Enhance Your Mutual Fund Portfolio with Color

With the festival of colours just round the corner it is that time of the year when we fill our own and others lives with bright colours. It is the time to forget all differences of caste and creed and enjoy the festival of colours – Holi. This Holi, while you get ready to paint the world with the colours of joy and get drenched in fun, looks like market regulator Securities and Exchange Board of India or SEBI has decided to add some colour to your Mutual Fund portfolio too.

In a move to provide retail investors an easy understanding of the kind of products they are investing in and risks associated with it, SEBI has prescribed a framework on `Product Labeling` with colour coding for mutual funds (MFs) from 1st July, 2013, for all existing and forthcoming schemes. This is being done to address the issue of mis-selling in the Mutual Fund industry.

According to the circular, it has been decided that all the mutual funds shall ‘Label’ their schemes.

A blue colour coded box would indicate principal at low risk, yellow would signify a principal at medium risk, while brown would be represent principal at high risk. The colour codes shall also be described in text beside the colour code box.

All mutual funds will `label` the risk represented by their schemes vide ‘blue’, ‘yellow’ or ‘brown’ on the basis of the parameters such as the nature of scheme – whether to create wealth or provide regular income and the indicative time horizon (short, medium or long-term); the investment objective followed by the kind of product - whether equity or debt in which the investor is investing.

As per the norms, product labels carrying details about the schemes would be disclosed on the front page of initial offering application forms. Besides, the labels would also have to be placed in common applications forms, Key Information Memorandum (KIM) and Scheme Information Documents (SIDs) and advertisements.

While the intent of this move by SEBI is noble to guide the retail investor but we think that in an effort to keep the colour coding simple for the retail investor and the distributor, the product labeling has lost out on the qualitative aspect. For example, a large cap, a multi cap as well as a sectoral equity fund will all be colour-coded brown but the risks for each of these categories under the same equity asset class is different.

A Sector fund is comparatively a more risky product. What if a fund house views its large cap or multi cap equity scheme as less risky and wants to grade it as yellow? Moreover there is no differentiation between schemes of same asset class of different fund houses and that the colour coding does not consider the scheme`s past track record or it’s fund manager`s ability to control risks or portfolio churning.

A common yardstick, something akin to a commoditised approach should not be used where the fund management capability is being evaluated and virtually graded.

To address some of these issues, additional grading could have been introduced. For instance, while an equity scheme can be depicted as brown, different shades of brown or stars of brown could have been used to denote the different levels of risk, with an additional clarification from the fund house to justify the particular shade or star.

Moreover this move could have effectively handled mis-selling in terms of a mismatch between the risk profile of the product vis-à-vis that of the investor, which unfortunately is not being achieved in the current stipulation.

While this initiative taken by SEBI is definitely a step in the right direction from the point of view of the new investor looking to start investing for the first time, for those of us who know the importance of asset allocation and risk mitigation this grading system might prove to be inadequate since it does not capture the various kinds of funds in each category.

Read the SEBI’s circular on Product Labeling in Mutual Funds