How To Measure Risk In Debt Funds

In our previous issue, we discussed the various types of risks in debt funds. This time, we will discuss the Sebi-mandated methods for communication of the risk level in a fund. Like we have speedometers in cars, where the needle points to the speed, we have a risk-o-meter for mutual funds. This ‘meter’ is computed as per guidance given by the Securities and Exchange Board of India (Sebi), the regulatory body overseeing mutual funds. There are separate criteria for equity and debt funds, as the nature of the underlying risks are different. There are three criteria for debt funds: (a) credit risk, (b) interest rate risk, and (c) liquidity risk. There are objective parameters for assigning a value to each of these risk aspects. Briefly, for credit risk, there is a scale of 1 to 12, where 1 is for government securities and top-rated corporate bonds, and 2 is for AA+ rated...