CHAPTER VI RISK TOLERANCE AMONG MUTUAL FUND INVESTORS 6.1. Introduction Risk and return are inseparable twins 1. In generic sense, risk means the possibility of financial loss. In the investment world, risk refers to the possibility of losing money (both principal and any earnings) or fail to make money on an investment. A fund with stable, positive earnings is less risky than a fund with fluctuating total return. Risk is thus equated with volatility of earnings. ICI surveyed mutual fund investors and reported that 57 percent define risk as the chance of losing some part of the original investment 2. The subprime mortgage crisis of 2008 and the global financial crisis of 2009 have caused investors in financial products serious losses. This and the risks inherent to financial products have given rise to a more cautious attitude towards such investments. Faced with the series of financial 1. Jonathan Burton (2001), Investment Titans, McGraw-Hill, USA, p.3. 2. John A. Haslem, Mutual Funds: Risk and Performance Analysis for Decision Making, Blackwell Publishing Limited, USA, p.166.
169 events leading to the current turmoil, unpleasant investor experience has become common and these personal experiences and reports of such are demonstrated in risk and attitudes to risk. Over the past decade, financial institutions have designed financial products having varying degrees of risk to meet differing investor preferences. These products range from very simple time deposits to complex structures with linked notes, all of which can vary significantly in their degree of risk. Naturally potential returns vary similarly. Thus investors are able to choose an investment with potential risk and returns to suit their own preferences. However, at the time of purchase, investor behaviour is formed by factors including expert advice from management consultants, and reference to past investment experience. Investors who have experienced loss make new investment decisions bearing such in mind. Additionally, investors refer to financial news and other information sources as basis for their assessment of risk in products they are considering. All these factors affect investor perception of risk, and aversion of risk. Compared with other financial instruments, the risk is low in mutual funds, but mutual funds are not free from risks. It is so because basically the mutual funds also invest their funds in stock market on shares which are volatile in nature and not risk free. Mutual funds have internationally proven to be a popular retail investment. It is an ideal investment vehicle in today s complex and modern financial scenario. The retail investors in the market need to allocate their money sensibly and refine it in step with their needs. Mutual funds are a good way to do it. Mutual funds collect the savings of investors and invest
170 them in to various financial instruments like shares, debentures, bonds etc. So the investor gets a benefit of all the financial instruments and also the negatives of the instruments. An efficient mutual fund can manage the investments in a successful way. 6.2. Mutual Fund Risks Investing in mutual fund is not only spending and making money, it is a commitment of funds in financial market. The following risks are inherent in mutual funds. 6.2.1. Market Risk The prices of shares are subject to wide price fluctuations depending upon market conditions over which nobody can control. This is called market risk. It can be reduced but cannot be completely eliminated even by a good investment management. Every economy has to pass through a cycle, boom, recession, slump and recovery. The phase of the business cycle affects the market conditions to a large extent 3. 6.2.2. Political Risk Successive governments bring with them new economic ideologies and policies. It is often said that many economic decisions are politically motivated. Changes in the government bring in the risk of uncertainty which every player in the financial service industry has to face. 6.2.3. Industry Risk This risk arises from the possibility that a group of stocks in a 3. Gordon, Natarajan, (2009), Financial Market s and Services, Himalaya Publishing House, Mumbai, p.306.
171 single industry will decline in price due to changes in the industry. For example, if any bad news comes from software industry, it will affect the software companies share price. This is a common risk. 6.2.4. Manager Risk This risk arises from the possibility that an actively managed mutual fund's investment adviser will fail to execute the fund's investment strategy effectively, resulting in the failure of the stated objectives. 6.2.5. Currency Risk This risk arises from the possibility that returns could be reduced for Indians investing in foreign securities because of a rise in the value of the Indian rupee against dollar, yero or yen etc. This is also known as exchange rate risk. 6.2.6. Risk in Change of Management It is not uncommon for a mutual fund to have changes in its management. The change in the funds management may effect the achievement of the objectives of the fund. The fund company may, for various reasons, replace a fund manager or may be the fund manager himself may resign from his job for any reason. This change will be significant since the fund manager controls the fund investments. 6.2.7. Investor Psychology Risk The investor psychology is such that most of the investors, be it mutual fund, behave like reactionaries. E.g. they enter the market when the market starts rising and they get panicky and exit as soon as market starts falling.
172 Investors resort to selling their investments when market starts looking down. Because of this, there will be a pressure to mutual fund manager to redeem the units. As a result of this, along with the redeeming unit holders, all the other unit holders who have invested in the fund suffer. 6.2.8. Choice Risks There are a number of schemes available in the market like equity schemes, sector schemes, index schemes, balanced schemes etc. The investor should select the right scheme at the right time. Sometimes, all sectors are not performing well in bull market. If the investor did not select the right scheme in the right time it affects the return of his investment. This is an important risk in mutual funds. 6.2.9. Risk of Changes in Regulatory Norms Mutual Funds are constantly regulated by SEBI and AMFI. SEBI introduce various regulatory norms time to time. This is mainly for the protection of investors and avoids fraudulent activities in market. Investors are subject to risk of the changes in the norms for the mutual funds. The above risks are common in mutual funds. In this chapter, the researcher made an attempt to analyse the risk tolerance among mutual fund investors with the help of the statistical tools like garrett ranking, t-test and regression. 6.3. Investors Perception on Risk among Types of Mutual Funds Mutual fund investments are subject to market risk. In addition to market risk, there are so many risks involved with mutual funds. Mutual funds are classified mainly on the basis of its nature of investment. The main types are
173 debt fund, gold fund, balanced fund, and diversified fund, tax saving fund, equity fund, index fund, reality fund and sector fund. Debt oriented schemes invest bulk of their funds in fixed income avenues like debentures, bonds, government securities and money market instruments. Equity schemes invest their major portion to equity shares. Balanced schemes lie between equity oriented schemes and debt oriented schemes. Diversified fund portfolio is diversified in nature. Tax saving fund is an equity fund which has a lock in period of three years. Gold funds in India are an exchange traded fund. Index funds portfolio follow the same pattern of the funds respective index like sensex, nifty etc., Sector funds invests in a particular sector like bank, infrastructure etc. Every fund has its own risk. The respondents are asked to rank the nine funds based on their risk level (rank from low risk to high risk). Garrett s ranking technique is used for the study. TABLE 6.1 RISK ELEMENT IN MUTUAL FUND INVESTMENT GARRETT S RANKING S. No. Mutual Funds Garrett Score Rank 1 Debt Fund 60.30 I 2 Gold Fund 53.15 II 3 Balanced Fund 52.89 III 4 Tax Saving Fund 52.26 IV 5 Diversified fund 49.55 V 6 Equity Fund 49.17 VI 7 Index Fund 48.38 VII 8 Reality Fund 46.50 VIII 9 Sector Fund 37.78 IX Source: Primary data.
174 Table 6.1 indicates that, the mutual funds which has low risk are debt fund, gold fund, balanced fund, tax saving fund and diversified fund with the score of 60.3, 53.15, 52.89, 52.26 and 49.55. Funds which have high risk are sector fund, reality fund, index fund, and equity fund with the scores of 37.78, 46.5, 48.38 and 49.17. A comparison was made among small and large investors regarding their perception on risk element among the different types of mutual fund. Analysis was made with the help of t-test and the results were exhibited on table 6.2. TABLE 6.2 INVESTORS PERCEPTION ON RISK ELEMENT AMONG SMALL AND S. No. Funds LARGE INVESTORS Mean Score among Investors Small Large T-Statistics 1. Sector Funds 4.6734 6.6845-3.0817* 2. Gold Fund 3.0899 5.0917-2.4508* 3. Balanced Fund 5.1144 6.8244-2.0173* 4. Diversified Fund 3.3089 6.9731-2.6108* 5. Index Fund 2.9173 6.6693-3.4892* 6. Reality Fund 3.6184 6.7384-2.9417* 7. Debt Fund 6.9083 3.3617-2.7082* 8. Tax saving Fund 7.2144 4.0944 3.6391* 9. Equity Fund 3.1874 6.9437-3.4829* *Significant at five percent level. Source: Primary data.
175 Regarding the risk level of small investors, the important groups are tax saving fund, debt fund and balanced fund since their means score of 7.2114, 6.9083 and 5.1144 respectively. Among large investors, these groups are diversified fund, equity fund and balanced fund with the means score of 6.9731, 6.9437 and 6.8244 respectively. Regarding the risk level of investors the significant difference among the small and large investors have been identified in the case of sector fund, gold fund, balanced fund, diversified fund, index fund, reality fund, debt fund, tax savings fund and equity fund since their respective t statistics are significant at five per cent level. 6.4. Investors Attitude towards Risk in investment on Mutual Funds Mutual fund investment includes so many risks. Weak economy, increase of inflation, recession in global market, bad market conditions, change in management, change of fund manager, political situations of the country, change in government policy, exchange rate risk or currency risk, change in regulatory measures are the major risks faced by the mutual fund industry. Every investor s attitude towards various risks on mutual fund investment is different. Risks are confined to market risk, economic risk, industry risk, political risk, management risk and currency risk. Respondents are asked to indicate their attitude.ie high risk, average risk, low risk and no risk. T-test is used to study the investor s attitude towards various risks.
176 TABLE 6.3 INVESTORS ATTITUDE TOWARDS VARIOUS RISKS ON S. No. Risk INVESTMENT IN MUTUAL FUNDS Mean Score among Investors Small Large T-Statistics 1. Market Risk 2.8006 3.1492-0.7392 2. Economic Risk 2.1447 2.9088-2.9976* 3. Industry Risk 2.2996 3.2643-3.1884* 4. Political Risk 2.6087 3.1308-2.5342* 5. Management Risk 2.5663 3.0924-1.8066 6. Currency Risk 2.4188 3.1385-2.7364* *Significant at five percent level Source: Primary data. The important risk among the small investors is market risk, political risk and management risk with mean score of 2.8006, 2.6087 and 2.5663. Among the large investors these are industry risk, market risk and currency risk which consist of 3.2643, 3.1492 and 3.1385 mean scores respectively. Regarding the investors attitude towards risk, the significant difference among the two group of investors have been identified are economic risk, industry risk, political risk and currency risk since the respective t statistics are significant at five percent scale. 6.5. Risk on Various Investment Options The investors are asked to extent their feeling about risk regarding the type of investment options in mutual funds. It is confined into investment in low performing fund, investment in new AMC s fund, investment in bullish market, investment in bearish market, investment in index fund, investment in
177 sector fund, investment in gold fund, investment in global fund, investment based on journals, investment in public sector mutual fund, investment in private sector fund, investment in growth fund, investment in dividend payout option, investment in dividend reinvestment option, investment without knowledge, investment in a high NAV fund, investment in a single fund, investment in a reality fund, investment in debt fund, and investment through SIP. T-test is used for analyzing the investors feeling about risk on various investment options. TABLE 6.4 EXTENT OF FEELING ABOUT RISK ON VARIOUS INVESTMENT OPTIONS Mean Score S. Type of Investment Options among Investors T- No. Small Large Statistics 1. Investment in a low performing fund 3.0624 2.3482 2.9089* 2. Investment in a new AMC s New fund 2.8742 2.4667 1.6403 3. Investment in bullish market 3.1147 2.3018 2.7639* 4. Investment in bearish market 3.2268 2.5879 2.8182* 5. Investment in index fund 2.8304 2.4037 1.4661 6. Investment in sector fund 2.7117 2.3998 1.0992 7. Investment in gold fund 2.6089 2.2091 0.9686 8. Investment in global fund 2.7886 2.1473 2.1089* 9. Investment based on business journals 3.0143 2.3084 2.6673* 10. Investment in public sector mutual fund 2.5089 2.2449 0.7642 11. Investment in private sector fund 3.1337 2.6508 1.3039 12. Investment in growth fund 2.6173 2.0873 2.2084* 13. Investment in dividend payout option 2.3094 2.1194 0.5182 14. Investment in dividend reinvestment option 2.7717 2.3037 0.9193 15. Investment without knowledge 3.1804 2.5644 1.6542 16. Investment in high NAV funds 3.2466 2.6088 2.3143* 17. Investment in a single fund 3.0997 2.7331 0.7349 18. Investment in a reality fund 3.1144 2.5043 2.1943* 19. Investment in debt fund 2.6655 1.7308 2.5642* 20. Investment in SIP 2.0447 1.2644 2.3408* *Significant at five percent level. Source: Primary data.
178 The important variables regarding the investors feeling on risk among small investors are investment options is high NAV funds, investment in bearish market and investment without knowledge since their respective mean scores are 3.2466, 3.2268, and 3.1804 whereas large investors, these variables are investment in a single funds, investment in private sector fund and investment in high NAV funds since their respective mean scores are 2.7331, 2.6508, and 2.6088. Regarding the investors feeling on risk, the significant difference among the two group of investors have been identified in the case of investment in low performing fund, investment in bullish market, investment in bearish market, investment in global fund, investment based on journals, investment in growth fund, investment in a high NAV fund, investment in a reality fund, investment in debt fund, and investment through SIP since their respective t statistics are significant at five per cent level. 6.6. Risk Tolerance of Mutual Fund Investors The retail investors always prefer risk-neutral or risk-averse investments for their surplus funds. During the last decade a phenomenal growth of capital market has been accompanied by the advent of equity cult among the retail investors. The question in the mind of retail investors is how to make money with controlled risk in such a volatile market. An investor s risk tolerance immensely affects his investment decision. Here, the risk tolerance of mutual fund investors is analysed by t-test. There are fifteen variables used for this study.
179 S. No. TABLE 6.5 RISK TOLERANCE AMONG THE INVESTORS Variables in Risk Tolerance Mean Score among Investors Small Large T- Statistics 1. Mutual fund investment is risky 3.0117 3.9909-3.2456* 2. 3. Fluctuation in capital market affect Mutual Funds Long term investment in mutual fund is less risky 2.4558 3.6617-3.8661* 2.3884 3.7025-4.3084* 4. Sell the units when market is down 2.7717 3.8516-3.3094* 5. 6. 7. 8. 9. 10. 11. Investment in bearish market is less risky Short term investment is always less risky Recommendation of friends/relatives reduce the risk High NAV funds are very risky for investment Political factor is one of the main factor in risk Mutual fund principal and returns are guaranteed by AMFI Investment in diversified funds are less risky 2.6503 3.7779-3.1776* 2.5991 3.6073-3.0881* 2.8086 3.8117-2.9968* 2.7134 3.6542-2.8082* 2.8241 3.8661-2.7969* 2.5667 3.6609-3.2088* 2.8089 3.9902-3.4173* 12. Mutual funds spread the risk 2.6671 3.8518-3.6896* 13. SIP investment reduce the risk 2.6038 3.7302-3.3082* Investment in single fund is 14. advisable Investment in new generation funds 15. are safe *Significant at five percent level. Source: Primary data. 2.7317 3.8117-3.1917* 2.9094 3.8046-3.3841* The important variables in risk tolerance level among the small investors are mutual fund investment is risky, investment in new generation funds are safe, political factor is one of the main factor in risk, and investment in
180 diversified funds are less risky since their respective mean scores of 3.0117, 2.9094, 2.8241, and 2.8089 whereas among the large investors,these variables are mutual fund investment is risky, investment in diversified funds are less risky, political factor is one of the main factor in risk and mutual funds spread the risk. Regarding the perception on risk tolerance, the significant difference among the two group of investors have been identified in the case of mutual fund investment is risky, fluctuation in capital market affect mutual funds, long term investment in mutual fund is less risky, investment in bearish market is less risky, sell the units when market is down, short term investment is always less risky, recommendation of friends/relatives reduce the risk, high NAV funds are very risky for investment, political factor is one of the main factor in risk, mutual fund principal and returns are guaranteed by AMFI, Investment in diversified funds are less risky, mutual funds spread the risk, SIP investment reduce the risk, investment in single fund is advisable and investment in new generation funds are safe since their respective t statistics are significant at five per cent level. 6.7. Impact of profile variables on risk tolerance level of mutual fund investors The profile variables namely gender, age, marital status, level of education, occupation, annual income, annual savings, family size, year of experience, and number of mutual funds invested may have impact on risk tolerance level of investors. It is highly imperative to analyse the impact of profile variables on the risk tolerance level of investors in mutual fund investment. The multiple regression analysis has been administered to analyse such impact.
181 The impact have been analysed among the small and large investors and also for pooled data. The resulted regression co-efficients are illustrated in table 6.6. S. No. TABLE 6.6 IMPACT OF PROFILE OF INVESTORS ON RTS Profile Variables Regression Coefficient among Investors Small Large Pooled 1. Gender 0.1841 0.1442* 0.1691* 2. Age -0.2069* -0.2346* -0.2108* 3. Marital Status 0.0644 0.0511 0.0422 4. Level of Education 0.1608* 0.1833* 0.1741* 5. Occupation 0.2361* 0.2708* 0.2507* 6. Annual Income 0.2842* 0.2193* 0.2418* 7. Annual Savings 0.1917* 0.2044* 0.1733* 8. Family Size -0.0904-0.1826* -0.1071 9. Year of Experience 0.1653* 0.2447* 0.2029* 10. Number of MFs invested 0.2643* 0.3082* 0.2732* 11. Constant 0.8193 1.4094 1.1394 12. R 2 0.7504 0.7949 0.8123 13. F Statistics 10.8143* 13.4194* 14.0944* *Significant at five percent level. Source: Primary data. The significant influencing variables on the risk tolerance level among the small mutual fund investors are age, level of education, occupation, annual income, annual savings, year of experience and number of mutual funds
182 invested since their respective regression co efficients are significant at five per cent level. A unit increase in the variables result in an increase in overall risk tolerance level of mutual fund investors by -0.2069, 0.1608, 0.2361, 0.2482, 0.1917, 0.1653 and 0.2463 units respectively. Among the large investors, a unit increase in the variables result in an increase in risk tolerance level of investors in mutual funds by gender(0.1442), age (-0.2346), level of education (0.1833), occupation (0.2708), annual income (0.2193), annual savings (0.1733), family size (-0.1826), year of experience (0.2447) and number of mutual funds invested (0.3082). The analysis of pooled data reveals that the significantly influencing profile variables are gender, age, level of education, occupation, annual income, annual savings, year of experience and number of mutual funds invested. The change in risk tolerance on profile variables explains the change in the risk tolerance level of mutual fund investors to the extent of 81.23 per cent. 6.8. Factors influencing risk tolerance among Mutual Fund Investors Factor analysis is used to study the factors influencing risk tolerance among mutual fund investors. The rotated factor matrix of the identified 15 variables is calculated to show the inter-relationship among the variables and feelings of investors about risk on various investment. The score of the feelings of investors about risk on various investment options have been included for the factor analysis. The rotated component matrix for the various investment options is given in Table 6.7.
183 TABLE 6.7 ROTATED COMPONENT MATRIX FOR INVESTORS FEELING ABOUT RISK IN VARIOUS INVESTMENT OPTIONS S. No. Variables Factor Loading F1 F2 F3 F4 F5 1 Sell the units when market is down.708 2 Investment in bearish market is less.747 risky 3 Short term investment is always less.684 risky 4 SIP investment reduce the risk.662 5 Investment in single fund is advisable.708 6 Investment in new generation funds are.700 safe 7 Political factor is one of the main factor.501 in risk 8 Mutual fund principal and returns are.594 guaranteed by AMFI 9 Fluctuation in capital market affect.804 mutual funds 10 Investment in diversified funds are less.584 risky 11 Long term investment in mutual fund is.807 less risky 12 High NAV funds are very risky for.746 investment 13 Mutual fund investment is risky.748 14 Mutual funds spread the risk.720 15 Recommendation of friends/relatives reduce the risk.598 KMO measure of sampling adequacy:.773 Bartlett s Test of Sphericity : Chi-square=1304.246 Significance Value :.000 Extraction Method: Principal component analysis Rotation method: Varimax with Kaiser normalization
184 The above table indicates the rotated factor loading for the 15 variable. It is clear from the table that all the 15 variables have been extracted into 5 factors. 6.8.1. Investors feeling about Risk in mutual funds The number of variables in each factor, Eigen value and the percent of variation explained by the factor are presented in Table 6.8. TABLE 6.8 INVESTORS FEELING ABOUT RISK IN VARIOUS S. No. Factor INVESTMENT OPTIONS No. of Variables Eigen Value Per cent of Variation Explained Cumulative Percent of Variation Explained 1 Risk based on market 3 3.788 25.255 25.255 2 Risk based on type of fund 3 1.484 9.895 35.150 3 Risk based on external factors 3 1.359 9.057 44.207 4 Risk based on nature of fund 3 1.169 7.791 51.998 5 Risk based on general factors 3 1.040 6.935 58.933 Source: Primary data. The important factors extent the feeling of investors to invest various options are risk based on market, risk based on type of fund since their eigen values are 5.467 and 1.533 respectively. Risk based on market consists of 3 variables with percent of variation explained of 25.255 per cent. Risk based on type of fund consists of 3 variables with the percent of variation explained of 9.895 percent. Risk based on external factors to the extent of 9.057 percent. The next factors are risk based on nature of fund and risk based on general factors since their respective eigen
185 values are 1.169 and 1.040. The percent of variation explained by these two factors are 7.791 and 6.935 percent. 6.9. Conclusion Risk is an unavoidable factor in any investment especially capital market related investment. Mutual fund is not an exception. Mutual fund industry and investors are facing various risks. The investors risk tolerance level is very important for the growth of mutual fund industry. In this chapter risk tolerance level of mutual fund investors are analyzed. Out of nine different types of mutual funds, investors feel the debt fund and gold fund has very low risk and sector fund and reality fund has high risk. Regarding the investors attitude towards various risk in investment on mutual funds, the important risk among the small investors is market risk, political risk and management risk. Among the large investors these are industry risk, market risk and currency risk. The significant influencing variables on the risk tolerance level among the small mutual fund investors are age, level of education, occupation, annual income, annual savings, year of experience and number of mutual funds invested. In this chapter the feelings of investors about risk on various investment options was analysed and found the important factor is investment in specialty fund/scheme. The above analysis depicts that the investors e know the risk level of each fund/schemes.