An individual should invest based on this risk-taking ability, but how to determine the risk of a mutual fund? Read full article
Before investing in mutual funds, people are normally concerned about the risk associated with it. In India, most of the people have never invested in any market-linked instrument and are not exposed to the concept of market risk or in simple terms the everyday fluctuating value of the investment. So people normally save money and deposit it in banks or buy an insurance product.
Now coming back to investment in the mutual fund; every individual has his risk-taking ability. An individual should invest based on this risk-taking ability. Sometimes investment objective also dictates the risk-taking ability. Let us see an example to understand the risk-taking ability of a person based on his/her investment objective; if someone is saving money for any event that will happen in six months or one year, he/she will not want to lose value his invested money due to market fluctuation. In this example his/her risk-taking ability is low. Now the question arises how to identify and measure the risk of market-linked products like mutual funds, share and other financial instruments. In this article, we shall discuss the market risk of mutual funds.
Most of the literature available in the public domain which talks about the descriptive risk of mutual funds and different fund category. The descriptive text does not help an individual in making an investment decision. What about some quantitative measures that spells out how much he/she will lose in a worst-case scenario. There are couples of measures that can quantify the risk of a financial instrument. An individual can use these measurements for making an investment decision based on his/her risk-taking ability or investment objective.
In the following analysis, we have calculated the risk at the fund category level. It will help an individual in deciding fund category based on his requirement. Say if any individual wants to invest in mutual funds and does not want to lose his investment amount; is there any fund category like that or not? If yes which fund category.
We have done this analysis for the period between 1 October 2015 to 30 September 2020. The period includes a large drop in the market, that will give us a fair idea of risk for each category of funds.
First, I have calculated the drawdown and EVT VaR for and each fund after that I have taken the median value at fund category level for both of the risk measures.
Table 1 shows the category-wise details of equity funds. The table has the fund category and its median drawdown, median EVT VaR of one month scaled to one year, and an annualised median return of five years. The table is ordered by the lowest drawdown to highest.
As per SEBI regulation equity funds are divided into 11 categories. One category is of sectoral or thematic funds. This category can be subdivided into multiple categories like banking & financial services, infrastructure, pharma and technology. These subcategories will cover most of the funds in the sectoral or thematic funds category.
How to read Table 1?
Answer: Drawdown median of a category tells us that from the maximum value in the last five years it has fallen by this much per cent. For example, the technology fund category median fall from the top is -23.2%. Similarly, EVT VaR (95% 1Year) says at 95% certainty one-year loss in the technology fund category will not exceed 18.6%.
| Fund Category | Drawdown Median | EVT VaR (95%, 1Y) Median | Annual Return (last five year) |
|---|---|---|---|
| Technology Fund | -23.16% | -18.55% | 14.85% |
| Pharma Fund | -23.36% | -27.7% | 4.82% |
| Consumption Fund | -26.59% | -28.07% | 8.82% |
| Large Cap Fund | -26.92% | -25.51% | 6.35% |
| Multi-Cap Fund | -28.57% | -27.36% | 6.24% |
| ELSS (Tax Saving Fund) | -28.7% | -27.96% | 6.9% |
| Focussed Fund | -29.11% | -26.99% | 7.46% |
| Contra Fund | -29.41% | -29.03% | 8.82% |
| Large & Mid Cap Fund | -30.46% | -28.05% |
7.22% |
| Dividend Yield Fund | -31.84% | -26.1% | 7.03% |
| Mid Cap Fund | -32.22% | -35.1% | 7.04% |
| Value Fund | -36.32% | -32.43% | 5.86% |
| Banking and Financial Services Fund | -37.43% | -33.65% | 6.59% |
| Infrastructure Fund | -40.87% | -35.89% | 1.84% |
| Small Cap Fund | -44.01% | -36.2% | 6.71% |
Table 2 shows the category-wise details of debt funds. The table has the fund category and its median drawdown, median EVT VaR of one month scaled to one year, and an annualised median return of five years and is ordered by the lowest drawdown to highest. Debt funds will also have credit risk that is not covered in this analysis. Debt funds have low drawdown and EVT VaR compared to equity or hybrid funds. The low maturity period (liquid, money market, overnight and ultra-short duration funds show very low drawdown (zero) and EVT VaR (zero). If the historical performance of these funds continues in future; they are suitable for preserving capital and a decent amount of return.
| Fund Category | Drawdown Median | EVT VaR (95%, 1Y) Median | Annual Return (last five year) |
|---|---|---|---|
| Liquid Fund | 0% | 0% | 6.64% |
| Money Market Fund | 0% | 0% | 7.33% |
| Overnight Fund | 0% | 0% |
5.64% |
| Ultra Short Duration Fund | 0% | 0% | 7.29% |
| Floater Fund | -0.14% | 0% | 8.07% |
| Short Duration Fund | -0.56% | -0.75% | 7.74% |
| Corporate Bond Fund | -0.57% | -1.38% | 8.39% |
| Low Duration Fund | -0.66% | 0% | 7.42% |
| Banking and PSU Fund | -0.69% | -1.19% |
8.55% |
| Gilt Fund with 10-Year Constant Duration Fund | -2.67% | -3.03% | 10.44% |
| Medium Duration Fund | -2.86% | -2.83% | 7.05% |
| Dynamic Bond | -2.87% | -4.47% | 7.49% |
| Long Duration Fund | -3.52% | -6.37% | 9.3% |
| Medium to Long Duration Fund | -3.81% | -4.77% | 7.61% |
| Gilt Fund | -3.92% | -5.65% | 8.59% |
| Credit Risk Fund | -6.92% | -4.29% | 5.43% |
Table 3 shows the category-wise details of hybrid funds. The table has the fund category and its median drawdown, median EVT VaR of one month scaled to one year, and an annualised median return of five years and is ordered by the lowest drawdown to highest. As hybrid funds are a mix of equity and debt assets, it shows drawdown that is middle of equity and debt funds.
| Fund Category | Drawdown Median | EVT VaR (95%, 1Y) Median | Annual Return (last five year) |
|---|---|---|---|
| Arbitrage Fund | -0.28% | 0 | 5.74% |
| Conservative Hybrid Fund | -6.79% | -6.84% | 6.22% |
| Equity Savings Fund | -12.28% | -9.71% | 5.91% |
| Dynamic Asset Allocation or Balanced Advantage Fund | -16.74% | -12.4% | 6.53% |
| Balanced Hybrid Fund | -19.49% | -19.85% | 7.39% |
| Multi-Asset Allocation Fund | -19.73% | -10.77% | 7.32% |
| Aggressive Hybrid Fund | -22.46% | -21.11% | 5.61% |
Table 4 shows the category-wise details of other funds. The table has the fund category and its median drawdown, median EVT VaR of one month scaled to one year, and an annualised median return of five years and is ordered by the lowest drawdown to highest. This category includes gold ETF and funds investing in the overseas market funds.
| Fund Category | Drawdown Median | EVT VaR (95%, 1Y) Median | Annual Return (last five year) |
|---|---|---|---|
| Gold ETF | -12.32% | -18.54% | 12.2% |
| FoF Domestic | -14.6% | -13.97% | 7.21% |
| FoF Overseas | -24.71% | -24.3% | 4.34% |
| Index Funds | -29.21% | -22.22% | 7.53% |
| Other ETFs | -29.22% | -22.5% | 7.99% |
A quantified measure of risk like shown above can help investors clearly aligning his fund selection with his/her risk-taking ability and investment objective. Risk of individual funds is coming soon... watch this space.