11.7 Measures of Risk and Provisions Relating to Credit Risk

Measures of Risk for Equity Schemes

Standard deviation

Measures the dispersion of returns around their average, capturing total risk. A scheme with a mean return of 13% and a standard deviation of 17% has experienced returns roughly between -4% and +30% in about two years out of three.

Use it when the scheme is the investor's whole exposure, and compare it only within a category — a small cap fund's standard deviation should not be compared with a liquid fund's.

Beta

Measures sensitivity to the benchmark alone, capturing systematic risk.

Beta is meaningful only where the scheme is well diversified and the benchmark is genuinely relevant. Beta measured against an unrelated index is a number without content.

R-squared

Measures how much of the scheme's movement is explained by the benchmark. A high R-squared makes beta trustworthy; a low one means beta describes little of what actually happens.

Measures of Risk for Debt Schemes

Modified duration

The price sensitivity of the portfolio to a change in yields:

Approximate price change  ~  - Modified Duration x change in yield

A portfolio with modified duration 5.2 loses roughly 5.2% for a 1% rise in yields, before accrual. Macaulay duration, the weighted average time to receive cash flows, is also disclosed and is used in SEBI's duration-based category definitions.

Average maturity

The weighted average time to maturity of the holdings. Related to duration and a rough guide to rate sensitivity, though duration is the precise measure.

Yield to maturity

The yield of the current portfolio. A statement about risk taken, not a forecast of return. A YTM well above peers signals more credit risk, more duration risk, or both.

Rating profile

The split across sovereign, AAA, AA, A and below. The single most informative debt disclosure, and the one that distinguishes a manager who earned returns through research from one who simply bought lower-rated paper.

The Credit Rating Scale

Suffixes of plus and minus refine positions within a band. Short-term instruments use a separate scale, commonly A1 to A4 with A1 plus the highest.

The BBB minus boundary is the one to memorise. A downgrade from BBB minus to BB is a downgrade below investment grade, and it is precisely this that constitutes a credit event permitting segregation.

Provisions Relating to Credit Risk

Rating-linked single-issuer limits

Exposure to one issuer is capped according to the rating of its paper, so weaker credits attract tighter limits:

The additional two percentage points require prior approval of both the Board of Trustees and the AMC's Board of Directors. Government securities and treasury bills are outside these limits.

Sector limit

No more than 20% of net assets in a single sector, with an additional 5% permitted for housing finance companies within financial services.

Valuation and downgrades

Debt securities are valued daily using prices from independent valuation agencies. On a downgrade the valuation falls immediately, so the NAV reflects the deterioration on the day it is recognised rather than when a default eventually occurs.

Segregated portfolios

On a credit event — a downgrade below investment grade, a subsequent downgrade, a reverse downgrade or an actual default — the AMC may create a segregated portfolio, isolating the distressed holding so its uncertain value does not distort the NAV of the rest of the scheme. The mechanics are set out in section 8.7.

Stress testing and liquidity disclosure

Schemes, and particularly mid and small cap equity schemes, are subject to stress-testing and liquidity-disclosure requirements showing how long it would take to liquidate a stated proportion of the portfolio. These exist because liquidity evaporates precisely when redemptions rise.

Reading the Measures Together

No single measure describes a scheme. The useful combinations:

A high YTM with a weak rating profile tells a coherent story. A high standard deviation with a beta near 1.0 tells a different one — the volatility is not coming from market exposure, which points to concentration or style. The measures are most useful where they disagree, because that is where the interesting question lies.