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Mitigate associated investment risks with the assistance of Mutual Funds

June 27, 2019

Rishi Taparia 2 - Mitigate associated investment risks with the assistance of Mutual FundsThe recent SIP flow information from AMFI shows that the May 2019 SIP input was Rs.  8,183 crore, reduced than the April 2019 Rs. 8,283. While the drop is marginal, the reason behind it may be that investors are cautious of the NBFC sector’s latest spate of downgrades and defaults.

The crisis impacted investors from mutual funds because the fund houses exposed to debt of such firms had to write- off their investments. This meant the scheme’s NAV fell to write-offs extent. As a consequence, the fund houses also had to face the pressure of redemption and they had to liquidate high-quality papers in order to satisfy the redemptions.

One fine thing, however, came out of the debacle — it broke many investors’ misperception about debt funds being a secure investment.

While the level and type of risk differs in investments, the reality is that no investment is safe and secure. The greater the expected yields, the greater the risk is involved.

This shows that one should not only look at the anticipated yields while making investment choices, but also at the risks associated with such investment.

Mutual fund investment can assist in minimizing the multiple investment-related risks. Note, however, that mutual fund investments are not risk-free.

Here’s how some investment-related risk can be mitigated when investment is made in mutual funds:

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Inflation risk

If investment’s value does not rise above inflation, it can erode your money’s buying power. With reduced inflation-adjusted yields and with the cash you have, you will be able to buy less products and services.

You should therefore invest in resources that will, over time, value your wealth and thus counter inflation. Diversified equity funds would be a better choice than debt funds for this purpose. Equity funds are capable of generating greater long-term yields.

Business risk

It relates to the danger that because of any internal or external variables, the company / business in which you have invested may fail to achieve their goal, suffer losses, bankruptcy, etc. If you invest in just one company / business, because of the concentration of your investment, your risk will be greater and consequently your loss may be greater too.

As the mutual fund invests in the shares of many companies, it enables diversification of your investment. It is unlikely to underperform all of the scheme’s stocks at the same moment. Thus, if the stocks in the scheme underperform, your losses will be reduced, but your profits will also be limited.

Credit risk

This is a significant problem these days for debt investors. People are investing in debt instruments hoping to get back their principal amount along with interest on the maturity day of the instrument. Investors experience credit risk if the business delays or defaults in payment.

In general, credit risk debts give greater interest rates to compensate investors for their risk. You can choose Gilt Funds to handle credit risk; they invest in public bonds supported by sovereign guarantee. Note that the interest rate they give will be smaller while government securities are safer.

Moreover, invest only in debt schemes provided by mutual fund houses that follow solid investment procedures and have in place appropriate risk management mechanisms in place.

Interest rate risk

The interest rate of fixed-income securities also shifts when the RBI changes its policy rate. The value of debt securities is inversely linked to the interest rate. Therefore, the securities price will increase or decrease in line with the shift in interest rate.

Interest rate fluctuate more when the debt instrument’s duration is higher. If you want to invest in low-interest-rate debt funds, you can opt for short-term debts like liquid / overnight funds, ultra-short and low-duration funds, money market funds, etc.

Liquidity risk

This risk makes it impossible for you to redeem your investment whenever you wish. Some investment avenues come with a lock-in period and redemption is not permitted during that period. You may have to suffer capital loss even if it is permitted. If you find that the chosen route is inadequate or not appropriate for your requirements during the investment process, you will have no option but to stick.

You can invest in open-ended mutual fund schemes instead of investing in lock-in period avenues. Open-ended mutual funds enable you to select funds from various categories and sub-categories, to select funds depending on your requirements. It also enables you to invest systematically on a regular basis.

Conclusion

Because of multiple variables such as economic performance, fiscal and monetary policy changes, political changes, and so on, investments will always be susceptible to risk. While there will always be volatility on the market, one can decrease its effect by choosing the correct mutual funds after assessing your requirements and staying invested for the long term as the short-term effect of volatility is greater.

The risks associated with investments are mentioned in the offer documents, brochure, and other sources of product detail. Go through the details carefully to understand the risk involved before making any investment decision.

Included in the offer documents, brochure, and other product detail sources are the risks connected with investments. Go through the information closely before making any investment decision to comprehend the risk involved.

Rishi Taparia

Head – Academic Affairs, ICoFP

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