Fund homes are required by SEBI to classify the risk of each structure as you have five levels: low, low moderately, moderate, moderately high, or high. But what exactly should we label of a structure whose risk level is defined by the fund house as, say, ‘moderately low’? On the other hand, what should we label of Value Research or Morningstar telling us that the risk grade or risk rating of that scheme (in accordance with its peers) is, say, ‘average’?
It isn’t just their ambiguity: I’d not rely on any of these labels as they largely stem from a slim view of risk. I believe that if we are not careful, these may lead us to make flawed assumptions about the riskiness of a structure and, worse, act upon them. To demonstrate the perils of relying upon these risk rankings, I’d like to take the case of a specific system whose risk ratings are currently poles apart from my assessment of its risk.
To be clear, this structure can be an extreme outlier: it might be hard to find a scheme quite like this. However, the extremity of this example is why is it beneficial to show the arbitrary character of fund-house risk rankings, and the restrictions of the technique followed by entities such as Value Morningstar and Research. The scheme involved is a debt fund that has been around for over a decade. From what I could see, for the majority of its existence, there’s been a noticeable regularity in the manner that its maturity/ length and its own credit profile have been maintained.
- Lump sum death benefits
- JMP Group Inc
- 18 Undefined IRR
- Chhattisgarh (Rs 58.73 to Rs 72.23)
- 48 See supra note 10
- Some policies enable you to pay rates out of your cash value
- The Terms of Reference of the Committee will be to
As regards its performance, in each one of the last 10 quarters, its return was above average (compared to its peers). In 3 of the last 6 quarters, its return was exceptional. The month of June In, this plan provided an increased come back than almost every non-gilt fund. Its return in June was also higher than its return in any of the preceding a year. The fund house has classified its risk as ‘moderately low’.
On the other hands, both Value Research and Morningstar have presently given it a risk grade/ ranking of ‘average’ and a standard rating of 5 stars (predicated on the performance of its direct plan, development option). So, what’s the nagging problem? Just as with various other schemes, within the last several months, this scheme saw a substantial fall in its AUM.
Consequently, there’s a certain illiquid NCD in its portfolio, which it hasn’t had the opportunity to market off, whose percentage to the portfolio has zoomed up as the AUM has fallen. As on May-end, this NCD comprised 71% of the scheme’s profile. As on June-end, this NCD made up 87% of the collection.
Take a minute to digest that, if you shall, because there’s more. That solitary NCD is currently scored BBB (CE) and is under “credit watch with negative implications”. Quite simply, that NCD is merely about making the slice for being ‘investment grade’ and is precariously close to sliding below that. If it can, well, there’s no saying how much an investor could be impacted. If industry practices are anything to go by, to begin with, the fund house would have to mark down the worthiness of this investment by at least 25%. And for those who have forgotten, here’s a bit of a flashback.