When filtering mutual funds on Tickertape, the investment checklist of each fund mentions the presence of red flags. In common parlance, a red flag means a danger of some sort.
Similarly, in the case of investing, red flags mean that the instrument has associated danger or risks. That said, a mutual fund with red flags is relatively riskier than those that have no red flags.
Mutual funds can have red flags due to various reasons depending on the type of fund. Note that mutual funds are categorized into three types based on the nature of the underlying assets: equity, debt, and hybrid.
Let’s evaluate red flags parameters for each of these types.
1. Equity mutual funds
Since these funds invest in stocks, the red flags associated with them are similar to the ones that equities have.
a. The fund is in the ASM list: ASM stands for Additional Surveillance Measures. Stocks of funds in this list have surveillance concerns such as volatility and price variation
b. The fund is in the GSM list: GSM stands for Graded Surveillance Measures. The stocks of these funds in this list see an abnormal rise in price, which is not in line with the fundamentals or financial health of stocks. Shares in such funds have poor fundamentals and low market capitalization and are likely to be illiquid
c. Promoter holding pledge: This parameter suggests the extent to which promoter holdings are pledged. Stocks with high pledges are considered to be risky while those with low pledges are less risky
d. Default issue: Default means failure to pay the dues on time. If a fund is associated with default issues, it means the fund manager may not have the ability to pay the total dues to the investor on time. As such, high default probability commands high risk and vice-versa
e. Unsolicited messages: These are messages circulated about the stocks via WhatsApp, SMS, and other channels that the recipients don’t have verifiable permission to view or receive the message
2. Debt mutual funds
Debt funds significantly invest in fixed-income instruments including debentures, bonds, and money-market securities. Such instruments are assigned a credit rating that suggests the ability and willingness of the issuer to meet their financial obligations in full and on time. Ergo, the higher the credit rating, the better it is.
Apart, debt funds can also be assessed based on the fund’s probability to default, as explained above.
3. Hybrid mutual funds
As the name suggests, hybrid funds are a combination of both equity and debt funds. Ergo, the red flags associated with such funds may include one or more of those relating to equity and debt funds, as explained above.