Sebi's move to introduce a system of colour coding and product labeling will help mutual fund investors better understand the products and their suitability

The Securities and Exchange Board of India (Sebi) has added yet another dimension to the colours in your life.

From July 1, blue would also mean low risk; yellow would tell you that you are taking medium risk, and brown would indicate that you are putting your money in a high-risk product. Well, this comes after Sebi's decision to introduce a system of colour coding and product labelling for mutual funds. According to the market watchdog, these would help investors to better understand the product they are investing in and its suitability to them. All mutual funds would label their new as well as existing schemes from July. A colour code will give an investor a preliminary idea of the kind of product he is looking to invest in, Wealth Forum. However, this doesn't mean that you would ignore other traditional parameters used to select a scheme. Investors need to choose a scheme based on their financial goals, time horizon and risk tolerance.

How Does It Work?

All common application forms, scheme advertisements and product brochures would have a product label, which will tell you about the nature of the schemes, investment objective, the kind of instruments it will invest in and the risk it will carry. This will be followed by the level of risk in a colour box. This would mean that all debt schemes -- be it a fixed maturity plan (FMP), liquid fund, income fund or gilt fund -- will carry a blue colour code.

On the other, hybrid products like a monthly income plan (MIP), or balanced fund will carry a yellow colour code; while all equity funds --- be it an index fund, large-cap fund, small-cap fund or a sectoral fund-—will carry a brown colour code.

As per Sebi illustration, a product label of an equity scheme which carries a brown label will say: This product is suitable for investors who are seeking long-term capital growth, investment in equity and equity-related securities, including equity derivatives of top 200 companies by market capitalisation and carries high risk.

If a retired investor wants to conserve capital and does not want equity at all, the brown colour could serve as a warning bell and he could question the distributor if he has been offered a high-risk product. The colour coding will help an investor start a discussion with his advisor. For example, a 30-year-old investor investing for his child's education, which is more than 10 years away, could have more than 60% of his portfolio allocated to brown funds; while a retired person averse to equities should not have any brown fund in his portfolio.

There are many critics to the colour scheme, who feel that just three colour codes may not work for the investors. Having only three colour codes will not be a full and final solution for an investor. For example, an index fund which carries lower risk than a sectoral fund or a small-cap fund will also carry the brown colour. However, it is well known that an index fund carries the lowest risk amongst equity funds, while a sectoral fund carries highest risk. Thus it would be very difficult for investors to choose merely by seeing the colour code. Similarly, a monthly income plan (MIP) and a balanced fund both would carry a yellow colour. While a MIP could have merely 5-10% equity component, a balanced fund could even have 70% of its corpus invested into equities, thereby carrying higher risk. But then there are many others who believe that too many colours could eventually end up confusing an investor, than helping him. That means you should use the colour coding only as a starting point and do further research before signing up for a product.