Summary of "NISM VA Mutual Fund Chapter 10 (Part 1) - RISK, RETURN & PERFORMANCE OF FUND | 2024 | #nism5a #nism"
Summary: NISM VA Mutual Fund Chapter 10 (Part 1)
Risk, Return & Performance of Fund | 2024
Focus: Risk Factors in Mutual Funds (Part 1 covers risk only)
Key Topics Covered
1. Overview of Risk in Mutual Funds
Mutual funds invest across various asset classes such as equity, debt, money market instruments, and fixed income securities. Each asset class carries different types of risks, which are broadly categorized into:
- General risks (applicable across asset classes)
- Specific risks (unique to equity or debt funds)
2. General Risk Factors in Mutual Funds
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Liquidity Risk The ability to convert assets into cash quickly without loss.
- Example: Savings accounts have high liquidity; real estate has low liquidity with lock-in periods and price fluctuations.
- Mutual funds may have lock-in periods (e.g., ELSS schemes with 3 years lock-in).
- ETFs’ liquidity depends on market trading volume.
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Interest Rate Risk Primarily affects debt funds and fixed income securities like bonds and government securities.
- There is an inverse relationship between interest rates and bond prices:
- When interest rates rise, bond prices fall.
- When interest rates fall, bond prices rise.
- Example: A bond with a 6% coupon becomes less attractive if new bonds offer 8%, causing its price to drop.
- There is an inverse relationship between interest rates and bond prices:
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Reinvestment Risk The risk that cash flows (coupon payments) from debt securities are reinvested at lower interest rates, reducing overall returns.
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Political Risk Political instability or elections can cause market volatility.
- Example: Indian markets rallied after the 2014 BJP election victory due to business-friendly expectations.
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Economic Risk Economic slowdown, fiscal deficits, and instability negatively affect investments.
- High fiscal deficits lead to government borrowing, impacting interest rates and market sentiment.
- Examples: Economic crises in Sri Lanka and Pakistan.
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Foreign Exchange Risk Applies to foreign portfolio investors (FPIs) investing in Indian mutual funds.
- Currency depreciation (e.g., INR vs USD) can reduce returns when converted back to foreign currency.
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Settlement Risk / Counterparty Risk Risk that one party in a transaction fails to fulfill their obligations (e.g., dividend or interest payments not made).
3. Specific Risks in Equity Funds
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Price Fluctuation / Volatility Equity prices fluctuate daily; investors must tolerate volatility.
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Liquidity Risk in Equity
- Blue-chip stocks (e.g., Reliance, TCS, ITC) have high liquidity.
- Small or less-researched stocks may have low liquidity, causing difficulty in buying or selling.
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Exchange Rate and Policy Risk Changes in currency value and government policies (taxation, regulations) impact equity fund NAVs.
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Short Selling Risk Involves borrowing shares to sell expecting a price decline.
- Profit if price falls; loss if price rises.
- Involves counterparty and liquidity risk.
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Market Capitalization Risk
- Large-cap: Market cap > ₹20,000 crore, stable but lower growth potential (e.g., Reliance, TCS).
- Mid-cap: ₹5,000 - ₹20,000 crore.
- Small-cap: < ₹5,000 crore, higher risk and volatility, potential for bankruptcy but higher growth.
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Dividend Risk Dividends are not guaranteed; companies pay dividends only when profitable.
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Derivatives Risk Futures and options trading involve counterparty risk and liquidity risk.
4. Specific Risks in Debt Funds
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Rating Migration Risk Credit rating of issuer (AAA, AA+, etc.) can be downgraded, impacting bond prices and investor confidence.
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Credit Risk Risk of issuer defaulting on interest or principal payments.
- Government securities have minimal credit risk; corporate bonds have higher risk.
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Interest Rate and Reinvestment Risks (Explained under general risks.)
5. Risk Management by Mutual Fund Managers
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Liquidity Risk Management Maintain some portion in cash or money market instruments to meet redemptions.
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Credit Risk Management Invest only in issuers with strong credit profiles after thorough due diligence (financial statements, credit ratings).
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Interest Rate Risk Management Manage portfolio duration actively; prefer short-duration securities when interest rates are expected to rise.
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Rating Migration Risk Management Invest in high-quality securities and monitor credit ratings continuously.
Professional fund management helps reduce risk compared to direct investing.
6. Factors Affecting Mutual Fund Performance
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Asset class characteristics (equity, debt, money market, real estate, gold) have varying risk-return profiles.
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Fund manager’s investment style:
- Active management: Stock picking, timing buys/sells.
- Passive management: Index replication (e.g., Nifty 50).
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Company-specific risk (unsystematic risk) can be reduced by diversification across companies and sectors.
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Systematic risk (market risk) affects all sectors and cannot be diversified away.
7. Important Concepts for Exam (MCC Questions)
- Systematic risk: Non-diversifiable risk (market risk).
- Unsystematic risk: Diversifiable risk (company-specific).
- Government securities are considered risk-free instruments (minimal credit risk).
- Fund performance should be measured relative to a benchmark.
- Sector funds carry higher risk compared to balanced or index funds due to sector concentration.
Key Terms & Instruments Mentioned
- Mutual Funds: Equity funds, Debt funds, ELSS, ETFs
- Asset Classes: Equity, Debt, Money Market Instruments, Fixed Income, Real Estate, Gold
- Stocks: Reliance, TCS, ITC (examples of large-cap, liquid stocks)
- Credit Ratings: AAA, AA+, etc. (by CRISIL and others)
- Derivatives: Futures, Options
- Government Securities (G-Secs)
- Interest Rates and their inverse relation with bond prices
- Foreign Portfolio Investors (FPIs)
- Market Capitalization Categories: Large-cap, Mid-cap, Small-cap
Methodology / Framework Shared
- Risk Categorization: General vs Specific risks
- Managing Risks in Mutual Funds:
- Liquidity: Maintain cash/money market instruments
- Credit: Invest in high credit quality issuers after due diligence
- Interest Rate: Active duration management
- Rating Migration: Continuous credit monitoring
- Diversification: To reduce unsystematic (company-specific) risk
- Performance Measurement: Relative to benchmark index
Disclaimers / Notes
- The content is primarily educational and aligned with the NISM Mutual Fund certification exam syllabus.
- Not direct financial advice; users should consult qualified professionals before investing.
- Emphasis on understanding concepts for exam preparation.
Presenter / Source
- Finance with Nobita (YouTube channel)
- Presenter explains Chapter 10 of NISM VA Mutual Fund certification focusing on risk factors in mutual funds.
This summary captures the finance-specific content related to risk, asset classes, mutual fund risk management, and performance measurement as covered in Part 1 of Chapter 10.
Category
Finance
