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The “risk-o-meter” is a popular tool used by investors to assess the current level of portfolio risk in a mutual fund scheme. As per the SEBI regulations, it is mandatory for every mutual fund scheme to have a risk-o-meter. It should also be updated every month according to the changing risk levels of the scheme.But apart from the current risk level, it is also essential for the investors to know the maximum risk fund managers are willing to take in the scheme. For instance, if a debt mutual fund currently has a “Moderate” risk profile as per the risk-o-meter, then it might be categorized as a “High” risk scheme in the future if the fund manager adds risky assets to the portfolio.Thus, the investors should know the degree of the potential risk of the scheme at the time of investing to make informed decisions. In 2021, SEBI introduced the Potential Risk Class matrix in debt funds to provide this information to investors. Here’s everything you should know about the PRC matrix-
What is the Potential Risk Class (PRC) Matrix in Debt Mutual Funds?
From December 2021, SEBI has made it mandatory for every debt mutual fund scheme to have a PRC matrix. It defines the maximum level of risk any debt scheme can take.There are basically two different types of risks associated with debt mutual funds - interest rate risk and credit risk.If the interest rate increases, then the value of underlying bonds in a debt scheme will decrease, and the NAV of the scheme will fall. This is known as the interest rate risk.On the other hand, if the scheme has invested in debt papers of a company and the company defaults on the principal repayment or interest payment, then the underlying bond’s value decreases, leading to a fall in the scheme value. This is known as credit risk.The PRC matrix categorizes debt schemes based on the maximum level of interest rate and credit risks.
What are the Different PRC Matrix Categories?
As per the PRC matrix rule, there are three interest risk categories- Class I, II, and III, and three credit risk categories- Class A, B, and C.Schemes categorized as Class I have the lowest level of interest risk, whereas schemes that fall in the Class III category come with the highest level of interest risk.Similarly, if a debt scheme is categorized as Class A, then it has the lowest level of credit risk. If the scheme is classified as Class C, then it has the highest level of credit risk.If we combine the two, an A-I debt scheme has the lowest interest rate and credit risk level, whereas a C-III scheme has the highest interest and credit risk.
How Does the PRC Matrix Categorize Debt Funds?
The Potential Risk Class matrix uses Macaulay Duration (MD) and Credit Risk Value (CRV) for categorizing the debt schemes. To be precise, MD is used to determine the risk of interest rate, and CRV represents credit risk.Here’s a quick overview of what these terms mean-
- Macaulay Duration MD defines the duration within which an investor will recover the bond price through interest and principal repayment. It is represented in years. The shorter the bond MD, the lower the bond's risk of losing the interest rate.The weighted average of MD of all the instruments is used to determine the overall MD of a debt scheme. So, Class I schemes have the shortest MDs and lowest interest risk. On the other hand, class III debt schemes have the longest MD, leading to the highest risk level.
- Credit Risk Value SEBI has created 13 CRV categories for various debt instruments depending on their credit risk. For instance, government securities are known to have the lowest credit risk, due to which they have a CRV of 13. Similarly, AAA corporate bonds have a CRV of 12.The weighted CRV average of all the instruments is used for determining the overall CRV of a debt mutual fund. Thus, Class A schemes have CRVs of 12+, leading to the lowest potential credit risk. Class C schemes have a CRV of less than 10 and the highest credit risk.
What Does the PRC Matrix Look Like?
Here is the PRC matrix to help you understand the categories better-
| Maximum Credit Risk (CR) → Maximum Interest Rate Risk (IRR) ↓ | Class A (CRV >12) | Class B (CRV 10-12) | Class C (CRV <10) |
| Class I (MD up to 1 Year) | IRR – Low CR - Low (A-I) | IRR -Low CR - Moderate (B-I) | IRR- Low CR - high (C-I) |
| Class II (MD up to 3 years) | IRR - Moderate CR- Low (A-II) | IRR - Moderate CR - Moderate (B-II) | IRR- Moderate CR- High (C-II) |
| Class III (Any MD) | IRR-High CR-Low (A-III) | IRR- High CR- Moderate (B-III) | IRR- High CR- High (C-III) |
Using PRC Matrix to Invest in Debt Mutual Funds
Understanding and using the Potential Risk Class matrix can take you one step closer to becoming a savvy mutual fund investor. If you are in the process of analysing debt funds for your portfolio, then add the PRC matrix to your research arsenal to choose funds that best match your risk appetite.If you are new to the world of mutual funds, then discuss your investment objectives and risk appetite with a professional investment advisor to make the most of your investment.
DISCLAIMER
The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.
