|
Crisil
Exclusive : Tracking Volatility
Volatility ratings, read in conjunction with credit quality ratings,
can provide investors with a full picture of the risks they are taking
when investing in mutual funds.
The Smart Investor Team
Over the
last two years, the Indian debt markets have seen high volatility
because of the downward movement in interest rates and a compression
in the spread between gilt's and corporate bonds of equivalent maturities.
There were many interest rate cuts in the key international markets
and in the local space.
In such markets, volatility of debt mutual funds becomes very critical
to funds' performance. The funds with very high volatility or variability
in returns are more prone to report capital erosion in unfavorable
market conditions. Debt funds aim to provide regular income, by taking
low risks, to the investors unlike equity funds, which promise to
provide capital appreciation through aggressive investment strategies.
The performance of bond funds, among other factors, depends on the
credit quality of the assets in portfolio and changes in market yields.
True, there are standard credit quality ratings, but these only indicate
the quality of assets in the portfolio and do not capture the market
risk. Interest rate movements in the market have an inverse relationship
to the market value of the bond. No matter how good the asset is,
if the interest rates rise, there will be depreciation in the value
of the asset.
Empirical studies have shown that the fund management styles do not
change frequently. More so because the fund manager is guided by the
mandate given to him by the fund house as to how he will make the
investments.
The bond fund volatility metrics uses this to find out how volatile
the fund has been in the past and compares this with some fixed or
absolute benchmark of pure market volatility. Standard deviation of
the daily returns on fund net asset value as also the benchmark index
is used for capturing the volatility of the fund and the benchmark
indices.
The benchmark is usually a constant-maturity portfolio of government
securities (which do not carry any credit risk). The volatility rating
helps the investors to understand as to what level of market risk
he is buying into. It also helps the asset management company to communicate
the investment style of the scheme: aggressive or cautious in terms
of market risk.
A fund with low to moderate volatility is expected to give low but
more steady returns. However, a fund with very high volatility will
give high returns when the going is good but also carries the risk
of a sharp fall in returns in the face of adverse market situations.
Constant maturity benchmark indices have been used for comparing volatility
within a group of funds. The concept of constant maturity benchmark
portfolio is introduced to help the investor identify with the level
of volatility he is willing to take in his investments. It is easy
to interpret and communicate from the perspective of the fund house.
Further, interpreting the volatility across time frames will be difficult
without the constant maturity benchmark portfolios.
The use of government securities in the benchmark also takes away
the credit risk since these securities do not carry any credit risk.
The constituents of benchmark portfolios are changed regularly to
ensure that it contains only liquid securities and that the selected
securities represent all maturity buckets.
The volatility rating can be extended to other investment categories
like gilts and money market schemes, too.
The rating expression in the volatility rating maps the volatility
of the scheme's net asset value to the volatility of a representative
portfolio composed of government securities. Thus, the rating conveys
to the investor the level of volatility he is investing into.
Internationally, the credit quality rating is used in conjunction
with the volatility rating in the case of bond funds in order to give
a fuller sense of risk (credit risk + market risk) in a corporate
debt portfolio. Typically, the credit quality and volatility ratings
are written together like "AAAf / Vb2+".
As the fund market in India continues to develop and grow, the fund
ratings are going to increasingly guide the investors in selecting
schemes to invest in over and above the pure performance rankings.
Fund
People : The
New Breed
Fund
Manager of the Year
: DEBT
Dynamo
Fund
Manager of the Year
: Equity
whizkid
Penny
Wise : Are
big funds also the best?
Fund
People : The
fund Kingpin
|
