Types of Risks Associated with Mutual Fund Investments
By Anupama Deshpande | May 23, 2018

Same as other types of investments, Mutual Fund Investments also have risks. There are some chances that you may lose some part of your invested money due to these risks. Therefore, all the mutual funds have to mention statutory details that "Mutual Fund investments are subject to market risks, read all scheme related documents carefully". Diversification of funds may reduce the risk to some extent.

The actual level of risk is dependent upon which type of assets class of mutual fund do you select for your investment. As much risk do you take, as much returns would you get. This means that in order to get higher returns from your investments, you will be ready to take more risks. With the change in the price, value or interest rates of the securities in which the mutual fund invests, the value of mutual fund investment may go up or down.

In order to manage Unsystematic Risks, the Mutual Fund may use derivatives including hedging for efficient portfolio management.

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Following types of risks are associated with Mutual Fund Investments:

1. Volatility Risk

   Equity and Equity related instruments are volatile in nature and are subject to daily price fluctuations due to various micro and macro economic factors affecting the securities markets. This may cause fluctuation in NAV (Net Asset Value) of the mutual fund schemes.

2. Liquidity Risk

   Liquidity risk refers to a firm's inability to meet its short term debt obligations. It happens when the firm is not able to convert its current assets into cash without incurring loss of capital. Assets which are very difficult to be sold in an illiquid market carry a liquidity risk. This risk is to be faced by the mutual fund investors.

3. Credit Risk

   Credit risk occurs when a borrower fails to repay the amount according to the agreed terms. It impacts negatively both on the principal and the interest. It results in inflow disorder and rise in collection costs. It is actually risk of probable loss to default by the debtor. As mutual funds also invest in debentures and other such debt oriented assets, credit risk is always involved there. Generally, mutual fund investors investing in fixed income funds are exposed to this risk.

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4. Systematic Risk (Market Risk)

   Systematic Risk is a Market Risk in simple words. As this risk affects the entire market, it cannot be diversified. This risk is caused by Macroeconomic factors such as change in government, political factors, economic crashes, threat of war, natural disasters, changes in taxation, etc. It specifies inherent risk in the unexpected nature of the market. It is external and uncontrollable risk. This risk can affect any company, any industry or any sector. All mutual fund investors have to face this risk.

5. Interest Rate Risk

   This risk is particularly related to debt mutual funds and hybrid funds. This risk is caused due to fluctuating interest rates. Changes in the interest rate will change the yield of the bond/ debenture. Generally, mutual fund investors investing in fixed income funds are exposed to this risk.

6. Exchange Rate Risk (Currency Risk)

   This risk occurs when there is a change in value of investment due to change in the value of currency exchange rates. This risk is associated with the international funds offered by mutual funds. As the fund managers of such funds invest in foreign assets, they are exposed to exchange rate risk. So the investors of international mutual funds may have Exchange Rate Risk (Currency Risk).

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7. Inflation Risk (Purchasing Power Risk)

   This risk arises when future cash flows from any investments will not be of worth much due to increase in inflation. Real returns are the actual returns minus inflation. Hence the real return will get reduced due to rising inflation. This will erode the income from an investment. Inflation reduces the purchasing power of money. Mutual fund investors are also exposed to such type of risk.

8. Reinvestment Risk

   This risk occurs due to uncertainty in the rate at which cash flows from an investment will be reinvested. This is because the debentures/ bond will pay coupons, which will have to be reinvested. The rate at which the coupons will be reinvested will depend upon prevailing interest rates at the time the coupons are received. Debt Mutual fund investors are exposed to such type of risk.

9. Country Risk

   It arises from the inability of a country, to meet its financial obligations. The value of an international investment comes down due to economic or social or political changes, change in taxation or instability in that country where the investment has been made. The investors of international mutual funds are exposed to this risk.

It is very important for you to first check as to which types of risks, you will be exposed to, if you invest in certain class of mutual fund. While investing, you may consider higher risk, if the returns of the funds are very attractive.

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