Colour codes for MF schemes confusing, say analysts

The colour-coding of mutual fund products ignores important risks such as interest rates, maturity and credit

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Colour-coding for mutual fund products, according to their risk profiles, has resulted in confusion among fund houses and investors, specially in the case of debt schemes.

Though the Securities and Exchange Board of India (Sebi)’s rules require funds to assign colours to products based on the risks to the principal invested, analysts say these ignore other risks such as interest rates, maturity and credit. Dhirendra Kumar, chief executive of Value Research, a mutual fund tracker, said, “Sebi is driving towards over-simplification, while mutual funds have developed a complex structure. There is not much you can derive from these colour codes. It just leaves investors confused.”

Earlier, Sebi had asked fund houses to categorise products according to risk profiles and colour-code each category for easy identification by investors. The three colour schemes are brown for high-risk products, yellow for medium-risk and blue for low-risk ones. The criterion considered is the risk on the principal invested. Based on this, all equity products have been classified as high-risk products, all debt as low-risk and all hybrid ones (mix of equity and debt) as medium-risk.

Though most fund houses have opted to follow these guidelines, they are using their discretion on debt product classifications. A chief executive of a mutual fund house said a liquid-plus fund could be classified as a medium-risk product by one and as a low-risk one by another. “This kind of classification could leave fund houses confused…This also highlights the need for a financial advisor for retail investors,” he said.

Funds cannot be classified as pure equity, hybrid or debt products, say officials. They say such definitions are unfair, as the levels of risk in each product vary. “For instance, a gilt product that invests in government securities could be considered safe if held to maturity. But it could lead to huge capital loss if the interest regime changes,” said the chief executive of a fund house.

Analysts say there should be sub-classifications for debt funds, as there are risks other than those associated with the principal. “There are risks involving interest rates, credit risks and risks related to returns that need to be taken into consideration,” said Hiren Dhakan, associate fund manager at Bonanza Portfolio. “An equity product can be viewed as a low-risk product for more than 10 years, but high-risk for less than a year.”

Officials said the colour-coding system was likely to aid the new cadre of distributors, set to be added to the fold of Association of Mutual Funds of India-registered distributors and financial advisors.

To raise the reach of mutual fund products, Sebi had created a category of distributors comprising retired government officials, teachers, bank officials, etc. They are allowed to sell only simple products. “It provides an indicative guidance for these distributors,” said a mutual fund house chief executive.”

Officials said since implementation was in the initial stages, they were following the regulator’s mandate. They added they were not holding talks with the regulator on the ambiguity surrounding the classification.