Color Code In Mutual Funds Is Not Enough

From July 2013, the  color code in mutual funds schemes got implemented. This was a new mandate by SEBI wherein every mutual funds scheme has to be label in a specific color (from three mandated) to show the level of risk and objectives of that scheme.  This was primarily done to ease the choice for investors. But it’s difficult to take a decision based on the color code alone. There are many other factors such as scheme performance, portfolio concentration, downside protection, your objective, etc… to decide whether any mutual funds scheme will actually fit your investment basket. At the most a color code can help you in first level of selection but then it has its own issues.

Let’s understand what these color code indicates and to what extent they are helpful for you –

What is the color code?

All mutual funds companies  have product label now where each scheme is coded in some color to differentiate the level of risk, investment objective, the nature of scheme and kind of instruments it is. There are three colors –Blue, Yellow and Brown within which mutual schemes are labeled.The label include details of the schemes such as “to create wealth or provide regular income in an indicative time horizon (short/ medium/ long term)”.Also mutual funds have to state a brief about the investment objective in a single sentence followed by kind of product in which investor is investing (equity or debt). They also need to carry disclaimer that “investors should consult their financial advisers if they are not clear about the suitability of the product’. This product labeling is carried in all common application forms, advertisement and product brochures companies come out with.

Colors

There are three colors which have been mandated for this purpose:

Brown– Any scheme with high risk is labeled in brown color. So all equity oriented schemes will be carrying this color code. However, there is no demarcation between the category of equity schemes which means whether it is an index fund, large cap fund or a  mid-cap fund, all have have brown color code against them.

Yellow– This color indicates that the scheme have a medium risk associated with it. All hybrid funds i.e. balanced fund and monthly income plans carry this color code.

Blue: This color indicates that the scheme carry lower risk. Debt Mutual Funds i.e. gilt funds, FMPs, Liquid funds or income fund are categorized under this color code.

With this color code SEBI aims to ease the selection process for investors. Through color codes investors will be able to differentiate between the high and low risk schemes.

Does it really benefit ?

A color code can only be taken a the first level of selection which does not require much of a research.  The more rigorous process is  when one has to create an optimum portfolio with mix of these schemes. One of the bigger drawback of this color code process is that it  has put all equity or debt scheme under one risk proposition which is not enough and some of it not even viable. For e.g. A sector funds carry much higher risk then a large cap diversified fund. Similarly there is a great difference in the level of risk between a balanced fund and an MIP. In fact a balanced fund is an equity oriented scheme where equity exposure can be as high as 75% while an MIP is a debt oriented scheme which can have a small 5% exposure in equity. Thus both of these categories are suited for different investors. The similar proposition holds in debt funds scheme where a liquid fund is a very low risk scheme while a gilt fund has higher risk associated. The second difficulty for investors is the objective statement as no MF scheme provides any fixed regular income. All options are through dividends or SWP which can vary and so it will not hold true for all of them.

Do your research

The color code is just a starting point for an investor to differentiate between schemes. But you cannot rely on it as it only differentiates high, medium or low risk. Your  actual research starts within these when you need to find one which can match your requirement. For this you have to analyse various schemes on different parameters such as performance among peers/benchmark, its portfolio, downside protection, etc. Thus, even within blue color schemes you will have to do lot of comparison to make your choice.

Considering all the discussion above its wiser then that you do a proper research and do not make a decision based on the color codes only.

 How you select a mutual funds scheme? Is color code benefiting you?

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