Equity mutual funds usually deliver gravity-defying profits to people adept at picking stocks. However, despite such high returns, investing in equity funds may also make you poorer if you do not trade carefully. This article discusses the top five risks associated with equity mutual funds in India so that you can neutralize or minimize the risks better.

Types of Risks in Equity Mutual Funds

Investing in equity funds may expose you to two broad risks - systematic and unsystematic. 

Unsystematic risk refers to the risks associated with a specific company or industry. In contrast, systematic risk refers to the risks characteristic of the broader market. An equity mutual fund investor is exposed to both types of risk. 

A company may face unsystematic risk because of several factors, including but not limited to a product recall, management change, regulatory shift, degradation in financial standards, or a new competitor’s arrival. All of these factors may make the company unstable and lead to a reduction in the stock price. Any stock price reduction has a ripple effect on the equity funds holding that stock, and they may tumble. 

Systematic risk is usually unpredictable and depends on a range of factors beyond the control of a company, such as geopolitical tensions, macroeconomic factors, interest rate changes, environmental issues, etc.  

Any intelligent equity mutual fund investor in India understands the various risks associated with mutual fund investments and takes steps to mitigate the risks.  

The following sections mention the top five risks associated with equity mutual fund investments. 

Five Systematic and Unsystematic Risks of Equity Mutual Funds

  1. Market Risk - Market risk refers to the systematic risk associated with equity market investments. Market risks depend on various geopolitical events, regulatory changes, interest rate changes, currency devaluation, etc. An example of market risk is the Great Recession of 2008. Before the unfortunate event, whoever invested in equity mutual funds saw a sharp degradation in their value. 
  2. Inflation Risk - Inflation reduces people’s purchasing power and eats into an investor’s profits from an equity mutual fund. For example, if an equity fund provides you with a 10% return and the inflation rate is 5%, your effective return becomes only 5%. 
  3. Liquidity Risk - Some mutual funds (read, ELSS or Equity Linked Savings Scheme) come with a three-year fixed lock-in period. Hence, you cannot sell the fund units before three years. Moreover, some illiquid stocks do not find enough takers, and if you buy such stocks, you may not be able to sell them. 
  4. Currency Risk - Some sectors, such as Information Technology, Exports, etc., react sharply to currency valuation changes. And, any sharp increase or decrease in currency rates might make the stocks in these sectors volatile. So, any equity mutual fund with overexposure to the IT or Exports sectors might be more prone to volatility risks.   
  5. Rebalancing Risk - Equity mutual funds in India have to follow the guidelines laid by the Securities and Exchange Board of India (SEBI). And, if the SEBI issues a guideline on fund portfolio restructuring, the mutual fund house has to rebalance the portfolio to adhere to it. Such rebalancing may tweak the returns in or out of the investors’ favor.  

How Can You Minimize the Risks of Investing in Equity Funds?

The Beta value of a stock may give you adequate hints about a stock’s susceptibility to volatility. The market Beta is generally 1. If a stock’s Beta is less than 1, you may consider the stock less volatile than the market and vice versa.

While investing in an equity fund, you may look at the Beta value of the stocks in the fund’s portfolio to measure the impact of volatility. If an equity mutual fund invests primarily in high-Beta stocks, its returns and risks are usually higher than an equity fund that invests in low-Beta stocks.   

 

It’s Time to Make an Informed Decision

The risks of equity mutual fund investments mentioned in this article can help you make better choices while investing. If you want to make consistent profits, consider diversifying your investment. PGIM Mutual Fund provides you with the right mix of risks and returns on its wide range of equity mutual funds. Click here to know the best way to find the top-performing equity mutual funds in India