"High risk equals high reward." If you're an investor, you've probably heard this saying before. It simply indicates that if an instrument offers a high return, it is quite likely that it also has a high risk. The same is true in the case of mutual funds. The risk-return characteristics of various mutual funds vary. When compared to other types of funds, some may provide larger returns but entail a greater level of risk. Now, since the increased risk does not correspond to the kind of rewards delivered, you are best off avoiding these risky mutual fund types.
Most Risky Mutual Fund Categories
- Small Cap Funds: Smaller firms can expand quicker than mid and large-cap enterprises. This is why small-cap equities often outperform large-cap and mid-cap enterprises during market rallies. However, they are likely to be hurt harder during market downturns. As a result, they are unable to create considerable alpha over mid or large-cap companies in the long run.
- Sectoral And Thematic Funds: A Sectoral Fund is an equity fund that invests at least 80% of its assets in companies in the same industry. For example, technology funds would invest 80% of their assets in technology businesses such as TCS, Infosys and others. Because the portfolio will be less diversified, the risk will rise. The success of the funds will be determined by the performance of the equities in that sector. Similarly, Thematic Funds are equity mutual funds that invest in companies that are related to a certain subject. At times, the sector might be fairly specific, such as energy, healthcare and so on. That is, they are just as risky as sectoral funds. Some Thematic Funds, on the other hand, follow broad topics such as business cycle, ESG and so on. These are so diverse that their portfolio is comparable to that of any other diversified fund. And you don't have anything special to give. Overall, diversified equities funds that invest across sectors and themes are preferable.
- Long Duration Funds: These funds must invest in debt securities having a maturity of at least seven years. Long-term paper prices are more susceptible to fluctuations in interest rates. As a consequence, as interest rates rise, the values of bonds owned by these funds fall, resulting in a negative NAV. This is what we are now seeing. Because the Reserve Bank of India (RBI) hiked interest rates this year, the category average return of Long Duration funds has fallen by roughly 2% year to date (January to July). These funds have also provided double-digit returns during periods of dropping interest rates, but when the interest rate cycle changes, they are likely to be hurt more than funds investing in shorter-term securities. As a result, investors must time their entrance and departure from these funds, which may be difficult for individual investors.
- Credit Risk Funds: These funds, as the name implies, take on credit risk. That is, they acquire papers with a significant chance of principal loss. Credit Risk Funds are required to invest at least 65% of their net assets in securities with lower credit ratings. These funds often have credit ratings of AA or below, with AAA being the highest. The fund management purchases these bonds or debt papers because they have higher coupon rates, resulting in larger returns for investors. Furthermore, if the grade improves, the capital gain is probable since the bond price in which the mutual fund has invested rises. However, things could not go as planned for the fund manager.
Buy Mutual Funds Online
Due to the lower risk and professionally managed fund, trying to invest in mutual funds online is a safer endeavour than investing in individual equities. However, mutual funds may still offer risks, and you can profit immensely by doing preliminary research on numerous mutual funds and then following these steps to purchase the best mutual funds for you. You may invest in mutual funds online via reputable brokers, and it is a good idea to talk with a financial counsellor before doing so.
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