Types of Risks Involved in Mutual Fund Investment?
All investments carry some degree of risk. Though mutual fund is considered a diversified investment vehicle, eliminate the risk completely. Still the risk involved in investing through the mutual fund will be much less than that when one is investing directly in those instruments.
Following are the types of risks Involved in mutual fund investments:
- Liquidity Risk: Some of the instruments in the portfolio such as thinly traded securities carry the possibility of not being saleable easily at or near their real values. Therefore, the fund manager may not be able to sell them quickly when required which results into affecting the price of the fund unfavourably. Liquidity risk generally occurs in fixed income / debt market. The fund manager is unable to sell an investment which is declining in value because there are no buyers.
- Credit Risk: In short, it is the risk of default on a debt that may occur if the borrower fails to make required payments in accordance with the agreed terms. It may involve loss of principal and interest as well. It occurs in fixed income / debt fund.
- Interest Rate Risk: It usually occurs in fixed income / debt market. Interest rate movement /volatility has a great influence on change in bond prices. Interest rate and bond price have a reverse relationship that means when interest rates rise, bond / debt prices of the securities fall and when interest rates fall, the bond / debt prices go up. Interest rate volatility will therefore lead to a large movement in the NAV of debt fund.
- Inflation Risk: It is sometimes also referred to as purchasing power risk. It states that the cash flows generated from a mutual fund investment will not be worth as much in the future because of changes in purchasing power due to inflation and one will received less future real value (after adjusting inflation) of the investment.
- Market Risk: It is the risk that the value of an investment will drop due to movement in market price of the securities. This may be caused by the macroeconomic factors. It is also called a Systematic Risk. It is not possible to eliminate this type of risk through diversification but it can be minimised with the help of hedging. The value of mutual fund investment may decline because of unavoidable risks that affect the entire market.
- Investment Risks: It is the probability of occurrence of losses due to the non receipt of expected return on any investment. For example, the NAV of a sector fund is linked to the performance of one particular sector and it will get impacted the most if that sector fails to perform well as expected and is therefore always more volatile than a more diversified portfolio of equities.
- Changes in the Government Policy: Changes in government such as changes in the tax rate, operational guidelines, etc. of a particular industry or sector will impact the business prospects of the companies of that industry or sector which will lead to affect the investments made by the fund.
- Country risk - This risk arises when there is a decline in the value of a foreign investment due to political changes or instability in the country where the investment has been made. It occurs in foreign / offshore fund.
- Currency Risk: It is a risk that arises from change in price of one currency against another. Whenever the investors have invested in assets of other than their own country then currency risk is involved in their investment. Currency risk will come into place when you invest your money in an international fund and when other currency declines against rupee. In that case, you will lose your investment value.