Understanding Risk and Return Profiles of Different Mutual Fund Categories

Investing in mutual funds involves understanding the trade-offs between risk and return. Different categories of mutual funds come with varying levels of risk and potential returns, and it’s crucial for investors to be aware of these characteristics to make informed investment decisions. In this blog, we will provide a comparative analysis of the risk and return profiles of various mutual fund categories and explain the concept of the riskometer.

Comparative Analysis of Mutual Fund Categories

Equity Mutual Funds

Large Cap Funds

Risk Level: Moderate
Return Potential: Moderate to High
Description: Invest predominantly in large-cap stocks, which are well-established companies with a stable performance record.
Example: SBI Bluechip Fund

Mid Cap Funds

Risk Level: High
Return Potential: High
Description: Focus on mid-sized companies that have the potential for significant growth but come with higher volatility.
Example: HDFC Mid-Cap Opportunities Fund

Small Cap Funds

Risk Level: Very High
Return Potential: Very High
Description: Invest in small-sized companies with high growth potential but also high risk and volatility.
Example: Nippon India Small Cap Fund

Multi Cap Funds

Risk Level: Moderate to High
Return Potential: High
Description: Invest across large-cap, mid-cap, and small-cap stocks, offering diversification benefits.
Example: Kotak Standard Multicap Fund

Debt Mutual Funds

Liquid Funds

Risk Level: Low
Return Potential: Low to Moderate
Description: Invest in very short-term money market instruments, providing high liquidity and stability.
Example: ICICI Prudential Liquid Fund

Ultra Short Term Funds

Risk Level: Low to Moderate
Return Potential: Moderate
Description: Invest in debt securities with short-term maturities, balancing returns and liquidity.
Example: Aditya Birla Sun Life Savings Fund

Short Term Funds

Risk Level: Moderate
Return Potential: Moderate
Description: Invest in debt securities with slightly longer maturities than ultra-short-term funds, aiming for higher returns.
Example: HDFC Short Term Debt Fund

Medium to Long Term Funds

Risk Level: Moderate to High
Return Potential: Moderate to High
Description: Invest in longer-term debt securities, offering potentially higher returns with moderate risk.
Example: SBI Magnum Income Fund

Gilt Funds

Risk Level: Moderate to High
Return Potential: Moderate to High
Description: Invest in government securities (gilts), known for their low credit risk but sensitivity to interest rates.
Example: ICICI Prudential Gilt Fund

Hybrid Mutual Funds

Conservative Hybrid Funds

Risk Level: Low to Moderate
Return Potential: Moderate
Description: Maintain a higher allocation to debt instruments to minimize risk.
Example: HDFC Hybrid Debt Fund

Balanced Hybrid Funds

Risk Level: Moderate
Return Potential: Moderate to High
Description: Maintain a balance between equity and debt, suitable for moderate risk-taking investors.
Example: SBI Equity Hybrid Fund

Aggressive Hybrid Funds

Risk Level: High
Return Potential: High
Description: Allocate a higher proportion to equities for potential capital appreciation, balanced with debt instruments.
Example: ICICI Prudential Equity & Debt Fund

Solution Oriented Mutual Funds

Retirement Funds

Risk Level: Moderate to High
Return Potential: Moderate to High
Description: Designed for long-term investment with a focus on retirement planning.
Example: HDFC Retirement Savings Fund

Children’s Funds

Risk Level: Moderate to High
Return Potential: Moderate to High
Description: Aim at fulfilling long-term financial goals related to children’s education and other milestones.
Example: ICICI Prudential Child Care Fund

Other Mutual Fund Categories

Index Funds

Risk Level: Moderate
Return Potential: Market-linked
Description: Replicate a specific market index (like Nifty 50 or Sensex), providing returns similar to the index.
Example: HDFC Index Fund – Nifty 50 Plan

Exchange Traded Funds (ETFs)

Risk Level: Moderate
Return Potential: Market-linked
Description: Traded on stock exchanges, tracking indices or commodities, offering liquidity and transparency.
Example: Nippon India ETF Nifty BeES

Sectoral and Thematic Funds

Risk Level: High
Return Potential: High
Description: Invest in specific sectors (like technology, healthcare) or themes (like ESG, infrastructure), focusing on growth opportunities in those areas.
Example: ICICI Prudential Technology Fund

Fund of Funds (FoFs)

Risk Level: Moderate to High
Return Potential: Moderate to High
Description: Invest in other mutual funds, providing diversification across multiple asset classes or fund managers.
Example: Franklin India Multi-Asset Solution Fund

International Mutual Funds

Global Funds

Risk Level: High
Return Potential: High
Description: Invest in international markets, offering diversification benefits and exposure to global economic trends.
Example: Franklin India Feeder – Franklin U.S. Opportunities Fund

Fund of Funds Investing Overseas

Risk Level: High
Return Potential: High
Description: Invest in other mutual funds domiciled overseas, providing access to global markets.
Example: ICICI Prudential Global Stable Equity Fund (FoF)

Tax Saving Mutual Funds

Equity Linked Savings Schemes (ELSS)

Risk Level: Moderate to High
Return Potential: High
Description: Offer tax benefits under Section 80C of the Income Tax Act, combining equity investments with tax-saving advantages.
Example: Axis Long Term Equity Fund

Understanding the Riskometer

The riskometer is a tool introduced by SEBI (Securities and Exchange Board of India) to help investors understand the risk associated with different mutual fund schemes. It categorizes mutual funds based on their level of risk, ranging from low to very high. Here is how the riskometer categorizes risk:

Low Risk: Funds with minimal risk, suitable for conservative investors (e.g., liquid funds).
Low to Moderate Risk: Funds with slightly higher risk but still relatively stable (e.g., ultra-short-term funds).
Moderate Risk: Funds with balanced risk and return potential (e.g., large-cap funds).
Moderate to High Risk: Funds with higher risk and potential for higher returns (e.g., mid-cap funds).
High Risk: Funds with significant risk and the potential for high returns (e.g., small-cap funds, sectoral funds).
Very High Risk: Funds with very high risk and the possibility of very high returns (e.g., small-cap funds).

Conclusion

Understanding the risk and return profiles of different mutual fund categories is essential for making informed investment decisions. By analyzing these characteristics, investors can choose funds that align with their financial goals and risk tolerance. The riskometer serves as a useful tool to gauge the level of risk associated with each mutual fund, helping investors make better choices.

Disclaimer: This blog is for educational purposes only and does not constitute investment advice. Please consult with a financial advisor before making any investment decisions.