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New color scheme for investment in mutual funds

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New color scheme for investment in mutual funds

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Your investments in mutual funds now becomes colorful. SEBI, the market regulator, in order to  help investors assess the risk associated with the mutual fund schemes, has issued a framework on ‘product labelling’ with colour coding. This would help investors to better understand the product they are investing in and its suitability to them. This would be effective from July 1, 2013, for all existing and forthcoming schemes.

All common application forms, scheme advertisements and product brochures would have a product label. The labels would include details about the nature of schemes “such as to create wealth or provide regular income in an indicative time horizon (short/ medium/ long term)”. Moreover, mutual funds would have to state a brief about the investment objective in a single sentence followed by kind of product in which investor is investing (equity or debt).

This will be followed by the level of risk in a colour box.

A blue colour coded box would indicate low risk, yellow would signify a medium risk, and brown would represent schemes with high risk.

As per SEBI illustration, a product label of an equity scheme which carries a brown label will say : “This product is suitable for investors who are seeking long-term capital growth, investment in equity and equity-related securities, including equity derivatives of top 200 companies by market capitalisation and carries high risk”. If an investor, who want to play safe and conserve capital and does not wants low or no exposure to equities, the brown colour could serve as a warning bell.

As per the guidelines, mutual funds would also have to include a disclaimer that “investors should consult their financial advisers if they are not clear about the suitability of the product”.

However, this new scheme has its own disadvantages. Financial products are much more complex. The type of risk associated with a product may differ with different products. As per the guidelines issued by the SEBI, the product labelling, all equity schemes will carry the high-risk tag, hybrid schemes will have the medium risk tag and fixed income schemes will have the low risk tag.

This is a very basic level of classification. In the same product category itself, there could be a huge difference in the return of the schemes. For example, over the last one year, the best equity scheme delivered a return of over 15%, but the worst scheme of the same category delivered a return as low as -14%. Further, there is no distinction of risks associated with index, large, small and mid-cap schemes. An index fund may offer comparatively lower risks than a small-cap fund. Also, an MIP and a balanced fund both would carry a yellow colour. While a MIP could have merely 5-10% equity component, a balanced fund could even have 70% of its corpus invested in equities, thereby carrying higher risk.

Investors need to consider their goals, and objective of investing in a mutual fund. Due diligence should be made before investing in any mutual fund scheme.

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