What is PRC Matrix in Debt Mutual Funds?
Meaning, Working, and Importance

If your portfolio includes debt mutual funds, you must have received an email or SMS from the fund house on or after December 1, 2021, indicating the debt fund's risk class.

This was merely a disclosure and not a call to action, even though many investors were mostly perplexed. Let's figure out what it was about.

Introduction to PRC Matrix:

SEBI mandated in December 2021 that all fund houses have a Potential Risk Class matrix (PRC matrix) and make sure it is disclosed appropriately. Because the PRC matrix would help investors make well-informed decisions, SEBI was attempting to increase investor safety.

Given that we already have a risk-o-meter at our disposal, one could question the necessity of a PRC matrix.

A PRC matrix provides a futuristic perspective, whereas the risk-o-meter merely takes into account the mutual fund's present risk and is only updated once a month.  It offers the maximum degree of risk that mutual funds are unable to surpass.

Let’s understand the PRC matrix in detail:

Meaning of PRC Matrix:

A debt-mutual fund's maximum risk potential is defined by the PRC matrix. On December 1, 2021, SEBI implemented this rule, which requires fund firms to categorize both their new and current schemes in a potential risk class (PRC) matrix.

In order to manage the fund in the future, this matrix asks debt funds to indicate the highest level of risk they are ready to take on through their present and future investments.

Credit risk and interest rate risk are constant threats to your debt mutual fund.

When the debt fund has principal or interest payment defaults from the institutions from which it bought bonds, credit risk arises. The debt fund's value decreases in the event of such defaults.

On the contrary, when interest rates are raised, bond yields decline due to the inverse connection between bond prices and interest rates, which lowers the scheme's NAV (Net Asset Value).  We refer to this occurrence as interest rate risk.

What are the Categories of the PRC Matrix?

Interest rate risk and credit risk fall into three categories.

Class I, Class II, and Class III are the three categories for interest rate risk, and Class A, Class B, and Class C are the three categories for credit risk.

Class I debt fund schemes have the lowest interest rate risk, whereas Class III debt fund schemes have the highest interest rate risk.  In the same manner, Class A credit rate risk plans are the least risky, while Class C schemes are the riskiest.

A debt mutual fund scheme, which is rated as A-I, has the lowest interest rate and credit risk. On the other hand, a scheme classified as C-III carries the most. This is because the risk associated with debt funds is always evaluated as a combination of interest rate risk and credit risk.

PRC Matrix Criteria for Debt Fund Classification:

Let's see how a PRC matrix classifies various debt schemes, given that we are aware of the risk categories. The two criteria used to classify debt funds are Macaulay Duration (MD) and Credit Risk Value (CRV). Credit Risk Value (CRV) assists in evaluating credit risk, whereas Macaulay Duration (MD) measures interest rate risk.

MD is the amount of time that the investor would get principal repayments and interest payments equal to the price he bought for the bonds held by the debt fund. A lower MD indicates a lower interest rate risk. MD is measured in years.

Therefore, the weighted average MD of all the schemes is used as the MD for a scheme that contains multiple securities.

Macaulay Duration (MD) Classification for Debt Funds:

• Class I: Duration up to 1 year (lowest potential interest rate risk)
• Class II: Duration up to 3 years (moderate potential interest rate risk)
• Class III: Any other MD (highest potential interest rate risk)

Since SEBI has given various debt instruments a Credit Risk Value (CRV), determining credit risk for debt schemes is rather simple. CRV and credit risk are indirectly related; the higher the CRV, lower the possible credit risk, and vice versa.

Government securities, for example, have a CRV of 13, AAA-rated securities have a CRV of 12, and unrated securities have a CRV of 2.

Credit Risk Value (CRV) Classification of Debt Funds:

• Class A: CRV equal to or greater than 12 (lowest potential credit risk)
• Class B: CRV of 10 and 11 (moderate potential credit risk)
• Class C: CRV below 10. (highest potential credit risk)

Let’s look at how a PRC matrix looks:

Key Takeaway

Since debt schemes are less risky than equity investments, they are included in portfolios to reduce overall risk. In the future, prudent investors would not want their hedging investments to become riskier than anticipated and contribute more risk to their portfolios.

The maximum amount of risk that an investor may have to take on was difficult to determine because of the existence of interest rate and credit risk. However, the PRC matrix has made it easy to differentiate between debt funds with varying levels of risk and make wise investment choices.

Investors can find the PRC (Potential Risk Class) matrix for a debt mutual fund in the fund's fact sheet or Scheme Information Document (SID)/Key Information Memorandum (KIM), which are available on the website of the mutual fund company.

So, make your choice accordingly.