A brief note on mutual fund PRC matrix

The Potential Risk Class (PRC) matrix is a risk measurement framework introduced by SEBI in 2021 to help mutual fund investors evaluate and compare the risk levels of different debt mutual fund schemes. To elaborate, the mutual fund PRC matrix assesses the interest rate risk and credit risk of debt funds and assigns them to one of nine categories based on their risk levels.

Read on to know what is PRC Matrix in detail and how it works.

• Table of contents

1. PRC matrix meaning
2. PRC matrix categories
3. Relatively Low interest rate risk
4. Moderate interest rate risk
5. Relatively High interest rate risk
6. Assessing credit risk
7. How the PRC matrix helps investors ?
8. Comparing risk levels of funds
9. Matching risk appetite
10. Informed decision making
11. Portfolio risk assessment
12. Limitations of the PRC matrix
13. FAQ

PRC matrix meaning

The PRC matrix is a 3x3 grid that classifies debt mutual fund different risk profiles based on two parameters:

Interest rate risk: The risk arising from volatility in interest rates which impacts the prices of debt instruments.

Credit risk: The risk that the issuer of a debt instrument may default on interest payments or principal repayments.

Funds are classified into 3 categories for each risk type – relatively low, moderate, and relatively high. By combining the interest rate risk and credit risk categories, funds are assigned to one of 9 PRC matrix cells ranging from A-I (lowest risk) to C-III (highest risk).

PRC matrix categories

The 9 risk categories in the PRC matrix are below.

Relatively Low interest rate risk

- A-I: Relatively Low credit risk, Relatively low interest rate risk

- B-I: Moderate credit risk, Relatively low interest rate risk

- C-I: Relatively High credit risk, relatively low interest rate risk

Moderate interest rate risk

- A-II: Relatively Low credit risk, moderate interest rate risk

- B-II: Moderate credit risk, moderate interest rate risk

- C-II: Relatively High credit risk, moderate interest rate risk

These funds have a balanced exposure to both short-term and long-term debt instruments. They carry higher interest rate risk than relatively low interest rate risk funds but lower than relatively high interest rate risk funds.

Relatively High interest rate risk

- A-III: Relatively Low credit risk, Relatively high interest rate risk

- B-III: Moderate credit risk, Relatively high interest rate risk

- C-III: Relatively High credit risk, Relatively high interest rate risk

Assessing credit risk

The credit risk of debt funds depends on the underlying securities in their portfolios. This includes -

• Government Securities: Have the lowest credit risk as they are sovereign debt.
• AAA or AA Rated Instruments: High credit quality instruments from reputed private companies. Low credit risk.
• A, BBB, BB and below rated instruments: Comparatively higher risk of default. Funds investing in lower rated instruments have higher credit risk.
• Unrated Securities: These involve the most risk as their creditworthiness is not assessed by rating agencies.

Debt funds with higher exposure to lower rated instruments will be classified as Moderate or relatively High credit risk categories in the PRC matrix.

How the PRC matrix helps investors ?

The PRC matrix allows investors to assess mutual fund risk in a structured manner based on the two key risk factors. Its key benefits are below.

Comparing risk levels of funds

The PRC matrix provides an apples-to-apples comparison of the potential risks of different debt funds. Investors can identify funds that carry a risk appropriate to their needs.

Matching risk appetite

By classifying funds into distinct risk categories, the matrix enables matching risk appetite with suitable schemes. Conservative investors can opt for lower risk A-I funds and those willing to tolerate more risk can invest in higher risk C-III funds.

Informed decision making

The matrix ties in risk and return, allowing investors to make prudent decisions factoring in their investment horizon, goals, and risk tolerance. For instance, short term investors may prefer funds with low interest rate risk.

Portfolio risk assessment

Investors can evaluate their overall portfolio risk by examining the PRC ratings of the schemes within their portfolio. This allows portfolio rebalancing if required to achieve the desired risk levels.

Standardization and transparency

The PRC matrix brings in uniformity and standardization in risk assessment across fund houses. This enhances transparency for investors to compare funds.

Limitations of the PRC matrix

While the PRC matrix is a useful tool, investors should note that it also has some limitations.

• The matrix provides an indicative risk profile that is not guaranteed. Actual fund performance may differ based on market conditions.
• It focuses only on two risk factors - interest rate and credit risk. Other risks like liquidity risk are not considered.
• The risk classifications are based on portfolio allocation and average maturity. Any sudden changes in portfolio composition may alter the risk profile.
• It does not consider fund performance metrics like returns and volatility. Performance should also be evaluated along with PRC matrix risk ratings.
• Lower risk category does not mean zero risk. Even funds in A-I category are subject to some degree of interest rate and credit risk.

Conclusion

The PRC matrix aims to provide a structured framework for risk assessment of debt mutual funds. It enables investors to gauge portfolio risk levels in line with their investment objectives. However, the PRC matrix risk indicator should be viewed as a preliminary risk analysis tool and not the sole criterion for making investment decisions in mutual funds. Thus, investors should always consult a financial advisor before making investment decisions.

FAQs:

What is a PRC matrix?
A potential risk class (PRC) matrix helps evaluate the degree of risk a debt mutual fund can take. For the purpose of PRC, a debt mutual fund carries credit risk and interest rate risk.

How can a PRC matrix help investors?
A PRC matrix can help investors make an informed investment decision by taking into consideration their risk appetite.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. This document should not be treated as endorsement of the views/opinions or as investment advice.
This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.