Mutual funds make investments in a wide array of securities that possess their own risk profile. Their asset allocation helps investors comprehend this risk that is involved in the asset. It also mentions the classes of assets and provides additional information on the securities in which the fund manager invests. While all funds come with their own risks, it is the ability and skill of a fund manager which helps balance out the risks involved in the fund. While most of these are under the control of the fund manager, some of these market risks are beyond his control.
A fund manager may constantly be plagued with several macro-economic risks such as fluctuations in the rate of interest, rate of inflation, rate of taxes, government policies, central bank policies, and currency value. Liquidity risks can also prove to be a matter of concern for fund managers. It refers to its function of trading volume and any restriction in the volume of its securities can seriously hamper the ability of a fund manager to conduct transactions, thereby affecting the net asset value of the fund. Funds that make investments in small-cap or mid-cap funds are more susceptible to these risks. A fund manager must also be wary of corporate-performance risks involved in the market. Often, fund managers seek to profiteer by making investments in companies that are undervalued, but have a strong potential to improve their performance over a definite period of time. However, the belief of fund managers may be misplaced when these funds do not perform well due to their reduced revenue generation and increased costs, thereby leading to lack of interest on the part of investors. Non-diversification risks can also be involved especially when a mutual funds seeks to remove company-specific risks through diversification. However, this strategy may backlash at times when a certain sector of the capital market gets hold of a sizeable portion of the fund’s assets, exposing it to non-diversification.
When equity funds make investments in overseas securities, they need to watch out for the risks such as country and political risks and currency risks. Country and political risks can occur with the onset of failing relationships between countries. Also, if a country fails to meet its financial obligations, then the value of the fund may drop instantly. Currency risks occur when a fund invest a sizeable proportion in the corpus of their stocks, where the prices are denominated in the value of foreign currencies. Any changes in the foreign currency with respect to the Indian currency would have an adverse reaction in the value of the funds.
As a prudent investor, it is important that you speak to your financial advisor and make sure that your financial decisions are taken with prudence. After all it is your money that is at stake, and any miscalculations on your part can create a huge impact on your finances, making you weak not only in your present situation but also weakening your financial position in the future as well. Just to bridge your gap between your goals and finances you might force yourself to buy debt. Due to a weak income structure due to the global financial downturn, it might be difficult for you to repay. You might not be in a position to acquire more credit if your Credit Information Report (CIR) shows dents like default on payments such as repayment of credit card bills, personal loan or home loan repayments etc. Therefore, if you seek to avail credit make sure that you have enough finances to prepay your loans. Apart from that set aside finances for emergency situations such that you need not depend on external debt to finance your requirements.