Mutual funds invest in market-linked assets such as equities, bonds, money market instruments and commodities. Changes in the prices or value of these underlying assets affect a scheme’s net asset value (NAV), which means the value of an investor’s units can rise or fall.
This is why mutual funds are subject to market risk and do not assure returns or capital protection. The nature and degree of risk differ across schemes, depending on what they invest in and how their portfolios are managed.
Understanding these risks can help you select a scheme that matches your goals, investment horizon and ability to tolerate fluctuations.
Key Takeaways
- Mutual fund returns are market-linked because a scheme’s NAV reflects the value of the securities in its portfolio.
- Every mutual fund carries some degree of risk, although the type and level of risk vary across fund categories.
- Diversification can reduce security-specific or sector-specific risk, but it cannot eliminate broad market risk.
- An SIP encourages regular investing and may average the purchase cost over time, but it does not protect against losses.
- The Riskometer, scheme documents and portfolio disclosures can help investors assess a scheme before investing.
Table of Contents
What is market risk in mutual funds?
Market risk is the possibility that broad movements in financial markets will reduce the value of an investment. These movements may be driven by economic conditions, interest-rate changes, inflation, political developments, company earnings, global events or shifts in investor sentiment.
A mutual fund pools money from investors and invests it according to a stated investment objective. When the market value of the portfolio’s securities changes, the scheme’s NAV also changes. Investors may therefore experience gains or losses when they redeem their units.
Market risk is sometimes called systematic risk because it can affect a large part of the market. It cannot be removed entirely through diversification.
Why are mutual funds subject to market risk?
Mutual fund investments are subject to market risk because mutual funds invest in securities whose prices or values change with market conditions. The effect depends on the scheme’s portfolio:
- Equity schemes are affected by movements in share prices, company performance and market sentiment.
- Debt schemes are affected by interest rates, credit conditions and changes in bond prices.
- Gold and other commodity-oriented schemes are influenced by commodity prices and, where relevant, currency movements.
- International funds are also exposed to developments in overseas markets and exchange-rate movements.
Professional management and diversification can help manage certain risks, but they cannot prevent the portfolio from being affected by wider market movements. A scheme’s returns and invested capital are therefore not assured.
Types of risks that can affect mutual funds
The risks relevant to a scheme depend on the assets it holds and its investment strategy.
Equity risk
The prices of shares may change because of company performance, economic developments, valuations, sector conditions or investor sentiment. A decline in the value of portfolio companies can lower the NAV of an equity-oriented scheme.
Interest-rate risk
Bond prices generally move inversely to interest rates. When market interest rates rise, the value of existing bonds may fall, affecting debt schemes that hold them. Schemes with longer-duration portfolios are usually more sensitive to interest-rate movements.
Credit risk
Credit risk is the possibility that a bond issuer may delay or fail to make an interest or principal payment, or that its credit quality may deteriorate. A downgrade or default can reduce the value of the affected security.
Liquidity risk
Liquidity risk arises when a security cannot be sold quickly at a reasonable price. This may make it difficult for a scheme to sell an investment without accepting a lower value, particularly during stressed market conditions.
Inflation risk
Inflation reduces the purchasing power of investment returns. Even when the value of an investment increases, its inflation-adjusted return may be lower.
Currency risk
Funds investing in overseas securities may be affected by changes in exchange rates. Currency movements can increase or reduce the rupee value of returns from foreign investments.
Concentration risk
A scheme with significant exposure to a particular sector, theme, issuer or group of securities may be more affected by developments in that segment than a broadly diversified scheme.
What does “mutual funds are subject to market risk” mean for investors?
The statement means that a mutual fund’s value can rise or fall and that neither returns nor invested capital are assured. The extent of fluctuation will depend on the scheme’s portfolio, market conditions and the period for which the investment is held.
A temporary decline should not automatically be treated as a permanent loss. However, markets are not certain to recover within an investor’s required timeframe. This makes it important to choose a scheme whose risk profile and suggested investment horizon suit the goal for which the money is being invested.
How to manage market risk in mutual fund investments
Market risk cannot be eliminated, but these measures can help investors manage it in line with their goals and financial circumstances.
Diversify the portfolio
Spreading investments across asset classes, sectors and securities can reduce security-specific and concentration risks. However, diversification cannot prevent losses when the broader market declines.
Invest regularly through an SIP
A systematic investment plan allows investors to invest a fixed amount at regular intervals. This can result in more units being purchased when the NAV is lower and fewer when it is higher, a process known as rupee-cost averaging.
An SIP encourages investment discipline and reduces dependence on a single entry point, but it does not assure returns or protect against losses.
Match the scheme with the investment horizon
The scheme should reflect when the money will be needed. A fund prone to sharp short-term fluctuations may not suit a near-term goal. A longer investment horizon may provide more time to withstand volatility, but it does not assure positive returns.
Review asset allocation
The allocation across equity, debt and other assets should reflect the investor’s goals, investment horizon and risk tolerance. Periodic reviews can show whether market movements have shifted the portfolio away from its intended allocation.
Changes should be based on the investor’s circumstances, goals or the scheme’s characteristics, rather than short-term market movements alone.
Seek professional guidance where needed
A SEBI-registered investment adviser can help investors assess their risk tolerance, asset allocation and investment suitability. A mutual fund distributor can recommend and facilitate mutual fund transactions but operates in a different capacity from a registered investment adviser.
How to assess a mutual fund’s risk before investing
Start with the scheme’s Riskometer, which classifies its assessed risk from low to very high. Use it to compare the scheme’s risk level with your risk tolerance. Also review:
- The scheme’s investment objective and asset-allocation range
- The sectors, issuers and securities held in the portfolio
- Interest-rate and credit exposure in a debt scheme
- The suggested investment horizon
- The scheme’s benchmark and the benchmark Riskometer
- The Scheme Information Document, Key Information Memorandum and latest factsheet
Because portfolio risk can change, check the latest Riskometer disclosure instead of relying on the level shown when you first invested.
Source: SEBI Investor guidance on the Riskometer.
Key considerations before investing in mutual funds
Before investing, consider these factors to assess whether a mutual fund scheme suits your needs:
- Define the goal: Identify what the investment is intended to fund and when the money may be required.
- Assess risk tolerance: Consider both your willingness and financial ability to accept a decline in value.
- Understand the scheme: Review its investment objective, portfolio strategy, Riskometer and material risks.
- Look beyond past returns: Historical performance can provide context but does not predict or assure future results.
- Review costs: Consider the expense ratio, exit load and other applicable costs because they affect realised returns.
- Avoid return guarantees: Be cautious of any claim suggesting that a market-linked mutual fund offers assured returns or capital protection unless the scheme documents expressly provide for a permitted guarantee.
How to start an SIP with Bajaj AMC
Follow these steps to start an SIP with Bajaj AMC:
- Click “Invest Now” in the header of the Bajaj AMC website.
- Enter your PAN and the OTP sent to your registered mobile number, followed by your four-digit PIN.
- On your account home page, select a fund and click “Start SIP”.
- Enter the SIP amount, frequency, start date and duration.
- Under “Investment Mode”, choose either the direct or regular plan.
- Review the plan and AutoPay details, accept the terms and conditions, and click “Invest”.
- Select your preferred AutoPay method, such as UPI, net banking or debit card.
- On your payment app or bank’s page, review and approve the AutoPay mandate.
Once the mandate is approved, your SIP will be set up.
Conclusion
The warning that mutual fund investments are subject to market risk is more than a standard disclosure. It tells investors that a scheme’s NAV and returns depend on the performance of its underlying investments.
Different schemes carry different risks, so the decision should not be based on past returns alone. Review the Riskometer, portfolio, investment objective, costs and scheme documents before investing. Diversification, appropriate asset allocation and a suitable investment horizon can help manage risk, but none of these measures can assure returns or prevent every loss.
FAQs
Why do mutual fund advertisements say “subject to market risk”?
The statement is a prescribed risk disclosure that reminds investors that mutual fund returns depend on market performance and are not assured. Investors are also directed to read all scheme-related documents carefully before investing.
Do all mutual funds carry market risk?
Yes. Every mutual fund carries some degree of market or investment risk because its portfolio contains securities whose values can change. The level and nature of risk differ across equity, debt, hybrid, commodity-oriented and other fund categories.
Are all mutual funds equally risky?
No. Risk varies according to a scheme’s asset allocation, investment strategy, portfolio concentration, maturity profile, credit exposure and other factors. Investors can refer to the scheme’s latest Riskometer and documents to understand its assessed risk level.
Can market risk in mutual funds be completely avoided?
No. Diversification and asset allocation can help manage certain risks, but they cannot eliminate broad market risk. A mutual fund’s value may still fall when the markets or securities in which it invests decline.
Do mutual funds guarantee returns?
Mutual funds generally do not guarantee returns or capital protection. Their performance depends on the value of the underlying portfolio, which can rise or fall with market conditions.
Can I lose my entire investment in a mutual fund?
A mutual fund investment can lose value, and the degree of loss depends on the scheme and market conditions. Losing the entire investment would be an extreme outcome for a diversified scheme, but mutual funds do not provide an assurance against capital loss.
Are debt mutual funds free from market risk?
No. Debt mutual funds may be exposed to interest-rate, credit, liquidity and reinvestment risks. Their NAVs can fall even though they primarily invest in fixed-income securities.
Are mutual funds safer than individual stocks?
A diversified mutual fund may carry less company-specific risk than holding a small number of individual stocks. However, the comparison depends on the fund category and the stocks concerned, and a mutual fund can still experience market-related losses.
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