NISM_VA_Ch_10_Risk, Return, _ Performance of Funds

NISM VA Chapter 10 – Risk, Return & Performance Of Funds July 13, 2022

Learning Objectives Learn About: • General And Specific Risk Factors • Factors Affecting Mutual Fund Performance Of Different Schemes • Drivers Of Returns And Risk In A Scheme • Measures Of Returns • SEBI Norms Regarding Return Representation Of Returns By Mutual Funds In India • Risks In Fund Investing With A Focus On Investors • Various Risk Measure • Certain Provisions With Respect To Credit Risk

General Risk Factors Transaction Risk Liquidity Risk Foreign Currency Risk Interest Rate Risk Economic Risk Re-Investment Risk Political Risk 3

Risks Related To Equity Funds Dividend Short-selling and Derivatives stock lending 4 Mid-cap and small-cap companies

Risks Related To Debt Funds 01 Re-investment Risk Rating Migration Risk 02 03 Term Structure Of Interest Rates 04 Credit Risk 5

Risks Related To Debt Funds Segregated Portfolios REPO Transactions In Corporate Bonds Floating Rate Securities 1 23 6

Risks In Securitized Assets Credit Rating & Credit Enhancement 01 Pool Characteristics 03 02 Asset Classes 7

Factors Affecting Fund Performance Difference between market risk and company-specific risk 01 04 Systematic risk :: Fund managers adopt active 02 No-diversifiable management strategy to outperform the scheme’s benchmark index 03 Company (unsystematic) risk :: diversifiable by investing in diverse companies 8

Factors Affecting Performance Of Equity Schemes Equity returns are linked to Two approaches to analyze business earnings of a company a security – • Fundamental Analysis • Technical Analysis Equity as an asset class Security selection is an attempt to represents growth select good companies that are investment likely to generate good business earnings in future 9

Fundamental Analysis • Earnings Per Share (EPS) • Price To Earnings Ratio (P/E) • Price Earnings To Growth Ration (PEG) • Book Value For Share • Price To Book Value • Dividend Yield 10

Technical Analysis Study of share Technical Analyst Technical analyst Fundamental price and volume believes that the a.k.a. Analysis works of shares over time price behavior of a better for long term share over a period Chartists, throws trend for future work better for short investments price term investments 11

Growth Investment Style In market correction such stocks tend to decline more Valuation of these stocks tend to be higher because Typically have: High PE, High PEG, Low Dividend Yield many are accumulating these stocks Investing in companies that are likely to grow faster than market 12

Value Investment Style Picking up When the market “High Valuation” A share price may A company may be stocks that are will realise such is NOT the same be high, say seen as over-valued, priced lower stock’sreal value Rs.100, but still even when its share than their then the price as “High Share reasonably valued price is Rs.5 intrinsic value, will shoot up, Price” given its earnings based on usually takes a fundamental longer term analysis horizon 13

Portfolio Building Approach BOTTOM UP • Company TOP DOWN • Industry • Economy • Economy • Industry Stock selection is the key • Company Sector selection is the key 14

Factors Affecting Performance Of Debt Schemes Interest Rates Inverse Relation Credit Spreads Improved credit ratings will lower the spread and increase the value of debt 15

Factors Affecting Performance Of Gold Funds Global Price Of Gold Strength of rupee Direct relation, hence Inverse relation, higher the better hence stronger Rupee lowers gold returns 16

Factors Affecting Performance Of Real Estate Funds 01 Economic Scenario Direct relation Infrastructure 02 Development Direct relation 03 Interest Rates Inverse relation, cheaper rates promotes real estate 17

Measures of Returns The rate of return on an investment is determined by comparing the expense of acquiring the asset (outflow) or the initial value of the investment (inflows) to what is obtained from it (inflows). Periodic payments such as interest from fixed income securities and dividends from equity investments, as well as gains or losses from a change in the value of the investment, may both be sources of inflows. Simple return, ((End value – Start value)/Start value) * 100 Annualized return, (Simple return * 12)/Period of simple return (in months) Compounded Return, (Later Value / Initial Value) ^(1/n) – 1 Compounded Annual Growth Rate, The CAGR calculation is based on an assumption that the dividend would be re-invested in the same scheme at the ex-dividend NAV. Scheme Returns and Investor Returns, Investors might have a return profile that is different, on account of the role of loads. 18

SEBI Norms Regarding Representation of Returns by Mutual Funds in India Unless it's an assured returns plan, mutual funds aren't allowed to guarantee any returns. A guarantor must be identified in the SID for guaranteed returns schemes. If the plan is otherwise unable to pay the guaranteed return, the guarantor would be required to write a cheque. Advertisement Code and guidelines for disclosing performance related information of mutual fund schemes are prescribed by SEBI. 19

Pros and Cons of Evaluating Funds Only on the Basis of Return Performance The return on investment is the most important consideration for investors when choosing a mutual fund to invest in. To make the decision more reliable, consider the accuracy of the return performance as well as the performance relative to the scheme's benchmark and peer group funds. It is important for an actively managed fund to perform well in rising markets and fall less than the benchmark in a declining market. However, the return number alone is insufficient to decide whether to invest in or leave a scheme. The scheme's suitability for an investor's needs must also take into account the risk involved. This involves assessing variables such as return volatility over time. The degree of uncertainty shows the scheme's riskiness. 20

Risks In Fund Investing With A Focus On Investors Risks in Equity Funds Risks in Debt Funds Risks in Hybrid Funds Risk in Gold Funds Risk in Real Estate Funds 21

Measures of Risk Variance Standard Deviation Beta Modified Duration Weighted Average Maturity Credit Rating 22

Certain Provisions with respect to Credit risk In the debt markets, the credit risk occurs on account of three things, viz., default, delay in payments, or rating downgrade. Any of these may result in fall in prices of the concerned debt securities. Such an event is also called a credit event. Whenever a credit event happens, it may lead to reduction in the trading volume of the respective paper. In such a case, mutual funds may come under stress. In order to reduce the impact of such risks, SEBI has allowed two provisions: • 1. Gating or restriction on redemption in mutual funds. • 2. Segregated portfolios or side-pocketing 23

Gating Or Restriction On Redemption In Mutual Funds Liquidity issues Market failure or Operational issues exchange closure 24

Segregated Portfolio Or Side Pocketing To ensure fair treatment to all “Segregated portfolio” means a “Main portfolio” means the investors in case of a credit portfolio, comprising of debt or scheme portfolio excluding the event and to deal with the liquidity risk, SEBI permitted money market instrument segregated portfolio. creation of segregated portfolio affected by a credit event, that of debt and money market instruments by mutual funds has been segregated in a mutual fund scheme. schemes. 25

Summary: • The Scheme Information Document (SID) highlights to broad categories of risk: (a) Standard risk factors (b) Specific risk factors • To assess performance of equity schemes, two types of analysis can be done, namely, Fundamental Analysis & Technical Analysis • The credit rating profile indicates the credit or default risk in a scheme. Government securities do not have a credit risk. Similarly, cash and cash equivalents do not have a credit risk. Investments in corporate issuances carry credit risk. Higher the credit rating, lower is the default risk

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