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Decoding the colour that shows risk of your fund

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THE actual implementation of colour codes by the mutual fund industry has meant that investors are now able to take a look at this specific aspect and then decide the extent of risk that is present in a particular scheme.

There are various benefits and also some shortcomings that need to be understood with respect to the colour codes that have been introduced. We decode these for investors to better understand it.

Colour coding:

Under the procedure, every mutual fund scheme needs to have a colour attached to it so that investors know the risks associated with it. Three colours have been proposed to be used by the schemes; the blue colour to represent low risk, yellow colour to represent medium risk and the brown colour to represent high risk. This would usually mean that all equity schemes would be using brown colour, clearly indicating the element of risk present in them.

Balanced schemes:

The next question comes with respect to the balanced schemes. Usually, the nomenclature would indicate a fund where there is an equal amount of debt and equity, but in reality this is not the case.

This happens because the composition of the funds is such that often there is a higher proportion of equity in the portfolio. This is why these schemes should actually be colour coded brown to rightly reflect comparatively higher risk to your investment, as there is a fair amount of risk of losing your capital.

Debt funds:

An element of confusion is likely to occur with respect of debt funds as well. There are just three colours in the whole colour coding scheme. This means there has to be an overall look at the nature of the fund while allocating the colour. In that sense, the colour code for all debt funds should ideally be blue. There is, however, a lot of difference when it comes to debt funds because of the fact that long term gilt funds will have a different risk profile compared with a liquid fund.

But there is no way the colour code can actually reflect this position. Investors should take a careful look at these funds and then do some additional work to judge the exact extent of risk present in such a scheme.

Outrider:

While colour-coding may reflect broad category-wise distinctions, it is important to take a closer look at the way various these funds have been classified. It is important to look at the core of a scheme to see an outrider, which has used a system that is different from what it should have normally been. For example, what if there is an equity-oriented scheme using a colour code other than brown. This might happen if the fund thinks its investment pattern is such that it required a lower risk grade. When such glaring cases of difference arises, it is important to take note of that situation and base the investment decision not just upon the colour, but also on the real risk position that one would see in front of his/her.

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