Tier-1 benchmark will show the risk matrix being followed by the debt fund, tier-2 the investment style.

The two-tier benchmarking structure mandated for mutual funds by the Securities and Exchange Board of India (SEBI) recently will lend force to the potential risk class (PRC) matrix introduced last December, and help investors compare funds better before investing.

While the new benchmarking guideline is applicable to all mutual fund categories, it would be particularly useful in capturing the granular risk elements of debt mutual funds.

To understand the changes, let us start with a brief look at the PRC matrix.

The PRC is a 3x3 matrix that showcases the maximum risk a debt mutual fund will take in terms of credit and interest rates. The credit risk is classified into three buckets – class A, B and C – basis the weighted risk value of each instrument accorded by the regulator. The interest rate risk, on the other hand, is measured in three blocks – class I, II and III – using the Macaulay duration.

Asset management companies are required to place their schemes on the PRC grid for investors to understand the maximum risk associated with these. If a scheme takes a higher risk than that signified by the PRC bucket it is placed into, it would mean a change in its fundamental attribute, thereby allowing investors to exit the scheme without incurring an exit load.