Product labelling and how the risk-o-meter is calculated
The dial investors see is the end of a monthly calculation. Here is the method, step by step.
Every mutual fund scheme carries a product label. It tells the investor three things: what the scheme is for and over what time horizon, a short description of its objective and the kind of product it invests in, and how much risk the principal faces, shown on a dial called the risk-o-meter with a written statement beneath it.
For investors the label is a picture. For the AMC and its RTA it is a monthly calculation. SEBI's October 2020 circular sets a scoring method: give each security a risk value, take AUM-weighted averages, and map the result to one of six levels. This page walks through that method and the operations cycle around it.
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From risk value to risk level
Table 11 of Annexure A to the October 2020 circular.
| Portfolio risk value | Risk-o-meter level |
|---|---|
| Up to 1 | Low |
| Above 1, up to 2 | Low to Moderate |
| Above 2, up to 3 | Moderate |
| Above 3, up to 4 | Moderately High |
| Above 4, up to 5 | High |
| Above 5 | Very High |
How debt securities are scored
Each debt holding gets three values, using holdings and ratings as on the last day of the month.
Credit risk
Scale
1 to 12 by rating
Examples
G-Sec, AAA, SDL, TREPS = 1; AA+ = 2; AA = 3; A = 6; BBB- = 10; unrated = 11; below investment grade = 12
Interest rate risk
Scale
1 to 6 by portfolio Macaulay Duration
Examples
Up to 0.5 years = 1; above 1 to 2 years = 3; above 4 years = 6
Liquidity risk
Scale
1 to 14 by rating, listing and structure
Examples
TREPS, G-Sec, AAA PSU, SDL = 1; listed plain AAA = 2; unlisted or structured paper scores higher; below investment grade and unrated = 14
| Parameter | Scale | Examples |
|---|---|---|
| Credit risk | 1 to 12 by rating | G-Sec, AAA, SDL, TREPS = 1; AA+ = 2; AA = 3; A = 6; BBB- = 10; unrated = 11; below investment grade = 12 |
| Interest rate risk | 1 to 6 by portfolio Macaulay Duration | Up to 0.5 years = 1; above 1 to 2 years = 3; above 4 years = 6 |
| Liquidity risk | 1 to 14 by rating, listing and structure | TREPS, G-Sec, AAA PSU, SDL = 1; listed plain AAA = 2; unlisted or structured paper scores higher; below investment grade and unrated = 14 |
The liquidity override
A debt portfolio's risk value is the simple average of its credit, interest rate and liquidity values. But if the liquidity value is higher than that average, the liquidity value is used instead. This one rule decides many exam answers.
Worked example: SEBI's own debt illustration
Illustration A in the circular: ten debt securities at 10% of AUM each, portfolio Macaulay Duration 1.41 years.
- 1
1. Credit risk value
AUM-weighted average of the ten credit values: 0.1 × (1 + 4 + 6 + 8 + 3 + 2 + 6 + 3 + 1 + 1) = 3.5.
- 2
2. Interest rate risk value
A duration of 1.41 years falls in the above 1 to 2 years band, so the value is 3.
- 3
3. Liquidity risk value
AUM-weighted average of the ten liquidity values: 0.1 × (1 + 7 + 7 + 9 + 5 + 5 + 7 + 4 + 2 + 1) = 4.8.
- 4
4. Simple average
(3.5 + 3 + 4.8) ÷ 3 = 3.8 (rounded).
- 5
5. Apply the override
Liquidity at 4.8 is higher than 3.8, so the risk value is 4.8.
- 6
6. Map to a level
4.8 is above 4 and up to 5, so the risk-o-meter shows High. Without the override, 3.8 would have shown Moderately High.
Free account, this exam preselected.
How other holdings are scored
| Holding | Risk value |
|---|---|
| Equity: market cap | Large cap 5, mid cap 7, small cap 9 (AMFI's six-monthly list) |
| Equity: volatility | Daily volatility over two years up to 1% = 5, above 1% = 6 |
| Equity: impact cost | Up to 1% = 5, above 1% to 2% = 7, above 2% = 9 |
| Equity portfolio | Simple average of the three equity values |
| Gold and gold-related | 4 |
| REITs and InvITs | 7 |
| Foreign securities, overseas MF units or ETFs | 7 |
| Units of domestic MF schemes | 1 to 6, from the underlying scheme's own level |
| Cash and net current assets | 1 |
| Derivatives used for hedging | Left out, except any quantity in excess of the hedged position |
| Interest rate swaps used for hedging | Left out |
Equity check from the same circular
In Illustration B, nine equity stocks at 10% each score 6.6 for market cap, 5.8 for volatility and 6.3 for impact cost. Their simple average is 6.2. The tenth holding, cash at 10%, adds 0.1 × 1. The portfolio value is 6.3, which is above 5, so the scheme is Very High.
The operations cycle
- 1
At launch
The AMC assigns a risk level from the scheme's characteristics at the NFO stage.
- 2
Every month
The level is evaluated again on month-end holdings and disclosed with the portfolio on the AMC's website and AMFI's website within 10 days from the close of the month.
- 3
When the level changes
Unitholders of that scheme are told through a notice cum addendum and by email or SMS. A change in risk-o-meter is not a change in fundamental attributes under regulation 18(15A).
- 4
Every 31 March
Each scheme's level as on 31 March and the number of changes during the year go on the AMC and AMFI websites. Annual reports and the abridged summary show the level at the start and end of the year and the number of changes.
Where the product label must appear
- check_circleFront page of the initial offering application form, the SID and the KIM, close to the scheme's caption and prominently visible.
- check_circleThe common application form, alongside the scheme information.
- check_circleScheme advertisements, placed so investors can see it clearly.
How the Series II-B exam tests this
- check_circleThe three labelling parameters: nature and horizon, objective and product type, and risk to principal on the risk-o-meter.
- check_circleThe six levels in order, and which value range maps to which level.
- check_circleThe liquidity override for debt portfolios.
- check_circleFrequency and deadline: monthly, disclosed within 10 days of month end on AMC and AMFI websites.
- check_circleHow a change is communicated: notice cum addendum plus email or SMS. It is not a fundamental attribute change.
- check_circleFixed values worth remembering: cash 1, gold 4, REITs, InvITs and foreign securities 7.
FAQs
How is the risk-o-meter of a mutual fund calculated?expand_more
Each holding gets risk values under SEBI's October 2020 method. Debt is scored on credit, interest rate and liquidity risk; equity on market cap, volatility and impact cost. AUM-weighted averages give a portfolio value, which maps to one of six levels.
How often is the risk-o-meter reviewed?expand_more
Every month. AMCs disclose it with the portfolio on their website and AMFI's website within 10 days from the close of each month.
Is a change in risk-o-meter a fundamental attribute change?expand_more
No. SEBI's 2020 circular says so expressly. The change is communicated by a notice cum addendum and an email or SMS to unitholders.
What is product labelling in mutual funds?expand_more
A label on every scheme showing its nature and time horizon, a brief objective and product type, and the level of risk to principal on the risk-o-meter, with a written risk statement below it.
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