Product labelling

A scheme name like "XYZ Opportunities Fund" tells an investor very little. Is it for regular income? For long-term growth? How risky is it? Mis-selling thrives in that gap.

In 2013, SEBI introduced product labelling of mutual funds to address the issue of mis-selling and give investors an easy understanding of the kind of product they are investing in and whether it suits them. All mutual funds were required to label their schemes.

A product label, as the workbook describes it, is the snapshot of suitability that must accompany any product literature. It identifies:

• the objective of the scheme — wealth creation, regular income generation, or providing liquidity;
• the asset class in which the scheme will invest to achieve that objective;
• the suitable investment holding period; and
• through the risk-o-meter, the risk to the capital invested.

The label also carries a line that dates from the 2013 circular: investors should consult their financial advisers if they are not clear about the suitability of the product.

The risk part of the label is the risk-o-meter, a pictorial depiction of the risk to the principal, with six levels:

The rules that keep it current:

• Each scheme calculates its risk value from SEBI's parameters and shows it on the risk-o-meter.
• The risk-o-meter is evaluated monthly.
• Any change in the risk level must be communicated by a notice-cum-addendum and by email or SMS to unitholders.
• When disclosing performance against the benchmark, the fund must disclose the risk-o-meter of both the scheme and the benchmark.

For commodities, SEBI assigns risk scores by annualised volatility, computed quarterly on 15 years of benchmark index prices: below 10% scores 3 (Moderate); 10–15% scores 4 (Moderately High); 15–20% scores 5 (High); above 20% scores 6 (Very High).

Specialized Investment Funds are treated separately, with a five-level Risk-Band instead of the six-level risk-o-meter, to avoid confusion given that SIFs are riskier than other mutual fund schemes.

The workbook's caution: the risk-o-meter is a first step in analysing scheme categories, and should not be the only factor in an investment decision. Schemes in the same category can take different risks.

Priya, 29, has Rs 3,00,000 she will need in 8 months for her wedding. Her colleague recommends a small-cap fund that "did 40 per cent last year". She reads the labels of three schemes. The labels and readings below are illustrative.

The small-cap label already answers her question: its objective, asset class and holding period all point to a horizon of years, and its risk-o-meter says her principal could be at very high risk. A 20 per cent fall in the month before the wedding would cost her Rs 60,000.

The liquid fund's label matches her need. That is the label doing exactly what SEBI intended in 2013 — surfacing a mismatch before the money moves.

One more check: if the liquid fund's risk level changes next month, she will receive a notice-cum-addendum and an email or SMS. And for a gold fund, a gold index with annualised volatility of, say, 14 per cent would carry a commodity risk score of 4 — Moderately High.

Chapter 5 (Scheme Related Information) covers the risk-o-meter, its six levels, monthly evaluation, commodity risk scores and the SIF Risk-Band; Chapter 11, section 11.9, describes what the product label identifies; Chapter 12, section 12.2, dates product labelling to 2013 and ties it to mis-selling. Expect recall of the introduction year and purpose, the elements of a label, the number of risk-o-meter levels, and the frequency of evaluation.

• Introduced by SEBI in 2013, to address mis-selling.
• The label covers objective, asset class, suitable holding period and risk — not past returns.
• Six risk-o-meter levels for mutual funds; five Risk-Band levels for SIFs. Do not mix them.
• The risk-o-meter shows risk to the principal, evaluated monthly.
• A change in risk level needs a notice-cum-addendum plus email or SMS.
• Scheme and benchmark risk-o-meters are both disclosed alongside performance.
• The risk-o-meter is a first step, not the whole decision. The workbook says it should not be the only factor.
• The label describes the product; risk profiling describes the investor. Suitability is matching the two.