What are the risks associated with various types of mutual funds in 2022?

Posted On Friday, Sep 23, 2022


Mutual funds have emerged as a popular choice of investment for many individuals. But just like any other investment, there are inherent risks associated with mutual funds.

As you may know, mutual funds invest in a range of securities such as stocks, bonds, commodities, etc. Since the value of these securities fluctuate every day due to various market forces, the value of mutual funds also changes daily. In other words, the returns are market-linked.

Thus, it is incorrect to assume that mutual funds offer guaranteed returns or are safe investment options. That said, if you need to understand the risks carefully before investing.

It is important to note that not all risks impact all mutual fund categories equally. An equity-oriented mutual fund may witness market volatility risk, concentration risk, underperformance risk, liquidity risk, etc. On the other hand, debt-oriented mutual funds come with credit risk, default risk, interest rate risk, etc.

Even within categories, certain sub-categories are more sensitive to certain risks, while some are exposed to others. For instance, a Mid Cap Fund is more likely to face sharp volatility in the interim compared to Large Cap Funds. Meanwhile, Sector/Theme oriented mutual funds are highly susceptible to concentration risk compared to diversified equity funds.

Diversifying the portfolio optimally and opting for the Systematic Investment Plan (SIP) -- a mode of investment -- helps mitigate the risk to an extent. However, if you truly want to manage risk, you need to select schemes thoughtfully taking into account your risk profile, investment horizon, and financial goals.

If you are concerned about the safety of your capital, then equity-oriented mutual funds are a strict no. These funds are highly volatile and prone to market risk.

However, this does not mean that investors preferring safety should stay away from all kinds of mutual funds.

Debt mutual funds are relatively less volatile compared to equity mutual funds. This makes them suitable if:

• You are a conservative investor.

• Your investment horizon is less than 3 years away and you are looking to gradually shift investment to a relatively safer and less volatile avenue.

Within the debt mutual fund category, Liquid Funds, and Overnight Funds are relatively less volatile options.

1) Liquid Funds

Liquid funds invest in debt and money market instruments such as Certificate of Deposits (CDs), Commercial Papers (CPs), Term Deposits, Call Money, Treasury Bills, and so on, with a maturity of up to 91 days. As the name suggests, you can expect Liquid Funds to offer you liquidity whenever a need arises.

Fund managers of liquid funds are expected to prioritise preservation of capital over maximizing returns. Liquid Funds typically offer returns comparable to a Bank savings account, and at times, even better than Bank FDs. Besides they are liquid. The units of Liquid Fund can be redeemed at any time without any exit load after you hold the units for at least 7 days.

A Liquid Fund could be suitable for you if you are looking to park your money for contingency needs, address very short-term goals, and/or tactically shift money to an equity fund (via the Systematic Transfer Plan).

Since Liquid Funds invest in low maturity debt instruments, the interest rate risk in these schemes is generally less. However, depending on the quality of the underlying portfolio, the scheme may expose you to credit risk.

 2) Overnight Fund

Overnight funds invest in securities that mature in one day. The category usually invests in Tri-party Repos, Reverse repo, and other debt and money market instruments having residual maturity of 1 business day. There is no entry or exit load applicable on transactions in overnight funds. Overnight Funds emphasise capital preservation over capital appreciation. Since the securities mature in one day, the interest rate risk and credit risk in overnight funds are lowest compared to other debt mutual fund categories.

This makes it suitable for risk-averse investors looking for a relatively safer fund having return potential competitive to a bank savings account. It can be a useful avenue to park their money for a very short period.

To conclude...

Investing in mutual funds (including debt mutual funds) is not risk-free. However, the risk can be managed if you select the schemes carefully. When you select schemes from the abovementioned categories, prefer the ones that emphasise the safety of capital over chasing high yields for high returns. Avoid schemes that hold higher exposure to instruments issued by private entities to avoid any potential credit risk to your investment portfolio.

Happy Investing!

Disclaimer, Statutory Details & Risk Factors:

The views expressed here in this article / video are for general information and reading purpose only and do not constitute any guidelines and recommendations on any course of action to be followed by the reader. Quantum AMC / Quantum Mutual Fund is not guaranteeing / offering / communicating any indicative yield on investments made in the scheme(s). The views are not meant to serve as a professional guide / investment advice / intended to be an offer or solicitation for the purchase or sale of any financial product or instrument or mutual fund units for the reader. The article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Whilst no action has been solicited based upon the information provided herein, due care has been taken to ensure that the facts are accurate and views given are fair and reasonable as on date. Readers of this article should rely on information/data arising out of their own investigations and advised to seek independent professional advice and arrive at an informed decision before making any investments.

Mutual fund investments are subject to market risks read all scheme related documents carefully.

Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors. Investors in the Scheme(s) are not being offered a guaranteed or assured rate of return and there can be no assurance that the schemes objective will be achieved and the NAV of the scheme(s) may go up and down depending upon the factors and forces affecting securities market. Investment in mutual fund units involves investment risk such as trading volumes, settlement risk, liquidity risk, default risk including possible loss of capital. Past performance of the sponsor / AMC / Mutual Fund does not indicate the future performance of the Scheme(s). Statutory Details: Quantum Mutual Fund (the Fund) has been constituted as a Trust under the Indian Trusts Act, 1882. Sponsor: Quantum Advisors Private Limited. (liability of Sponsor limited to Rs. 1,00,000/-) Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited. The Sponsor, Trustee and Investment Manager are incorporated under the Companies Act, 1956.

Above article is authored by Quantum.

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