MF colour codes: Good move but will it prevent mis-selling?

The Securities and Exchange Board of India, (Sebi), came out with a circular on product labelling for mutual funds to make the investors aware of any risks associated with it, and to address the issue of mis-selling, yesterday.

According to the circular, it has been decided that all the mutual funds shall 'Label' their schemes on the parameters as mentioned under:

First is the nature of scheme such as to create wealth or provide regular income in an indicative time horizon (short/medium/long term).

Moneycontrol.com

A Blue box would indicate; principal at low risk. Moneycontrol.com

Second is a brief about the investment objective (in a single line sentence) which is followed by kind of product in which investor is investing (Equity/Debt).

And third is the level of risk, depicted by colour code boxes:

A Blue box would indicate; principal at low risk.

A Yellow box would indicate; principal at medium risk.

And a Brown box would indicate; principal at high risk

Srikanth Meenakshi, CEO, Fundindia.com, said, "This is a laudable initiative from Sebi, but I am not convinced it will help the cause of mis-selling. Since there are just three colours to show the risks; a grade-wise points system of 1-10 would have worked better."

He further explains, just three colours do not serve the range of indicating risk. For instance, for hybrid funds; an equity oriented hybrid fund would have a yellow box. And a debt oriented hybrid fund too would have a yellow box. But in reality, the risks associated with each is very different.

Likewise, Gilt funds, FMP and liquid funds would have a blue box, but the risk associated with gilt funds is very different (due to longer duration) than liquid funds.

Meenakashi says, "The beauty of mutual funds is that it has a spectrum of products with different risks. Just three colours would not work; a spectrum of colours probably would have served better. Also, people would see the box and assume the risk of the product."

For instance FMCG and a large cap equity funds, both of which have a brown box, but the risks associated with FMCG funds would be slightly higher.

You will see the product labelling, on the front page of the initial-offering-application-forms. Also the application form, will come with information about the scheme. The product label will mention the nature of the scheme as well as a brief objective, and it will be visible easily.

Suresh Sadagopan, Mumbai based Certified Financial Planner, said, "This is a very good initiative from Sebi. I think, by having only three colours, Sebi wants to keep things simple." Sebi has been coming out with investor friendly initiatives for sometime now. Sadagopan says, "Sebi has taken many investor centric initiatives, but the most important part which I think, which is necessary is investor education." After all, unless there is enough investor education, all these initiatives won't work. Sadagopan is of the view that a regulator can do only up to a point, and it's also an investor's responsibility to get educated about the product he plans to invest in. For instance, even ULIPs mentions their charges in the terms and conditions, but investors don't read them.

According to the Sebi, circular, "This circular shall be applicable with effect from July 1, 2013, to all the existing schemes and all schemes to be launched on or thereafter. However, mutual funds may choose to adopt the provisions of this circular before the effective date."

When you buy an edible product in a super mall, it usually comes with a green - veg label or red-non veg label. While this has worked with edible products, only time will tell, if it will work for MFs. After all, with only three colours, there is a good possibility that the coloured box, would be used for mis-selling, defeating the very purpose as to why it will be introduced.