.

b. Scheme cannot borrow for more than 6 months.

c. Scheme can borrow only to meet cash flow needs– dividend payment or re-purchase payment.

  1. Derivatives are instruments whose value depends upon underlying assets like shares, exchange rate, interest rate, precious metals, commodities, etc. and Types of derivatives are – Forwards, Options, Futures, Swaps.  
  2. Derivatives can be used for Hedging against risk, Re-balancing the portfolio and Leveraging. In India, investment in derivatives for leveraging is not allowed by SEBI.
  3. If a scheme wants to invest in derivatives, it should have included this clause in the Offer Document.
  4. If the derivative clause was not included in the Offer Document, then the mutual fund must explain the quantum and manner of investment in derivatives and the existing unit holders will be given a time of at least 30 days to exit at existing NAV without exit load.
  5. SEBI has mandated that every mutual fund scheme should have at least 20 investors and no investor should represent more than 25 per cent of the net assets of the scheme. This is called 20:25 rule.


  1. In equity funds there may be Generic Risk, Portfolio specific risk, Investment style related risk and portfolio turnover risk.
  2. Under portfolio specific risks, Sector funds suffer from concentration risk since investment is made in only one sector and if that sector performs poorly, the fund also performs badly.
  3. If the portfolio consists of diversified equity, it means Scheme invests across multiple sectors and in stocks of many companies, hence the risk is lowered except for focused funds which invest in only a few companies hence Risk increases in such funds.
  4. Thematic Funds Invest in stocks of a particular theme. Their exposure is wider than sector funds but narrower than diversified funds. Hence the risk is also less than sector funds but more than diversified fund.
  5. Mid Cap Funds present a greater volatility than large cap stocks. During boom, often mid-caps give good returns but they also present higher risk and these are less liquid than Large cap funds.
  6. Contra Funds behave in a manner contrarian from rest of the market. E.g. they may buy stocks that others are selling and vice versa but it carries high risk of misjudgment on the part of the fund manager.
  7. Dividend Yield Funds invest in those shares whose price fluctuate less but offer attractive dividends to the investors.
  8. Investment Style can be either growth or value. Growth investment style picks up the stocks which offer higher growth with higher risk. Value style is a conservative style seeking to identify the stocks that are priced lower than their real value hence these carry lower volatility.
  9. The formula of Portfolio Turnover Ratio = (Purchase Value of Securities + Sale Value of Securities) /Average Size of Net Assets. High portfolio turnover means the fund manager is buying and selling stocks to book profits and time the markets which is a risky strategy.


  1. The Generic Risks relate to risk of wrong judgment about the movement of interest rate, Credit Risk, risk of downgrading of credit rating, risk of liquidity and the risk of subjectivity in valuation of non-traded debt securities.
  2. Under Portfolio specific risks:

a. Short maturity securities have less fluctuation in their value, lower risk than long maturity securities, earn returns from interest hence their returns are more stable.

b. Gilt schemes invest in Government securities, carry high price risk because they are sensitive to change in yield in the market, carry lowest credit risk and the NAV of long maturity securities fluctuates more.

c. Bond Funds sometimes take high credit risk by buying low rated securities to earn higher interest income. However, this strategy has high risk of fluctuation in value of debt securities or even default in payment of interest/principal. If the FMPs have invested in non-Government securities, they also carry credit risk.

d. Junk Bond Schemes invest in securities which have poor credit quality with the aim of earning higher interest and appreciation of value if their credit rating improves. However, these schemes are extremely risky. SEBI has set limit on the exposure on unrated debt securities and securities rated below investment grade.

e. Capital Guaranteed Schemes are those where guarantee comes because the investment has been made in the government securitiesIf the investment has been made in non-Government securities, then even if the scheme is named capital guarantee, it actually is a capital protection-oriented scheme, unless such return is guaranteed by AMC or the Sponsor.


  1. Hybrid schemes invest in a mix of debt and equity to reduce risk.

a. Monthly Income Plans invest larger portion of their funds in debt securities (to lower the risk) and smaller portion in equity securities (to earn good returns).

b. Arbitrage funds buy and sell the same security at the same time in different markets and take advantage of price difference. The risks are low as they get cancelled out between Cash and F&O market.


  1. Gold as an investment option gives two benefitsof price transparency and good performance when there is financial or political turmoil.
  2. There are two types of gold funds– Gold Sector Fund and Gold ETF.


  1. Risk in Real Estate Funds are subjective valuation, less liquidity, unorganized intermediaries, high transaction cost (Stamp duty), risk of litigation, corporate governance and transparency.


  1. Volatility in returns leads to risk. Hence, volatility is a measure of risk. Volatility can be measured in relation to itself or in relation to some other index.
  2. Variance- the scheme whose returns fluctuate more is riskier and will have a higher variance.
  3. Standard Deviation is equal to the square root of variance and measures fluctuation in returns in relation to its own average return. It measures total risk of an investment and is relevant for both Debt and equity. High Standard Deviation means higher volatility and higher risk.
  4. Systematic Risk is measured by Beta by comparing fluctuations in periodic returns of the scheme with those of a diversified stock index which has Beta of 1. Schemes whose beta is more than 1 are considered riskier than the market. It is relevant for equity schemes.
  5. Modified duration measures sensitivity of value of a debt security to change in interest rates. Higher the modified duration, higher is the interest sensitive risk. It is relevant for Debt Funds and Hybrid Funds with Debt component only.
  6. Weighted Average Maturity of debt securities in a scheme is also indicative of interest rate sensitivity of a scheme but this method is not used by professionals.
  7. Credit rating is done by Credit Rating agenciesHigher the credit rating, lower the default risk of the security. Government securities, cash and cash equivalent do not have credit risk.


  1. Benchmarks are developed so that a scheme’s performance can be compared with it to assess performance of the scheme.
  2. A benchmark can be considered good if it is in sync with the scheme, developed by an independent agency, transparent and is published regularly.
  3. The benchmark and its performance along with that of the scheme has to be mentioned in the Offer Document. The fund can also change its benchmark on a later date if a better benchmark becomes available or if scheme’s investment objective changes or construction of index changes.
  4. Earlier, benchmark used was Price Return variant of Index (PRI). Since Feb 1, 2018 schemes are bench marked to Total Return variant of Index (TRI). PRI captured only capital gains of the constituents of Index. TRI captures dividends and interest payments as well.
  5. Benchmarks to be chosen for Equity Schemes depends on Scheme Type, Choice of Investment Universe and Choice of Portfolio concentration.

a. Under scheme type, Diversified funds will have diversified benchmark index like – S&P BSE Sensex, Nifty 50, etc. whereas Sectoral/ thematic funds will have index like – S&P BSE Bankex etc.

b. Under Choice of Investment Universe, funds which invest in large cap stocks will have benchmark index like – S&P BSE Sensex (30 Large Companies), etc. whereas funds which invest in mid cap stocks will have benchmark index like – Nifty Midcap 50, etc.

c. Under Choice of Portfolio Concentration, funds having fewer stockswill have benchmark index like –Nifty 50 (50 companies), etc. whereas funds having more stocks will have benchmark index like Nifty 100 (100 Companies), etc.

41.  As per SEBI guidelines, benchmarks for Debt Schemes should be developed by research and rating agencies recommended by AMFI i.e. – CRISIL, ICICI Securities, NSE, BSE. Example

a. By NSE- Nifty Composite G-sec index – for Government securities

b. By BSE- S&P BSE India Sovereign Bond Index – for Government securities

c. By ICICI Securities- ICICI Securities’ Sovereign Bond Index – for Government securities with three sub-indices –Si-Bex (1- 3 years), Mi-Bex (3 – 7 years),Li-Bex (more than 7 years)

d. By CRISIL- CRISIL Money Market Index for Money Market Funds

42.  Benchmarks for Other Schemes

a. Hybrid Funds invest in both debt and equity; hence the benchmark should also be a mix of equity and debt benchmark index as per table given below:

SEBI CategoryIndexDebt IndexEquity Index
Aggressive Hybrid FundCRISIL Hybrid 25+75 – AggressiveCRISIL Composite Bond Fund Index [25% allocation]S&P BSE 200 (TRI) [75% allocation]
Balanced Hybrid FundCRISIL Hybrid 50+50 – ModerateCRISIL Composite Bond Fund Index [50% allocation]S&P BSE 200 (TRI) [50% allocation]
Conservative Hybrid FundCRISIL Hybrid 75+25 – ConservativeCRISIL Composite Bond Fund Index [75% allocation]S&P BSE 200 (TRI) [25% allocation]

b. Benchmark for Gold ETF is – Gold Price

c. Benchmark/Indices for Real Estate Funds have been developed by some real estate companies but these have yet to gain wider acceptance.

d. For International Funds it would depend on where the investment is being made. If investment is made in China – Hang Seng .Apart from the scheme benchmarks, International funds also need to disclose the return in INR and in CAGR according to scheme type (Equity/Debt etc.)


43.  Absolute & Relative Returns-When returns of a scheme are compared with its benchmark, the process is called relative return comparison. 44.  Risk-Adjusted Returns- Technicallyif a scheme takes higher risk then it should give higher returns to the investor. A better approach is to compare risk-adjusted returns. Various measures of risk-adjusted returns are detailed below. 45. Sharpe ratio means average return earned in excess of Risk Free Rate per unit of total risk. Sharpe ratio of only similar schemes can be compared. Formula –Sharpe Ratio = (? minus Rf) ÷ Standard Deviation, where Rf = Risk Free Rate of Return e.g. T-Bill Index and ? = Average Return earned. 46. Treynor Ratio is risk premium per unit of risk. As a unit of risk, Treynor uses Beta and is more relevant for diversified equity schemes. Formula –Treynor Ratio = (? minus Rf) ÷ Beta 47. Alpha is the difference between optimal return of a scheme and actual return of the scheme. Positive alpha is out-performance by the fund manager and negative alpha is under-performance. Alpha is relevant for diversified equity schemes. 48. An index fund mirrors the index hence its return should also be the same as the index. However, there are differences in the returns. 49. The standard deviation of the difference between an index fund’s return and market return is called tracking error. It is used to measure how consistently is the fund return able to out-perform the benchmark. 50. The tracking error should be low if the index fund is consistently beating the benchmark.

Quick Revision

[WATU 18]

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