Debt mutual funds invest in a wide range of fixed-income securities, such as bonds, debentures and money market instruments. Although they are considered to be less risky than equity funds, debt funds are not completely without risk.
Unfortunately, many investors fell into the trap of thinking that debt mutual funds were a safe and stable investment option with no risks. A series of credit defaults and the winding up of many debt schemes, as a result, broke the confidence of investors, who started to stay away from these mutual funds altogether.
Here’s where the Indian financial market regulator, the Securities and Exchange Board of India (SEBI), stepped in and introduced the Potential Risk Class matrix. Designed to provide investors with accurate information regarding the risk level of a debt fund, the matrix is a crucial factor that every investor must analyse before investing.
Continue reading to find out all about the PRC matrix, its various components and how it can help investors better evaluate debt mutual funds.
PRC Matrix: An Overview
Debt mutual funds are a good way to diversify portfolio risk since they are widely considered to be a safer option compared to equities. However, not all debt funds may share the same level of risk. Some funds may invest only in high-quality bonds, which makes them less risky than funds that invest in a mix of high-quality and moderately risky bonds.
One of the many ways to assess the risk of a debt fund is to thoroughly look at and analyse the various fixed-income securities that it invests in. Unfortunately, not all investors are capable of or may have the requisite knowledge to carry out such an in-depth analysis.
In a bid to increase transparency and help investors choose the right fund according to their risk profile, the Securities and Exchange Board of India took a few measures. One of the measures included a circular published on June 7, 2021, that mandated all debt mutual fund schemes to disclose their respective Potential Risk Class matrix.
The PRC matrix is a 3 x 3 matrix that displays three levels of credit risk horizontally and three levels of interest rate risk vertically. The Asset Management Company (AMC) is required to categorically state exactly which of the cells of the 3 x 3 matrix their debt fund falls under. Investors interested in investing in debt funds could simply check the Potential Risk Class matrix and get a snapshot of the amount of risk involved with a fund.
Components of the PRC Matrix
To understand just how the PRC matrix works, we need to first look at the two major components associated with it: the Macaulay Duration (MD) and the Credit Risk Value (CRV).
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Macaulay Duration (MD)
The Macaulay Duration (MD) measures the weighted average time until a bond’s cash flows are received. It considers both interest payments and the return of principal. MD helps estimate a bond’s sensitivity to interest rate changes. For instance, the longer the Macaulay duration, the greater the bond’s price volatility in response to interest rate fluctuations and the greater the risk.
In addition to bonds, MD can also be extrapolated to measure the maximum weighted average interest rate risk of entire debt schemes.
The Potential Risk Class matrix classifies debt funds into three classes based on the fund’s Macaulay Duration.
- Class I: Macaulay Duration of less than or equal to 1 year
- Class II: Macaulay Duration of less than or equal to 3 years
- Class III: Any Macaulay Duration
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Credit Risk Value (CRV)
The Credit Risk Value (CRV) is a metric that indicates the likelihood of a bond going into default due to the issuer failing to repay their debt obligation. The CRV can be calculated for both individual bonds and entire debt mutual fund schemes. The higher the Credit Risk Value, the safer the bond or debt scheme is.
To make it easier for both the investors and the AMC, SEBI has notified the CRV of different debt instruments depending on their credit rating.
| Debt Instrument | Credit Risk Value (CRV) |
| Government Securities (G-Secs), Repo on Government Securities, State Development Loans (SDLs), TREPS and Cash | 13 |
| AAA | 12 |
| AA+ | 11 |
| AA | 10 |
| AA- | 9 |
| A+ | 8 |
| A | 7 |
| A- | 6 |
| BBB+ | 5 |
| BBB | 4 |
| BBB- | 3 |
| Unrated | 2 |
| Below the Investment Grade | 1 |
The Potential Risk Class matrix categorises debt funds into three classes depending on their Credit Risk Value (CRV).
- Class A: Credit Risk Value equal to or greater than 12
- Class B: Credit Risk Value equal to or greater than 10
- Class C: Credit Risk Value less than 10
Categorisation of Debt Funds Based on the PRC Matrix
Now that you’ve seen the two components of the Potential Risk Class matrix, let us look at how debt funds are categorised and labelled according to the cell in which they fall.
| Maximum Interest Rate of the Scheme Based on the Macaulay Duration | Maximum Credit Risk of the Scheme Based on the CRV | ||
| Class A (CRV = > 12) | Class A (CRV = > 10) | Class C (CRV < 10) | |
| Class I (MD < = 1) | Relatively Low Interest Rate Risk and Relatively Low Credit Risk | Relatively Low Interest Rate Risk and Moderate Credit Risk | Relatively Low Interest Rate Risk and Relatively High Credit Risk |
| Class II (MD < = 3) | Moderate Interest Rate Risk and Relatively Low Credit Risk | Moderate Interest Rate Risk and Moderate Credit Risk | Moderate Interest Rate Risk and Relatively High Credit Risk |
| Class III (Any MD) | Relatively High Interest Rate Risk and Relatively Low Credit Risk | Relatively High Interest Rate Risk and Moderate Credit Risk | Relatively High Interest Rate Risk and Relatively High Credit Risk |
For example, let’s take the case of an open-ended short-duration fund where its Macaulay Duration is 2.5 and its Credit Risk Value (CRV) is equal to 12. In this case, it would be classified as a debt fund with “moderate interest rate risk and relatively low credit risk”. In the PRC matrix, the fund would appear as follows.
| Maximum Interest Rate of the Scheme Based on the Macaulay Duration | Maximum Credit Risk of the Scheme Based on the CRV | ||
| Class A (CRV = > 12) | Class A (CRV = > 10) | Class C (CRV < 10) | |
| Class I (MD < = 1) | |||
| Class II (MD < = 3) | A-II | ||
| Class III (Any MD) | |||
How Does the PRC Matrix Help Evaluate Debt Mutual Funds?
Here’s a quick overview of the different ways in which the 3 x 3 matrix assists investors in evaluating funds.
- The PRC matrix offers clear and standardised information for debt funds, enabling investors to better understand the associated risks at a single glance.
- Investors can accurately assess the interest rate and credit risk profiles of debt funds using the Potential Risk Class matrix.
- Since the information provided by the matrix is standardised, investors can quickly compare different funds with each other and select funds that align with their preferences and risk appetites.
Conclusion
The PRC matrix plays a crucial role in helping investors evaluate debt mutual funds by providing clear and standardised information about the risk associated with each fund. It enhances transparency, facilitates risk assessment and comparison and empowers investors to make informed investment decisions.
As per the notification by SEBI, all Asset Management Companies are mandated to disclose the Potential Risk Class matrix for their debt mutual funds, clearly indicating the category in which the scheme falls. You can find this information on the fact sheet of the respective debt fund. As an investor, remember to read through the fact sheet and the PRC matrix for a fund before investing.
FAQs
Do AMCs also classify equity funds based on the PRC Matrix?
No. The PRC Matrix is only used to represent the risk associated with debt mutual funds and not equity funds. For equity mutual funds, however, the SEBI mandates using a mutual fund riskometer to visually represent the risk associated with them.
Where can I find the Potential Risk Class Matrix for a debt fund?
You can find the PRC Matrix of a particular debt fund on its fact sheet published by the Asset Management Company (AMC).
What are the key components of the PRC Matrix?
The PRC Matrix has two key components – the Macaulay Duration (MD) and the Credit Risk Value (CRV). The Macaulay duration is used to measure interest rate risk, whereas the Credit Risk Value is used to measure credit risk.
Are there any drawbacks associated with relying solely on the PRC Matrix for risk assessment?
Yes. The Potential Risk Class Matrix only considers two risks – interest rate risk and credit risk and doesn’t account for a lot of other risk factors. Such oversimplification of risks associated with debt funds is a major limitation of the PRC Matrix.
