MUTUAL funds are considered to be an investment option for those who do not generally devote a lot of time to monitoring and managing their portfolios.
Investors experience both good as well as tough times as far as mutual fund investments are concerned.
But while evaluating the portfolio of their equity mutual fund holdings there are a few points that one should check to know about the level of risk that they are facing. Often there are situations where there is a higher risk than what was estimated initially.
Here are a few ways to evaluate various risk levels.
Individual holding exposure:
The portfolio of the equity fund where one has invested or plans to invest needs to be scrutinised to see whether the risk levels are such that could lead to a larger volatility in the holdings. Depending upon this factor and the risk taking ability of the investor the choice about a particular fund as an investment should be made.
One key point to watch out is whether there is a large exposure to just a few stocks. In a diversified equity fund there is a limit of 10 per cent for exposure to a single stock.
But if there are four to five stocks where the exposure is high, or around 9-10 per cent, then it could be that these holdings determine the performance of the fund. Several investors might not find such a situation suitable for their needs, while others who want some concentration for an outperformance would welcome such a mix.
Sector exposure:
There also has to be a limited exposure to a particular sector in the portfolio. There is a tendency among fund managers to increase a fund's exposure to a few particular areas when they are doing well. This can be a dangerous as it could lead to a situation where the movement of an entire fund is being dictated by a particular sector. Usually, MFs have internal limits.
For example, some limit a fund's exposure to a single sector to not more than 20-25 per cent and so on.
Another risk is where the exposure is spread across more than one sector, but are often linked in terms of performance. For example, automobiles, tyres and auto ancillary sectors are linked, so a deterioration or improvement in the condition of any one will impact all the other related sectors.
This can have a big impact on the portfolio as a whole. Another example is the construction field that would include real estate, cement and steel sectors among others.
Market cap exposure:
The re is often a market-cap driven trend in the equity markets. This would mean a situation where there is a rally in large-cap stocks or where the conditions are weak for mid-cap IT stocks and so on. Often the portfolio might seem to be diversified as there is no concentration on a specific company or sector, but there is another form of risk that is present there.
If majority of the holdings belong to a certain market-cap then a similar risk situation can arise. The investor can find that there is just a one-way movement on several occasions in the portfolio. A fund with a specific market-cap investment mandate, like a mid-cap scheme, will be forced to invest in holdings with a particular marketcap. But in case of diversified equity funds, too, the situation needs to be checked to see the extent of risk in this area.
Group exposure:
There are a lot of ways in which the holdings in various companies can be classified.
The situation could be such that while the holdings are diversified across sectors and also across market-cap, there is a slightly higher exposure to companies from a single business group. This kind of exposure, too, can create a higher amount of risk especially when the performance of group companies on the stock market follows a similar trend.
While having more than one company in the portfolio of a group is not a negative factor, having too much of a weight could lead to a situation where the fund's performance will be magnified either on the upside or the downside whenever a trend like this is witnessed.
