When you open a mutual fund factsheet, you'll often see a riskometer, frequently pointing to 'Very High Risk.' While designed to inform investors, this standardized gauge doesn't always provide a complete picture of a fund's actual risk profile or how it might behave during market fluctuations.
The Limitations of a Standardized Riskometer
Since January 2021, mutual funds have been required to calculate their riskometer score monthly, based on the underlying securities in their portfolio. This rules-based measure considers factors like company size, volatility, and liquidity of holdings. An average score above a certain threshold, typically 5, results in a 'Very High Risk' classification.
However, this standardization can be misleading. Financial expert Harsh Soni highlights that three funds with the same 'Very High Risk' label can exhibit significantly different risk behaviors. For example, the Parag Parikh Flexi Cap, UTI Nifty 50 Index, and Nippon India Small Cap funds were all classified as 'Very High Risk' as of August 31, 2026. Yet, their five-year annualised volatility and maximum drawdown figures varied considerably:
- Parag Parikh Flexi Cap: 10.56% annualised volatility, 14.01% maximum drawdown
- UTI Nifty 50 Index: 13.11% annualised volatility, 14.73% maximum drawdown
- Nippon India Small Cap: 17.53% annualised volatility, 23.18% maximum drawdown
These figures demonstrate that while the riskometer placed them in the same category, their historical performance during downturns and overall price swings were distinct.
Beyond the Label: What Investors Need to Know
Soni points out several crucial aspects the riskometer does not directly incorporate:
- Historical Declines: It doesn't show how much a fund has actually fallen in the past.
- Portfolio Concentration: The measure doesn't account for how concentrated a fund's holdings are.
- Correlation: It omits the correlation between different securities within the portfolio.
- Investor Time Horizon: Crucially, it doesn't consider when an individual investor might need to access their funds. A temporary decline impacts a long-term investor differently than someone with a short-term goal.
The 'Very High Risk' classification describes the portfolio's characteristics, not whether that level of risk is appropriate for *your* personal financial situation or goals.
Empowering Investors with Deeper Metrics
To gain a truly comprehensive understanding of mutual fund risk, Soni advises investors to use the riskometer as a starting point, not the final assessment. Investors should delve deeper into a fund's factsheet and examine metrics like:
- Historical Volatility (Standard Deviation): This shows how much a fund's returns have fluctuated over a period.
- Maximum Drawdown: This indicates the largest peak-to-trough decline in a fund's value during a specific period, providing insight into its worst-case performance.
By analyzing these additional metrics, investors can better comprehend how a portfolio has behaved under various market conditions and determine if those risks align with their investment horizon and comfort level. Looking beyond the simple 'High Risk' label is essential for making informed investment decisions.