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Risky Mutual Funds That Investors Can Avoid

27 July 2022

We've all heard the phrase "Mutual Funds are a good form of investments," but this is a very general statement. Whether you are considering investing in Stocks or Mutual Funds, the most crucial thing is for you to understand which Stocks and Mutual Funds you SHOULD NOT invest in.

By avoiding the bad funds, your returns will automatically be admirable. Therefore, in this blog, we'll concentrate on a few mutual fund types that you should steer clear of.

Most Risky Mutual Funds You Should Avoid

  • Balanced Hybrid Mutual Funds

As the name suggests, Hybrid Funds are a combination of equity and debt investments that are designed to meet the investment objective of the scheme. Each Hybrid Fund has a different combination of equity and debt targeted at different types of investors.

Hybrid Funds carry an investment risk proportionate to the allocation of assets in their portfolio. Hence, it is important to analyze the portfolio of the scheme carefully to get a good understanding of the risks involved. For example, if you are investing in an Equity-Oriented Hybrid Fund, then you must look at the kind of stocks the fund owns. Are they majorly Large-Caps or Small/Mid-Caps? This helps you understand the risks better.

Further, it will also give you an idea of the kind of returns that you can expect. The biggest impediment to the success of Balanced Hybrid Mutual Funds, according to many Mutual Fund participants, is the taxation of such schemes.

As previously stated, a Balanced Hybrid Fund must invest 40–60% of its assets in either equity or debt. These schemes would be regarded as debt schemes for taxation purposes as a result of this investment mandate. For tax purposes, a Mutual Fund scheme must invest at least 65% of its total assets in Indian stocks in order to qualify as an Equity Mutual Fund scheme.

  • Fund of Funds

A Fund of Funds is a Mutual Fund that utilizes its pool of resources to invest in various other kinds of Mutual Funds available in the market. Alternatively, investment in hedge funds can also be made via this Mutual Fund.

Expense ratios to manage a fund of funds Mutual Funds are higher than standard Mutual Funds, as it has a higher managing expense. Added expenses include primarily choosing the right asset to invest in, which keeps on fluctuating periodically. This expense amounts to a substantial amount and is deducted from the annual returns generated by the asset management company. Tax levied on a fund of funds is payable by an investor, only during redemption of the principal amount.

However, during recovery, both short-term and long-term capital gains are subjected to tax deductions, depending upon the annual income of the investor and the time period of investment. It should be noted that the dividend received on the investment is not taxable, as the burden is borne by the issuing fund house.

  • Sector Mutual Funds

Sector Mutual Funds are equity schemes that invest in a specific sector of the economy. These sectors can be utilities, energy, infrastructure, etc. Sector Funds also sometimes referred to as Sectoral Funds can invest in stocks of companies with varying market capitalizations and security classes. These funds allow people to invest in the best-performing stocks in the specified sector.

For instance, a Sector Mutual Fund is an Equity Fund that places at least 80% of its capital in companies operating in the same industry. For example, 80% of the assets will be invested by technology funds in tech firms.  Because the portfolio is much less diversified as a result, the risk will be higher. The efficiency of the funds will be influenced by how well the stocks in that specific sector perform.

  • Small Cap Funds

Small-Cap Funds invest a major portion of their investible corpus into equity or equity-related instruments of small-cap companies. According to the Securities and Exchange Board of India (SEBI), small-cap schemes need to invest at least 80% of their total assets in small-cap companies.

Also, SEBI defines small-cap companies as those which are ranked below the 250th rank in terms of market capitalization. In monetary terms, these are companies with a market capitalization of less than Rs. 500 crores.

The Net Asset Value (NAV) of a Small Cap Fund is highly sensitive to the movements of its underlying benchmark. Hence, when the market conditions are not good, many small-cap funds suffer losses.

Having said this, it is also a great opportunity for investors who are willing to take the risk and desire aggressive growth. Small Cap Funds offer great potential to earn benchmark-beating returns.

However, these are highly risky investments and should be considered only if you can stomach the volatility in prices. Further, you can dedicate a small portion of your portfolio to small caps and stay invested for a long period to boost your wealth creation efforts. 

  • Credit-Risk Mutual Funds

Credit Risk Mutual Funds are debt funds that invest in low-credit quality debt securities. These funds have higher risks since they invest in low-quality instruments.

Credit risk funds have a higher risk as compared to other debt schemes. While the fund manager anticipates an upgrade in the credit rating of an underlying security, there is a possibility of a further downgrade of a low-rated instrument.

This can have a huge impact on the performance of the fund. Hence, you must consider investing in these funds if you have a medium-to-high risk tolerance and want to invest in debt funds.

You may also want to read Risks Associated With Mutual Funds

Conclusion

If you know what you're doing, investing in Mutual Funds is safe. When investing in equity funds, investors shouldn't worry about the returns fluctuating temporarily. Choose a Mutual Fund that aligns with your investment objectives and invest with a long-term time horizon.

Not everyone is a good fit for every Mutual Fund. Prior to making a decision, you should decide which Mutual Fund is best for you by taking into account all relevant factors and your financial objectives.

It is advised to conduct research and learn more about mutual funds before making an investment.

Happy Investing!

FAQs

What is the risk in Mutual Funds?

Investments are always accompanied by some risks. For instance, an investment tool like Mutual Funds offers benefits like value-for-money and diversification to investors but still bears some associated risks. The best an investor can do to minimize Mutual Fund risks is to learn more about them and practice ways to cushion the same.

How risky is Mutual Funds?

A mutual fund's level of risk is determined by the investments it makes. Typically, the risk will increase as the potential returns do. For instance, an equity fund is typically riskier than a fixed income fund because stocks are typically riskier than bonds.

In an effort to generate a higher return, some speciality mutual funds concentrate on specific investment categories, such as emerging markets. Additionally, these funds frequently run the risk of experiencing a larger value decline.

What makes Mutual Funds risky?

The fundamental reason which makes Mutual Fund investments risky lies in the fact that it puts money in a variety of investment instruments - debt, equity, and corporate bonds, among others. Since the prices of these investment instruments tend to fluctuate in response to several factors, investors may be subjected to loss.

It mainly happens because of the fall in the NAV of these investments. However, Mutual Fund investors can make the most of the risk-reward arrangement of the investment tool by identifying the risk involved in Mutual Funds beforehand.

What are the Types of Risks associated with Mutual Funds?

Most mutual funds are not assured, an investor might lose money over what he has invested. So, the immensity of risk in a mutual fund scheme is subjected to where the fund manager invests in. Depending on the investment objective and category, a mutual fund scheme can be subject to any or all of the following risks which could impact the scheme's performance:

  • Market Risk
  • Credit Risk
  • Interest Rate Risk
  • Liquidity Risk
  • Iinflation Risk

Disclaimer

The stocks mentioned in this article are not recommendations. Please conduct your own research and due diligence before investing. Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. NBT do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.
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