Understanding the investment style matrix of your mutual fund scheme
28 May, 2025
Synopsis:
For Investors, it is essential to select mutual fund schemes that suit their financial objectives and risk tolerance.
SEBI mandated that mutual funds declare the potential risk class of their debt mutual funds through the PRC Matrix from December 1, 2021. The matrix analyses their Interest Rate Risk and Credit Risk potential to determine their total risk level.
Equity funds receive analysis through an equity-style box system that categorises investments as large, mid, or Small Capitalisation funds and Growth, Value, or Blend investment types, providing a clear strategic understanding.
Evaluation tools enable investors to select funds perfectly aligned with their risk appetite and investment objectives.
Imagine you are at a buffet and are confused about selecting food from a variety of dishes. You will decide to eat food based on your taste and preferences. Similarly, you need to understand the investment styles of mutual funds so that your investment aligns with your financial needs and risk tolerance.
Investing in different investment strategies requires a detailed understanding before making a decision. The assessment of mutual fund strategies relies heavily on two fundamental evaluation tools: the Potential Risk Class (PRC) matrix for debt funds and the Equity Style Box for equity funds.
Understanding the Potential Risk Class (PRC) Matrix for Debt Funds
To help investors make informed decisions, SEBI introduced a standardised tool called the Potential Risk Class (PRC) Matrix, also commonly referred to as the Debt Style Box. This framework is designed to simplify how investors evaluate the overall risk exposure of debt mutual fund schemes.
The Debt Style Box follows a 3x3 matrix, where each fund is assessed based on two core risk factors:
- Interest Rate Risk: the fund’s sensitivity to changes in interest rates
- Credit Risk: the risk of default or credit downgrade of the securities held
Each of these two risk components is classified into three categories:
Interest Rate Risk:
I - Low
II - Moderate
III - High
Credit Risk:
- A - Low
B - Moderate
C - High
Every debt fund is placed into one of the nine possible combinations, such as A-I, B-II, or C-III. For example:
A debt fund rated A-I is considered to have low interest rate sensitivity and low credit risk, making it more conservative in nature.
On the other hand, a fund labelled C-III carries high credit risk and high interest rate risk, indicating a more aggressive strategy suitable only for high-risk investors.
This style box allows investors to visually interpret the risk-return profile of debt mutual funds and choose schemes that align with their own investment horizon and risk appetite.
Understanding the Equity Style Box
Morningstar developed the Equity Style Box to illustrate a fund's investment orientation and help investors better understand its characteristics.
This 3x3 grid assesses:
1. Market Capitalisation- shows the allocation of funds between companies of different sizes, categorised as:
Large-Cap
Mid-Cap
Small-cap.
2. The Investment Approach of the fund:
Growth
Value
Blend (combination of value and growth)
The fund utilises each of the nine available combinations to display its strategic approach. A fund in the "Large-Cap Growth" category utilises its principal investments to target firms with solid growth prospects. This evaluation tool allows investors to allocate resources to suitable investments based on personal preferences.
Understand the complexities of the PRC matrix and the Equity Style Box, as they enable you to select funds that match your financial needs and risk management capabilities. Evaluating funds through these tools provides individuals with clear information about their investment risk characteristics and strategic objectives, enabling investors to make more informed investment decisions.
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