SEBI directs debt mutual funds to specify the maximum risks they can take

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When debt funds specify the maximum interest rate and credit risks, investors can take informed decisions

In a bid to further empower debt fund investors, Securities Exchange Board of India (SEBI) has come out with a mechanism that defines the maximum quantum of risk a scheme can take.

A circular issued on Monday by SEBI read, “It has been decided that all debt schemes be classified in terms of a Potential Risk Class Matrix (PRCM) consisting of parameters based on maximum interest rate risk (measured by the Macaulay Duration (MD) of the scheme) and maximum credit risk (measured by Credit Risk Value (CRV) of the scheme).”

Capturing risks during portfolio changes

The existing risk-o-meter captures the actual risk in the portfolio of the bond scheme. However, the portfolio may change over a period of time and the fund manager may choose to take more risk to increase returns. The new system of PRCM will give a clear idea of how much risk the fund manager can take. This will give two information points to investors – how much risk exists in the portfolio and how much risk the fund manager can take. This should help investors take more informed decisions.

The PRCM will have nine cells defined by three levels each of CRV and MD. The least potential risk level is defined by relatively low interest rate risk (Class I) and relatively low credit risk (Class A). The highest potential risk level is defined by relatively high interest rate risk (Class III) and relatively high credit risk (Class C).

MD and CRV of a scheme will be determined by the risk weights of the fixed income instruments it holds. While calculating both the CRV and MD, the proportion of assets under management invested in the bonds and their risk weights will be considered.

SEBI has allowed the fund houses to place one or more schemes in a cell of PRCM. If the fund manager chooses to take more risk than the one specified by the PRCM cell it has chosen, and the scheme moves to a cell with higher potential risk, then the same is treated as a change in the fundamental attribute of the scheme. “The potential risk class matrix may give a better idea of the risk associated with the scheme. But making it a fundamental attribute is a case of regulatory overreach,” says a senior fund manager.

The circular shall come into force from December 1, 2021 for all existing schemes. New debt fund schemes will choose the PRCM cell at the time of filing scheme information document for the new fund offer. Fund houses must also communicate the level of potential risk of a scheme to investors through SMS and provide a link of the mutual fund website. Like the risk-o-meter of the scheme, the maximum potential risk of the scheme (PRCM cell positioning) needs to be clearly mentioned in all scheme related communications to the investors.

Nikhil Walavalkar

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