amfi-training w.e.f 1 june 2010
TRANSCRIPT
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A presentation by
A J Venture with Standard Life Investments
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Mutual Fund Distributors Certification
Examination NISM Series V-A work book on the www.nism.ac.in
website. Annex in the earlier work book done away
with.
Effective from 1st June 2010. Only online exam possible. No written exam
available.NSE preferred over BSE for ease of Q
paper layout.
Certification Validity for 3 years now only.
Refresher program available thereafter ± validity for
3 years.
Online Test available throu` MCX-SX,NSE and BSE
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Examination assessment
Structure Examination consists of 100 questions of one mark
each.
Duration: 2 Hrs. Passing score is 50%
Negative marking of 25% of the marks for wrong
answer.
NISM Workbook needs to be read page by page to
understand the contents and help in clearing the
exam.
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1.Test Objectives: Concept & Role of
a MF
a) Concept & Advantages of MFs
b) Brief History of MFs in India
c) Differentiation between various types of fundsd) Key Developments over the years
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The Basics
1. Direct v/s Indirect investment
2. Individual and Collective Investment
3. Equity v/s Debt
Equity gives ownership rights and Debt instruments
means lending money to someone.
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What is a Mutual Fund ?
A mutual fund is a collective investment ( pool) that allowsmany investors, with a common objective, to pool
individual investments and give to a professional manager
who in turn would invest these monies in line with the
common objective.
Each pool of money is called a Mutual Fund Scheme.Bybuying a MF scheme investors are buying into investment
objective.
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How do
MF sc
heme Operate ?
Investment made by investors in a scheme is translated into
certain no. of UNITS in the scheme.
Every UNIT has a fave value of Rs.10 ( older schemes may
have different face vale)
UNITS of a scheme * Face value = UNIT CAPITAL
Scheme purchases/ sells investments earning Capital gains/
Capital losses. Called REALIZED CAPITAL GAINS / REALIZED
CAPITAL LOSSES.
Investments in schemes may be quoted in the market at higher than cost paid. Called VALUATION GAINS or VALUATION
LOSSES when quoted at a price lower than cost price
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How do MF schemes operate
Investment is handled profitably , if the following
PROFITABILITY metric is + ve:
Interest Income + Dividend Income + Realized Capital Gains +
Valuation gains ± Realized Capital losses - Valuation losses ±scheme expenses
Investment Activity is +ve , true worth of unit goes up.True worth of
a unit of a scheme is called NAV
Different expectations of investors are handled by offering options-
div/growthRelative size of a MF is assessed by their AUM- captures
profitability metric & flow of investor money
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Operation flow chart
FUNDMANAGER
SECURITIES
RETUR NS
INVESTORS
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Characteristics of Mutual Funds Investors own the mutual fund.
A portfolio is a collection of securities.These can be
E/D/MM/derivatives and the like.
Professional managers (AMC) manage the fund for asmall fee.
Fee is expressed as a percentage of assets managed
The funds are invested in a portfolio of marketable
securities, reflecting the investment objective.
Value of the portfolio and investors¶ holdings, alters
with change in the market value of investments.
Investor does not bear a loss higher than the amt
invested by him.
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Mutual Funds:
A Packaged Product
Professional
Management
Convenience &
Flexibility Tax Benefits
Liquidity
Portfolio
Diversification
Reduction of
Transaction
Cost
Safety
Reduction/
Diversification
of risk
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Portfolio Diversification
Portfolio of investments spreads out Risk
Attempts to Minimize value erosion
Potential losses are shared with other investor
(Each investor in a fund is a part owner of all the
funds assets)
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Liquidity
Open-ended: Assures liquidity
As liquid as the banks.
Close-ended:
Buying and selling can be done through thestock exchange
OR
Periodic Redemption by Mutual Funds
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Convenience & FlexibilityEasy way to Invest
Reduces excessive paperwork
Outsourcing of expertise
AMCs offer many investor services that a
direct investor cannot get ± Switching, SWP,
SIP, Buying/ Selling through internet or emailor phone.
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AffordabilityProvides an opportunity for a small investor
Invest as less as an amount of Rs.5000/Rs.500 and in multiples of
Rs.1000/100 depending on the Scheme
Provision to apply using SIP.
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Professional Management
Irrespective of the amount of investment,
benefits from the professional management
skills brought in by FM research into available
investment options.
Few investors have the skills and resources
to succeed on their own.
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Reduction/Diversification of Risk Investor acquires diversified portfolio, no
matter how small his investment is.
Diversification reduces risk of loss ascompared to investing directly.
Investing in a pool of funds with other investors helps sharing losses, if any, in one
or two securities.Risk reduction is one of the most important
benefits of collective investment.
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Reduction of Transaction cost
What is true of risk is also true of transaction
costs.
Mutual Fund provides benefit of economies of
scale.
( Lesser cost because of larger volumes )
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SafetyMF Industry is well regulated by SEBI which
lays down rules to protect the investors.
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Wide Choice
Offers a VARIETY OF SCHEMES.
Meet the investment needs of all investors.
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T
ax Deferral Mutual funds offer options, whereby the investor can
let the moneys grow in the scheme for several years.
By selecting such options, it is possible for the
investor to defer the tax liability. This helps investors
to legally build their wealth faster than would have
been the case, if they were to pay tax on the income
each year.
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T
ax Benefits Specific schemes of mutual funds (Equity Linked
Savings Schemes) give investors the benefit of
deduction of the amount invested, from their income
that is liable to tax. This reduces their taxable
income, and therefore the tax liability.
Further, the dividend that the investor receives from
the scheme, is tax-free in his hands.
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Convenient Options The options offered under a scheme allow investors
to structure their investments in line with their liquidity
preference and tax position.
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Investment Comfort
Once an investment is made with a mutual fund, they
make it convenient for the investor to make further
purchases with very little documentation. This
simplifies subsequent investment activity.
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Regulatory Comfort
The regulator, Securities & Exchange Board of India
(SEBI) has mandated strict checks and balances in
the structure of mutual funds and their activities.
These are detailed in the subsequent slides. Mutual
fund investors benefit from such protection.
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Systematic approach to
investments Mutual funds also offer facilities that help investor
invest amounts regularly through a Systematic
Investment Plan (SIP); or withdraw amounts regularly
through a Systematic Withdrawal Plan (SWP); or
move moneys between different kinds of schemes
through a Systematic Transfer Plan (STP). Such
systematic approaches promote an investment
discipline, which is useful in long term wealth creationand protection.
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Disadvantages of Investing in the MF's
The benefits far out weight the disadvantages
a)No Control over costsThe cost is paid by investor as long as he remains in
the fund, albeit in return for the professional
management & research.
The fees is also a percentage of the value of his
investments; irrespective of market going up or down.( Distribution is cost which is not incurred in direct
investing)
However the limits for costs have been set by SEBI.
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b) No Tailor-Made Portfolios By investing directly one can build own portfolio of
shares bonds & other securities.
Investing therein Mutual Funds means he delegateshis decision to FM. (Constraint for HNW/ Corporate
clients)
This is overcome by offering large options of
schemes by a MF house.Investor can choose
different investment schemes/plans/options andconstruct an investment portfolio that meets his
investment objectives.
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c) Managing a portfolio of funds Availability of a large no. of options from MF's
can actually mean too much choice for the
investor.Will need advice similar to the situation when
he has to select individual shares or bonds to
invest in.
Country has a large no. of AMFI registered
FPs who are capable of guiding the investors.
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Growth of Mutual Funds in India AUM of Industry as on Feb 2010 by 38 MFs & 832 Schemes
OpenEnded
CloseEnded
Interval Total %
Income 441422 26203 8759 476384 62.1%
Equity 148726 19621 325 168672 22.0%
Balanced 15277 1864 - 17141 2.2%
Liquid 73030 - - 73030 9.5%
Gilt 3171 - - 3171 0.4%
ELSS 19617 3047 - 22664 3.0%
Gold ETF 1583 - - 1583 0.2%
Other ETFs
1342 - - 1342 0.2%
F OF F 2882 - - 2882 0.4%
Total 707050 50735 9084 766869 100%
% 92.2% 6.6% 1.2% 100% 31
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Types of Mutual Funds
MFs can be classified based on their structure:
# Open-ended funds V/s Closed-ended funds
MFs can be grouped based on if it collects any charge:# Load fund ( Front End load/ Entry load, Back End load/
Exit load or deferred load/ CDSC) V/s No Load Funds
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Open-ended vs. Closed-ended
Funds
OPEN-ENDED
No fixed maturity
Variable Corpus
Not Listed
Buy from and sell to
the Fund Entry/Exit at NAV
related prices
CLOSED-ENDED
Fixed Maturity
Fixed Corpus
Generally Listed
Buy and sell in the
Stock Exchanges Entry/Exit at the
market prices
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Interval Funds
Combination of open Ended and Close Ended
Largely Close ended , become open ended for
specific period Benefit to investors- not completely dependent on the
stock exchange to buy/sell their units.
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Actively v/s Passively managed Funds
Actively Managed Funds : eg Open Ended Diversified
Fund. Actively managed funds are funds where
the fund manager has the flexibility to choose the
investment portfolio, within the broad parameters of the investment objective of the scheme.
Passively Managed Funds: eg, Index Fund. P assive
funds invest on the basis of a specified index,
whose performance it seeks to track. Thus, the
performance of these funds tends to mirror the
concerned index. They are not designed to perform
better than the market.
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Debt, Equity & Hybrid Funds
A scheme might have an investment objective to
invest largely in equity shares and equity-related
investments like convertible debentures. Such
schemes are called equity schemes.
Schemes with an investment objective that limits
them to investments in debt securities like Treasury
Bills, Government Securities, Bonds and Debenturesare called debt funds.
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Mutual Funds Types contd
Broad Types by Risk Profile: Funds can be grouped
according to the risk associated in their portfolio and
investment objective.
Equity funds have a greater degree of risk as
compared to a debt funds. Liquid funds are least
risky as they invest in short-term securities
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Risk
Potential
forreturn
Liquid Funds
DebtFunds
c) Broad Fund types by Risk Hierarchy
Growth Funds Aggressive, Value,
Growth
Balanced Funds
SectoralF
unds
Gilt Funds, Bond
Funds, High
Yield Funds
Ratio of Debt : Equity
Hedge Funds
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Money Market/Liquid Funds
Lowest range in the order of risk level.
Invest in debt securities of a short term nature,
means securities of less than one-year maturity
(invests in T-Bills issued by govt, CDs issued by
banks and CPs issued by companies)
MMFs are liquid and safety of principal.Interest rate riskis present , the impact is low as maturities are short.
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Gilt Funds
Gilt Funds are govt. securities with medium to
long term maturities, typically of over one year.
In India Gilt Funds invest in dated securities (
unlike Treasury Bills that mature in less than 1
year)
Issuer is the Govt. of India/ states, thereforethese funds have little risk of default. They face
interest rate risk however.Their prices falls when
Interest Rate increases and vice versa.40
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Debt Funds (or Income Funds)
Next in order of risk level is debt funds, they invest inDebt instruments issued not only by Govt. but alsoby private co¶s, banks and financial institutions.
These funds target low risk and stable income. Theyhave higher price fluctuation risk, since they invest inlong term securities. Higher risk of default debt fundscan also be of different risk profile
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Debt Funds Contd«
High Yield Debt Funds :They seek to obtain higher interest returns by investing in debt instruments thatare considered ³below investment grade´ E.g.Below
BBB, Junk bond funds in U.S.
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Debt Funds Contd«
Fixed Maturity Plans : Another Indian variant : These
are debt schemes essentially closed ended in naturefor a time period varying from 1 month to 36 months
most commonly.Here the underlying debt
instruments are held to maturity in these schemes.
Contd«.
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Equity Funds
There is large variety of equity funds each with
slightly different risk profile .Equity funds are
generally considered at higher end of risk spectrum
amongst all available funds in the market.
a) Diversified Equity Funds
b) Sector Funds
c) Thematic Funds
d) ELSS
e) Equity Income/Dividend Yield Schemes
f) Arbitrage Funds: take contrary positions in diff
markets/securities .Risk is neutralized but a return is
earned.
Contd...44
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Types of Funds
Hybrid Funds :
A) MIPs
B) Capital Protected Schemes/Capital Protection Oriented
Schemes
Gold Funds :
Gold ETF v/s Gold Sector Fund
Real Estate Funds:
Commodity Funds: MFs are not permitted to invest in
commodities. They are in nature of Commodity sector Funds.
Fund of Funds:
International Funds:
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Asset Allocation Funds
The proportion of money to be invested in a particular
class of assets is pre-defined. FM given the flexibility
to move to equity when equity is expected to do well
and to shift to debt when debt market is expected to
do well. As the skill depends on the FM, these funds
could be riskier.
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Exchange Traded Funds
It tracks market index and trades like single stock on
the stock exchange. Its pricing is linked to index and
units can be bought or sold on the stock exchange.
ETFs are less costly and more efficient in terms of
tracking the index performance.
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Fund of Funds
Investment of its cor pus in other mutual fund
schemes
Schemes of same mutual fund house
Schemes of other mutual fund house
Is considered like a Debt scheme for tax
pur poses
The effective ex
penses become higher as theinvestors have to bear the expenses of the
invested schemes as well
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Test understanding Concept and
Role of MFsa) Sector Funds invest in a diverse range of sectors:
True / False
b) Open Ended Schemes generally offer exit option to
investors throu` a stock exchange
True / False
c) High yield bond Schemes invest in junk bonds
True / False
d) The no. of schemes in India is around:
800/ 1000/ 100/ 2000
e) Investment objective is closely linked to:
Scheme/ option/ Plan/ SIP 49
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2.Test objectives: Fund Structure &
Constituents
Legal Structure of MFs in IndiaOther Fund constituents
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Fund Structure and Constituents
It is established as a trust
It raises money through sale of units to the public
The units are sold under one or more schemes
The schemes invest in Securities or Gold or RealEstate.
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Fund Structure and Constituents
In India: laid down under SEBI ( MF) Regulations,1996.
3 tier structure
Sponsor
Trust/Trustee
AMC
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Legal Structure
Mutual Fund
MF trust created by one or more sponsors
Every trust has beneficiaries.They are investorswho invest in various schemes
MF operations are governed by the Trust deed,executed by sponsors. SEBI clauses in Trust deed.
Role of protecting the beneficiaries ( investors) isthat of the trustees.
To perform trusteeship role- individuals or atrustee co. may be appointed. Appointedindividuals are referred to as Board of Trustees
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Legal Structure
Day to day mgt is handled by AMC. AMC is
appointed by the sponsor or the Trustees
AMC manages the scheme.
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SPONSOR : Role
Promoter of the mutual fund
Creates a Trust under Indian Trusts Act, 1882
SEBI Regulation defines sponsor as any person who either itself
or in association with another body corporate establishes a
Mutual Fund. A sponsor is an entity that sets up the MF.(This trust becomes the MF)
Appoints trustees to manage the trust with approval of SEBI
Creates/Appoints AMC under Companies Act,1956 which will
act as the investment manager of the MF. Fulfils necessary formalities and applies to SEBI for registration
of the Trust as a Mutual Fund.
Must own at least 40% of the Asset Management Company
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Who is eligible to be a Sponsor«?
Criteria :
Sponsor should be carrying on business in financial
services for a period of not less five years
Networth is positive in all the immediately precedingfive years
Networth in the immediately preceding year is more
than the capital contribution of the sponsor in the
asset management company The sponsor has positive PAT in three out of
preceding five years including the fifth year
(As per chapter II of SEBI (Mutual Fund)
Regulations,1996)56
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TRUSTEE
Fiduciary responsibility to the Investors- protector of Unitholders interest & MF complies with all regulations.
Directors to be approved by SEBI and appointed by
Sponsor
Execution of trust deed by sponsor in favour of trustee.
Trust deed is stamped and registered with SEBILegally responsible for administering the Trust and
Compliance with Regulations.
Norms for Trustees
Experience in Financial Services
Minimum 4 members on the board and 2/3rd of the
members not to be connected with the sponsor
All major Decisions need trustee approval
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ASSET MANAGEMENT COMPANY An AMC is a Co. registered under The Companies Act, 1956.Sponsor
creates the AMC & this is the entity which manages the funds of MF.Obligations of the AMC & its directors :
Launching Schemes
Managing Funds for Schemes
Performing Accounting Functions
All day to day affairs of the Mutual FundQuarterly reporting to Trustees & answering them.
Income of an AMC / Asset Management Fee
1.25% of weekly average NAV of each Scheme upto Rs.100 cr of
assets managed
1.00% greater than Rs.100 cr Minimum 4 directors with 1/2 independent
At least Rs 10 cr of net worth to be maintained at all times
The sponsor appoints directors on board of the AMC
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Asset Management Company
Operations of AMC are headed by MD, ED, Chief
Executive Officer
CIO: Is responsible for overall investments of the
Funds. FMs assist the CIO. Same FM may manage
multiple schemes
Securities Analysts : Support FMs throu` their
research inputs
Securities Dealers: help in putting the transactionsthrou` in the market.
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The other constituents that work along with AMC to
manage the investors money in a MF are :
Registrar & Transfer agents: Appointed by AMC
Custodian: Appointed by the Board of Trustees
Depository Participant
Broker
Selling & Distribution agents
Auditors: Scheme auditors are appointed by Trustees, AMC
auditor is appointed by the AMC.
Legal advisor Fund Accountants
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REGISTRARS & TRANSFER AGENTS
Processing investors¶ application
Recording of Transactions
Issue of Account Statements to Investors
Arranging payment to Investors when they redeem
Taking care of Non commercial transactions like change
of address,loss of account statement etc.
Should be registered with SEBI
Appointed by Board of Trustee
Responsible for issuing & redeeming units of the MF.
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CUSTODIAN & DEPOSITORIES
Safe keeping of the assets held by the Fund
Receives and Delivers Securities out of de-mat
account as and when necessary
Follow up on Corporate benefits
Provide an independent means of control
Independent of Sponsors
Should be registered with SEBI
Appointed by board of trustees
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Other Constituents
Broker -Purchase and sale of securities-Not more than 5% through a related broker
-Transactions through any other broker- The AMC can
exceed the limit of 5% provided it has justification inwriting & sent the report to trustee on a quarterly basis.
Auditor : AMC is a Co. under Companies Act,1956 &therefore is required to get its accounts audited as per theprovisions of the Co¶s Act.
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Test Understanding Fund Structure and
Constituents
a) Assets of the MF are held by: AMC/ Trustees/
Cutodian
b) Min Net worth requirement of AMC is
Rs.20 Cr/ Rs.10 Cr/ Rs.2 Cr
c) AMC directors are appointed with permission of
Trustees: True/ False
d) Most Investor Service centres are offices of :
Trustees/ Registrar
e) Fund Accounting activity of a scheme is to be
compulsorily outsourced: True/ False
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3.Test Objectives: Legal and Regulatory
Environment
Role of regulators in India
Know investment restrictions & related regulation
Understand Investors Rights and obligations
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Legal & Regulatory Environment
SEBI - Securities and Exchange Board of India,1992. ApexCapital Markets Regulator. Issues guidelines for all Mutual
Fund.
RBI - Reserve Bank of India.Central Bank & Money MarketsRegulator. Issues guidelines for all bank-owned Mutual Funds.
MOF - Ministry of Finance,Implementing Govt.
policies,supervises SEBI and RBI.
SAT - Securities Appellate Tribunal, 2003.Created to provide
apex appeal mechanism for any decisions taken by SEBI
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SEBI
All Mutual Funds / AMC/ Trustee Companies tobe registered with SEBI.
Responsible for protecting investors interest and
promote orderly growth of Mutual Fund Industry.
Issues guidelines for all MF operations including
where they can invest, what investment limits &
restrictions must be complied with, how they
should account income & expense, how theyshould make disclosures of information to the
investors
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Reserve Bank of India & SE
RBI
Dual supervision for bank sponsored AMCs
Issue concerning ownership bank promoted AMC falls with RBI
Stock Exchange (SE)
Close ended MF listed of SE. Needs tocomply with listing guidelines.
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Self regulatory Organizations
Agencies like the RBI, SEBI, NSE are regulators with legal powers
to set rules & enforce them on market participants over whom
they have jurisdiction.
Derive powers from regulator
Ability to make bye laws
Example : Stock Exchanges (NSE, BSE,ICAI )
Industry Associations
-Collective Industry opinion-Guidelines and recommendation
-Example : Association of Mutual Funds in India
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AMFI objectives
To define and maintain high professional and ethical
standards in all areas of MF operations
To recommend and promote best practices and code
of conduct amongst members
Interact with SEBI and to represent on matters
concerning MFs
To represent to Govt, RBI and other bodies
To develop agents and certify them
Undertake nation wide investor awareness
programme
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AMFI code of Ethics (ACE)
SEBI regulations , 1996 requires all AMCs & trustees
to abide by the code of Conduct as specified in the
5th schedule to the regulation.
AMFI Code of Ethics Sets out the standards of goodpractices to be followed by AMCs in their operations
and their dealings with investors,intermediaries and
the public.
AMFI guidelines and Norms for Intermediaries (
AGNI)
The code of conduct is in appendix 2. SEBI has made it
mandatory for intermediaries to follow the code of
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In the event of breach of the Code of Conduct by anintermediary,
the following sequence of steps is provided for:
Write to the intermediary (enclosing copies of the complaint and
other documentary evidence) and ask for an explanation within
3 weeks.
In case explanation is not received within 3 weeks, or if theexplanation is not satisfactory, AMFI will issue a warning letter
indicating that any subsequent violation will result in cancellation
of AMFI registration.
If there is a proved second violation by the intermediary, the
registration will be cancelled, and intimation sent to all AMCs.
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Investment restrictions for
Schemes The SEBI regulations provide for various limits to the
kind of investments that are possible in MF Schemes.
The limits are beyond the scope of the workbook.
Investment Objective: Investment objective of a
diversified Equity fund may read as : ³ to generate
capital appreciation from a portfolio of predominantly
equity related securities
Investment Policy: describes the kind of portfoliothat will be maintained. Eg: investment will be
predominantly in mi-cap stocks
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Investment restrictions in MFs
Investment Strategy : Goes into detail such as:
A) Should we increase the cash component in the
scheme
B) Should we go overweight on Pharma sector.
Investment strategy is decided more often. The
frequently may be different for different AMCs based
on review meetings.
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Service standards mandated for a MF
towards its investors
Schemes other than ELSS , need to allot units /
refund money within 5 business days of closure of
the NFO.
OEFs other than ELSS have to re-open for ongoing
sale/ Re-purchase within 5 business days of
allotment
Statement of a/cs are to be send to investors:
- In case of NFO within 5 business days of closure of NFO
- In case of post-NFO within 10 working days of the
investment
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Service standards mandated for
a MF towards its investors In case of SIP/STP /SWAP:
- Initial transaction ± within 10 working days.
- Ongoing- Once every calendar qtr( March, June,Sept, & Dec ) within 10 business days of the end of
the Qtr.
On specific request from investor within 5 working days
without any cost
Statement will be send to dormant investors who have
not transacted in the previous 6 months with no. and
value of units held.
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Contd..
Investors can ask for Unit certificate of his/her unit
holding.This is different from statement of account:
- SOA shows opening balance, transactions during the
period and closing balance.
- UC only mentions only the no. units held by the
investor
- SOA is like the bank pass book, while UC is like a
balance confirmation certificate issued by the bank.
- AMC is bound to issue UC within 30 days of receipt
of the request
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Contd
NAV has to be published daily in atleast 2
newspapers.
NAV, Sales Price , Re-purchase price is to updated
on AMFI & MF website
- In case of F of F , by 10 am the following day
- In other schemes by 9 pm the same day
Investors can appoint upto 3 nominees specifying the %
, otherwise equal distribution will be presumed.
Investors can pledge the units.
Dividend warrants within 30 days of declaration of the
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Contd.
Redemption/re-purchase cheques needs to be
despatched within 10 working days from the date of
receipt of transaction request.
In event of delay in despatching the div warrants/
redemption/re-purchase cheques, interest @ 15% pa
will be paid to unit holder . Cannot be charged to
scheme
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Investors Rights and Obligations
Other rights of Investors :
Investors can choose to change their distributor or go
direct. In such cases, AMCs will need to comply,
without insisting on any kind of No ObjectionCertificate from the existing distributor.
The mutual fund has to publish a complete statement
of the scheme portfolio and the unaudited financial
results, within 1 month from the close of each half
year. The advertisement has to appear in oneNational English daily, and one newspaper published
in the language of the region
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Other rights of Investors
Debt-oriented, close-ended / interval, schemes /plans
need to disclose their portfolio in their website every
month, by the 3rd working day of the succeeding
month.
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Other Rights of Investors
Unit holders can inspect Trust deed, Investment mgt
agreement, Custodial Services agreement, R & T
agent agreement & M & A of Asso of the AMC
Scheme wise Annual Report or abridged summary
has to be mailed within 6 months of close of Financial
year.
Annual Report has to be displayed on AMC website
Pending investor complaints can be a ground for SEBI to refuse permission to launch new scheme
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Investors Rights and Obligations
Limitations of rights of investors
Cannot sue the trust because as per law
they are not distinct from the trust However they can sue the trustees
Cannot ask the AMC to meet shortfall inreturns in case of non-assured schemes
Can sue the sponsor if returns are assuredspecifically in the offer document
Prospective investors have no rights at all
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Unclaimed Amounts
MF can deploy unclaimed div / redemption amts in
money market.AMC can recover investment mgt fees
and advisory fees on mgt of these funds @ rate not
exceeding 0.50% p.a.
If investor claims within 3 years then payment is
based on prevailing NAV i.e. after adding the income
earned on the unclaimed money
If claimed after 3 years then it is at NAV at the end of 3 years.
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Proceeds of illiquid securities It is possible that a security was treated as wholly or
partly non recoverable at the time of maturity or
winding up of a scheme. The security may
subsequently yield a higher amount to the scheme.
Treatment of such excess is as follows:
If the amounts are substantial, and recovered within 2
years, then the amount is to be paid to the old
investors.
In other cases, the amount is to be transferred to theInvestor Education Fund maintained by each mutual
fund.
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Test understanding Legal &
regulatory environmenta)Investment objective defines the broad investment
charter: True/ False
b) Statement of a/cs has to be send to investors in ___
Days of NFO closure: 3/5/7/15
c) Unit holders ca: n hold units in demat form:
True/False
d) SEBI regulates : MFs/Depositories/R & T agent/ All of
above
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4.Test Objectives: Offer
Document Understand regulatory aspects of OD
Understand regulatory aspects of KIM
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What is an offer document ? Legal offer from AMC to investor ± for him to make an informed
investment decision.
Contains vital information and about Fund to be launched and
performance of existing schemes of the MF.
AMC prepares it in SEBI approved format & needs approval of
Trustees Key Information Memorandum (KIM) contains vital information
pertaining to the scheme, objective of the scheme, Asset allocation
pattern, Sale & re-purchase procedure, load & expense structure,
accounting & valuation policies and it is mandatory to attach KIM to
the application forms. Investor has no recourse for not having read the OD/KIM
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Significance
Legal document that protects and governs the right of theinvestor to information
Is the primary vehicle for the investment decision
Is the operating document and describes the fundamentalattributes of schemes.
One of the most important sources of information for the
prospective investor
Is a reference document for the investor to look for relevantinformation at any time.
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Period of Validity
O D issued for launching the new schemes are valid for
period of 6 months from date of receipt by the AMC of the
letter from SEBI.
Updated every 2 years for OEFs
Regular Addendum for results
Updated for every major change
-Change in the AMC or Sponsor of the mutual fund
-Changes in the fundamental attributes of the schemes-Changes in the investment options to investor; inclusion
or deletion of options
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Contents of Offer Document
A. Scheme Information Document(SID), detailsof the scheme
Contents:The cover page has the name of the scheme followed
by its type viz. ± Open Ended/ Close Ended/Interval
-Equity/Balanced/Debt/Liquid/ETF
Has the face value of the units , relevant NFO dates,
date of SID, name of AMC & contact details
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Contd..
Table of contents
Highlights
Introduction
Risk Factors- Standard and Scheme specific Risk
factors
Min no. of investors in the scheme
Any other special considerations
Definitions
Due Diligence Certificate
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Contd.
Information about scheme
Units and offer
Fees and expenses
Rights of Unit Holders
Penalties , Litigation, etc
Draft SID is a public document available for viewing inSEB`s website for 21 days. Final SID with SEBI
observations has to hoisted on AMFI website 2 days
prior to scheme launch
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Update of SID
Regular:
If scheme launched in the first 6 months of FY , say
April 2010 , then first update of the SID is due within
3 months of the end of the FY i.e. June 2011 If scheme is launched in the second 6 months of the
FY say, Oct 2010, then first update is due within 3
months of the end of next FY i.e. June 2012.
Thereafter SID is to be updated every year.
Need based:
In case of change of Fundamental Attributes, SID to be
updated immediately after the lapse of time given to
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In case of any other changes in
SID Printed via addendum and distributed along with SID
, until the SID is updated
If change is superseded by a further change , eg,
Change in load, then addenda is not required for thesuperseded change i.e. required to disclose the latest
position only
Change to be mentioned in MF website
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Contents of SAI
- Information about Sponsors, AMC and
Trustee Company and contact information of
service providers
- Condensed Financial Information ( for schemes launched in the last 3 financial
years)
- How to apply
- Rights of Unit holders
- Investment valuation norms
- Tax, Legal and General information96
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Key Information Memorandum
Role of KIM: Is a summary of SID & SAI. More easily
and widely distributed in the market. KIM has to be
accompanied by a application form
Contents of KIM:
- Name of the AMC, MF, Trustee, FM and Scheme
- Date of opening , Issue Closing& Re-opening for sale
& Re-purchase
- Plans and Options under the scheme
- Risk Profile of scheme
- Issue price and minimum amounr
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Contents of KIM
Bench Mark
Dividend Policy
Performance of scheme and benchmark over 1, 3
and 5 years
Loads and expenses
Contact information of Registrar
Update of KIM: To be updated atleast once in a year As in the case of SID, KIM is to be revised in case of
change in fundamental attributes. Other changes can
be disclosed throu` addenda
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Fundamental Attributes
Scheme type
Investment objective
Investment pattern
Terms of the scheme with regard to liquidity
Fees and expenses
Valuation norms and accounting policies
Investment restrictions
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Changes in Fundamental Attributes
Approval form trustees
Approval from SEBI
Public announcement by AMC Investors to be informed and option given to
exit at NAV without any exit load
New offer document
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REQUIREMENT OF MINIMUM INVESTORS IN THESCHEME
(Applicability for an open-ended scheme)
The Scheme/Plan shall have a minimum of 20
investors and no single investor shall account for
more than 25% of the corpus of the Scheme/Plan(s).However, if such limit is breached during the NFO of
the Scheme, the Fund will endeavour to ensure that
within a period of three months or the end of the
succeeding calendar quarter from the close of theNFO of the Scheme, whichever is earlier, the
Scheme complies with these two conditions.
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REQUIREMENT OF MINIMUM INVESTORS IN THESCHEME
If there is a breach of the 25% limit by any investor
over the quarter, a rebalancing period of one month
would be allowed and thereafter the investor who is
in breach of the rule shall be given 15 days notice toredeem his exposure over the 25 % limit.
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REQUIREMENT OF MINIMUM INVESTORS IN THESCHEME
(Applicability for a Close ended scheme / Interval
scheme)
The Scheme(s) and individual Plan(s) under the
Scheme(s) shall have a minimum of 20 investors andno single investor shall account for more than 25% of
the corpus of the Scheme(s)/Plan(s). These
conditions will be complied with immediately after the
close of the NFO itself i.e. at the time of allotment.
F or interval scheme the aforesaid provision will be
applicable at the end of N FO and specified
transaction period.
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Pricing of Units
Example: If the applicable NAV is Rs. 10, entry load
is 2% then sales price will be: Rs. 10* (1+0.02) = Rs.
10.20
Example: If the applicable NAV is Rs. 10, exit load is
2% then redemption price will be: Rs. 10* (1-0.02) =
Rs. 9.80
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Investor¶s complaint redressal
mechanism
Client Servicing
Compliance Officer
Investors cannot be protected by companies Act.
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What is KIM?
KIM - Key Information Memorandum. The
offer document is a detailed document and
runs into around 80 or more pages.
Therefore, an abridged version of offer
document is made.
As per SEBI regulations, it is mandatory to
attach KIM along with every application form.
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What is Due Diligence Certificate?
Whenever a new schemes offer document is made, thiscertificate is given by the Compliance officer of the mutualfund that proper care is taken in making the scheme andthe offer document.
It certifies that :
a. The offer document is prepared as per SEBI regulations asamended until date.
b. Legal requirements regarding launch of the scheme havebeen complied.
c. The information given in the offer document is true and fair.
d. The intermediaries involved with the mutual fund schemeare all registered with SEBI and their registration is validuntil date.
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What are the risk factors of investing
in a MF scheme?A. Standard Risk Factors :
i. Market risks
ii. NAV can go up or down depending on Capital/Debtmarkets.
iii. Past performance of sponsors/AMC/MF does not indicatefuture performance of the scheme.
iv. Name of scheme does not indicate either quality or futureprospects & returns.
v. Sponsor is not responsible or liable for any loss beyondinitial contribution of Rs. 1 lakh.
vi. No guarantee or assurance on frequency or quantum of dividends although there is every intention to declaredividends
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B. Scheme Specific Risk Factors :
Trading volumes & settlement periods may restrict liquidityin equity and debt investments.
Investment in Debt is subject to price, credit & interest raterisk.
NAV may be affected by market conditions, interest rates,trading volumes, settlement periods & transfer procedures.
Liquidity may be restricted by trading volumes, settlementperiods and transfer procedures.Offer document must bereferred as and when required.
Fund may invest in overseas securities. Net assets,distributions and income may be affected by fluctuations invalues of foreign currencies.
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Test understanding OD
a) NFOs other than ELSS can be open for a max
period of : 7/ 10/15/30 days
b) Legally , SAI is part of Sid: True/ False
c) OD of MF schemes are approved by SEBI:
True/False
d) Application form is attached to : SID/SAI/KIM
e) KIM has to be updated every 6 months:True/False
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5. Test objectives: Fund Distribution
and Ch
annelM
anagement Practices Understand who can invest and types of investors
Understand various distribution channels for MF
Existing Sales practices and commission structure
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Distribution Channels
Individual Agents
Institutional Channels eg: Brokerages, Banks
Newer Distribution channels
Internet: direct contact with investors. Helped optimize
on comm costs. Investors have a lot of convenience.
Stock Exchanges: Cost effective All india net work of
brokers and trading terminals. ETFs are bought and
sold on SE
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Pre-requisites to become MF
distributor Everyone selling MFs i.e. individual, employee of
distributors, employees of AMC have to pass SEBI
prescribed certifying Exam.
Is compulsory for anyone who interacts with MFinvestors , including investor relations teams and
employees of call centres.
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Conditions for Empanelment
Simple form needs to be completed and given to
each AMC
Needs to sign a declaration
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Channel Management Practices
No SEBI regulations regarding Min or Max comm that
distributor can earn.
There are limits on what the total expense in the
scheme can be
Initial or upfront Commission
Trail commission, calculated as a % of the net assets
attributable to the units sold by the distributor. Paid
for as long as money is with MF scheme
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Multi Level Distribution Channel
Sub-brokers also need to comply with all the
regulations
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Sales Practices
SEBI¶s advertising code
Should not be misleading
Dividends should be declared in Rs. / unit
For performance reporting Annualised returns only for periods of one year and more
Absolute returns for periods less than one year
Consistency in comparison to benchmarks
Past performance may or may not be sustainedRankings need to be explained
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Sales Practices
Terms of appointment of agents
No approval from SEBI is required for agentsappointed by mutual funds. They are normally
appointed on the following terms Provide customer a copy of offer document
Customer has no recourse to agent
Agent will sell only at public offering price
Agent responsible for his own actions and cannot hold the fund houseresponsible
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Sales Practices
AMFI code of ethics
Interest of unit-holders primary
High service standards
Adequate disclosures
Professional selling practices
Fund management as per stated objective
Avoid conflict of interest with directors / trusteesRefrain from unethical market practices
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SEBI Advertising Code
Important Provisions are listed here:
Advt should be truthful , fai and clear. Shall not contain a
statement,promise or forecast.
All statements made and facts reported in sales literature of ascheme should be supported with disclosures made in the SID
& SAI.
Advt shall not contain information , the accuracy of which is to
any extend depended on assumptions.
MF investments are subject to risks of NAV fluctuation,
uncertainty of dividends needs to be explained.
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Guidelines regarding Advertisements Advertisements through Hoardings/Posters : Offer documents and
risk factors must read by investors considering the fact that
hoardings/posters, etc. carry only the statement ³Mutual Fund
investments are subject to market risks, read the offer document
carefully before investing´. The above statement shall be displayed in
black letters of at least 8 inches or covering 10% of the display area, on
white background.
Advertisements through Audio-Visual Media : In advertisements
through audio-visual media like television the above statement shall be
displayed for at least 5 seconds, covering 80% of total screen space &accompanied by a voice over reiteration.Remaining 20% can be used
for MF,logo or Name of Scheme
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Guidelines regarding Advertisements
Advertisements through audio media like radio,
cassettes, CDs etc. shall also read the above
statement in a way that is easily understandable to
the listeners over a period of 5 seconds.
122
Performance Advertisements
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Performance Advertisements Disclosure of Benchmarks in Advertisements : All performance
advertisements disclosing return statistics shall mention the returns on
the benchmark indices.
Performance of Money Market Schemes :The performance can be
advertised by simple annualisation of yields if a performance figure is
available for at least 7 days, 15 days and 30 days provided it does not
reflect an unrealistic or misleading picture of the performance or future
performance of the scheme.
Impact of Distribution Taxes : While advertising returns by assuming
reinvestment of dividends, fact whether distribution taxes are excluded
may also be disclosed.
Pay-out of Dividend : Here it shall be disclosed that NAV will fall, to
the extent of pay-out, after payment of dividend.
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Contd...
For schemes other than MM Schemes:
Advt & Sales literature cannot use rankings based on
yields below one year.
Rankings can be mentioned for 1,5, 10 years periods.
124
C td
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Contd«
Ranking advertisements : Any ranking set forth in anadvertisement or sales literature must be current to the
most recent quarter ended or such periodicity/frequency of
ranking as may be applicable, in the case of advertising
prior to the submission for publication or in the case of the
sales literature prior to use.
Fund of Fund¶s Advertisement : In case of Fund of
Funds scheme, the mutual funds shall disclose in the offer
document as well as in the advertisements that the
investors are bearing the recurring expenses of thescheme in addition to the expenses of other schemes in
which Fund of Funds scheme makes investment.
125
Test understanding Fund distribution
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Test understanding Fund distributionand Sales Practices
a) The max initial comm that an AMC can pay to
distributors is: Nil/ 0.05%/ 0.50%/ 2.25%
b) Institutional distributors build reach throu`:
Employees/ Agents/ Sub-brokers/any of the abovec) The distributor can charge fees from investors: True/
False
d) Trail comm is linked to valuation in the market:
True/ Falsee) Stock Exchange brokers are permitted to sell MFS
without passing the certifying test: True/ False
126
6 Test Objectives: Accounting
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6.Test Objectives: Accounting , Valuation & Taxation
Understand Accounting and expenses
Valuation process carried out by MFs
Understand applicability of various taxes and know
related regulations
127
Accounting & Expenses
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Accounting & Expenses
NAV = Net assets of scheme / No of units Outstanding
i.e. (Market value of investments+ Receivables+ Other accrued
income+ Other assets- accrued expenses- Other Payables- Other
liabilities) / No. of units outstanding as at the NAV date.
I mp : Day of NAV Calculation is known as valuation day.NAV is computed for each business day
The day¶s NAV must be posted on AMFI¶s website by 9 pm (for
those close ended funds which are not mandatorily required to be
listed in any Stock Exchange- Those funds may publish NAV at
monthly or quarterly intervals as permitted by SEBI.
NAV- Computation:
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NAV Other information
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NAV - Other informationOpen end funds to declare NAV daily
NAV has to consider up to date transactions
Major expenses such as Mgt. Fees should be accrued on a day to day
basis while others need not be so accrued if non-accrual does not affect
NAV by more than 1%.
NAV¶s are required to be rounded off up to 4 decimal places in case of
liquid/ MMM & up to 2 decimal places for all other schemes.
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HOW NAV IS COMPUTED
Market value of Equities - Rs.100 crore - Asset
Market value of Debentures - Rs.50 crore - Asset
Dividends Accrued - Rs.1 crore - Income
Interest Accrued - Rs.2 crore - Income
Ongoing Fee payable - Rs.0.5 crore - Liability
Amt.payable on shares purchased -Rs.4.5 crore - Liability
No. of units held in the Fund : 10 crore units
NAV per unit = [(100+50+1+2)-(0.5+4.5)]/10
= [153-5]/10= Rs. 14.80
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NAV
N AVs include the Amts originally invested,the profitsbooked,& appreciation in the investment portfolio.
N AVs go up when the market prices of securities held in theportfolio go up, even if the investments have not been sold.
Any incomes relating to the period will boost profits ,irrespective of whether or not it has been actually receivedin the bank a/c.This is in line with accrual principle.
131
Pricing of Units
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Pricing of Units
Entry Load or front ended load
Paid at the time of purchase
Sale Price = N AV / (1- Sales Load, if any)
Exit Load or back ended loadPaid at the time of exit
Repurchase/Redemption Price = N AV /(1+ Exit Load)
Contingent Deferred Sales Load (CDSL)Deferred exit load depending on the period
Also known as deferred load
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Repurchase Price
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Repurchase Price
Repurchase Price is the price at which units are
repurchased from the investors.
Sale price = NAV - Exit load
Formula for computation of Sale price =
NAV *( 1 - Load)
Assuming an exit load of 2%
NAV computation example :
Sale price = 14.80*( 1- 0.02 ) = 14.50.
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The position as on Aug 1, 2009
SEBI has banned Entry loads. So Sales Price is
same as NAV.
Exit loads/CDSC in excess of 1% of the redemption
amt have to be credited back to the schemeimmediately i.e. they are not available to AMC to bear
selling expenses.
Exit loads need to be same for all unit-holders
representing a portfolio.
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Mark to Market
The process of valuing each security in the
investment portfolio of the scheme at its market value
is called Mark to Market.
Mark to Market helps investors buy and sell units of ascheme at fair prices , which are based on
transparently calculated and freely shared info on
NAV.
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FEES & EXPENSES
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Initial Issue
ExpensesTransaction Cost
Entry / Exit load
CDSC for no-load
schemes
FEES & EXPENSES
Recurring
ExpensesAMC Fee
Custodian Fee
Registry Exp.
Trustee Fee
Audit FeeMktg. & Selling Exp.
Brokerage Exp.
Others
Investment
Mgt
& Advisory
fees
A
B
C
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Fees & Expenses
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Fees & Expenses Initial Issue expenses :One time expenses that
come up when the scheme is offered for first
time(NFO).These are borne by AMC.
AMCs could charge up to 6% of initial resourcesraised under the scheme. In order to prevent the
scheme from causing a drastic fall in N AV, theguidelines permit a deferred load. E.g. a 5 yrs(260 weeks) close ended equity schemes withinitial issue expenses of Rs. 5 lacs shall charge Rs.1923 (5,00,000/260) every week.
137
Fees & Expenses Contd
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Fees & Expenses Contd..
Recurring Expenses :These can be charged toscheme.Since they drag the NAV down, SEBI has laiddown the expenses which can be charged to thescheme:
Fees of various service providers such asTrustees,AMC,Registrar& Transfer agent, Custodian, &
Auditor.
Selling expenses including scheme advertising & commto distributors
Expenses on investor communication, accountstatements,, dividend/redemption cheques/ warrants.
Listing fees and depository fees.
Service Tax138
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Cannot be charged to Scheme
Penalties and fines for infraction of laws
Interest on delayed payment to uint holders
Legal, marketing,publication and other general
expenses not attributable to any schemes
Fund accounting fees
Expenses on Investment mgt/General mgt.
Expenses on General Admn, Corp Advertising and
Infrastructure costs.
Depreciation on fixed assets and software dev
expenses
139
F & E
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Fees & Expenses
AMC can charge Investment management fee to the fund
on weekly avg. net assets.
The limits are: (Subject to overall total expenses limit of
2.25%)
1.25% for up to Rs.100 cr of weekly avg net assets
1% in excess of Rs.100 cr.
Mgt fees cannot be charged by Debt/Liquid funds on funds
parked in short term deposits of comm banks.
140
d
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Fees and Expenses
The expense limits for Index /ETFs is as follows:
Recurring expense limit: 1.50%
Management fees: 0.75%
For F of F , the recurring expense limit ( including
management fees) is 0.75%
141
Limits on Fees & Expenses
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Limits on Fees & Expenses Total Expenses that can be charged to the Fund (
excluding exit loads)other than Index Funds:
Equity Debt
On the first Rs.100 cr 2.50% 2.25%
On the next Rs.300 cr 2.25% 2.00%On the next Rs.300 cr 2.00 % 1.75%
On the balance assets 1.75% 1.50%
Based on average weekly net assets
142
Dividends and Distributable
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Dividends and DistributableReserves
Income and expense are accounted on the basis of
accrual principle.They may not have been received or
paid, however considered as accrued as income or
expense , if they relate to a period until theaccounting date.
Investments in a portfolio , if not sold, are only on
paper- they are not realized. They will be realized
when sold only.
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SEBI guidelines on dividend distribution
Dividends can only be paid from distributable
reserves.
In calculation of distributable reserves:
All profits earned are treated as available for distribution.
Valuation gains are ignored. Valuation losses to be
adjusted against valuation losses.
Thus dividend is payable out of real profits, after providing for possible losses.
144
Key Accounting and Reporting
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Key Accounting and ReportingRequirements
Accounts of the Scheme have to be distinct from the
accounts of the AMC.Auditor too has to be different.
NAV calculation upto 4 decimals for Index , Liquid &
other debt funds. NAV calculation upto 2 decimals for Equity &
Balanced funds.
145
V l ti
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Valuation
Key factor driving the NAV is the portfolio
valuation.Valuation can be subjective. To reduce
subjectivity and increase the comparability of NAVs
across schemes valuation guidelines have been laiddown:
Equity, closing price needs to be considered
Equity shares not traded on a day/thinly traded , a
formula is used, based on the Earnings per share of the Co., its Book Value and the valuation of similar
shares in the market.
146
V l ti
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Valuation
Debt, not traded on the valuation date are valued on
the basis of the yield matrix prepared by authorized
valuation agency.
Security to be treated as Non-performing Asset(NPA)- how much has to be written off at varoius
points of time, etc.
If an individual security that is not traded or thinly
traded, represents more than 55 of the assets of ascheme , an independent valuer has to be appointed.
147
Valuation- Equity & Debt
TRADED SECURITIES
d l i i h h i i ll d d
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q yLast quoted closing price on the SE where principally traded
If N
ot traded on anySE on a particular day, then earliest previousday price is taken (not more than 30 days)
Valuation = MP * current holding
Thinly Traded Securities: For some securities market prices arenot available easily and always . SEBI gives freedom to AMCs to use
their methods of valuation.Definition of thinly traded: Equity/Convertible Debenture/Warrant isconsidered thinly traded if both a) trading value is < Rs.5 Lacs andb) volume is < 50,000 shares
for preceding calendar month.
No individual trade in that security in the marketable lots( Rs.5Cr)on the principal SE
148
V l ti td
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Valuation contd«
NON - TRADED SECURITIES
Stocks which are not traded for more than 30 days on
any SE are valued on good faith basis by AMC within
following parameters
149
Ta abilit of M t al F nd
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Taxability of Mutual Fund
The MF trust is exempt from tax. The trustee Co.
however pays tax in the normal course on its profits.
Equity-oriented Scheme: where atleast 65% of the
assets are invested in equity shares of domesticcos.Average of opening and closing % is calculated
for each month. Then the average of such value is
taken for the 12 months in the FY.
150
Equity Schemes Other Schemes
STC LTCG Div DD TDS STCG LTCG Div DDT TDS
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151
STCG
LTCG Div DDT
TDS STCG LTCG Div DDT TDS
Liquid Others
Resident/HUF 15% Nil TaxFree
Nil Nil As per Slab
10%20% withIndexation)
TaxFree
28.325%(Sur charge+Edu
cess)
14.1625%(12.5%+Surcharge+E
du Cess)
Nil
Partnership Firms
15% Nil TaxFree
Nil Nil 30% 10%20% withIndexation)
TaxFree
28.325%(Sur charge+Edu
cess)
22.66%(12.5%+Surcharge+Edu
Cess)
Nil
AOP /BOI 15% Nil Tax
Free
Nil Nil As per
Slab
10%20% with
Indexation)
28.325%(Sur
charge+Educess)
14.1625%(12.5
%+Surcharge+Edu Cess)
Domestic Cos 15% Nil TaxFree
Nil Nil 30% 10%20% withIndexation)
TaxFree
28.325%(Sur charge+Edu
cess)
22.66%(12.5%+Surcharge+Edu
Cess)
Nil
NRIs 15% Nil TaxFree
Nil11.33
%(10
%+Sur charg
e+Edu
Cess
As per Slab
10%20% withIndexation)
TaxFree
28.325%(Sur charge+Edu
cess)
22.66%(12.5%+Surcharge+Edu
Cess)
30%
Capital Gains Tax
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Capital Gains Tax
Capital Gain is the difference between sale price and acquisition
cost of the investment.
Investors in mutual fund schemes need to pay a tax on their
capital gains as follows:
Equity-oriented schemes
Nil ± on Long Term Capital Gains (i.e. if investment was held for
more than a year) arising out of transactions where STT has
been paid.
15% plus surcharge plus education cess ± on Short Term
Capital Gains (i.e. if investment was held for 1 year or less)
arising out of transactions, where STT has been paid
Where STT is not paid, the taxation is similar to debt-oriented
schemes.
152
Capital Gains Tax
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Capital Gains Tax
Debt-oriented schemes
Short Term Capital Gains (i.e. if investment was held for 1 year
or less) are added to the income of the investor. Thus, they get
taxed as per the tax slabs applicable. An investor whose income
is above that prescribed for 20% taxation would end up bearing
tax at 30%. Investors in lower tax slabs would bear tax at lower rates. Thus, what is applicable is the marginal rate of tax of the
investor.
In the case of Long Term Capital Gain (i.e. if investment was
held for more than 1 year), investor pays tax at the lower of the
following:10% plus surcharge plus education cess, without indexation
20% plus surcharge plus education cess, with indexation
153
Indexation
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Indexation
Investor buys on March 31, 1999 and sells on April 1,
2000. What is the indexation adjustment factor? 1998-99 351
1999-00 386
2000-01 406
Investor buys on April 1, 1998 and sells on March 31,
2001. What is the indexation adjustment factor?
154
Indexation Example
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Indexation Example
If the investor bought units of a debt-oriented mutual fund
scheme at Rs 10 and sold them at Rs 15, after a period of over
a year. Assume the government¶s inflation index number was
400 for the year in which the units were bought; and 440 for the
year in which the units were sold. The investor would need to
pay tax on the lower of the following: 10%, without indexation viz. 10% X (Rs 15 minus Rs 10) i.e. Rs
0.50 per unit
20%, with indexation.
Indexed cost of acquisition is Rs 10 X 440 ÷ 400 i.e. Rs11. The
capital gains post indexation is Rs 15 minus Rs 11 i.e. Rs 4 per unit. 20% tax on this would mean a tax of Rs 0.80 per unit.
The investor would pay the lower of the two taxes i.e. Rs0.50 per
unit.
155
Setting off Gains and Losses under
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gIncome Tax Act
A few key provisions here are:
Capital loss, short term or long term, cannot be set off against
any other head of income (e.g. salaries)
Short term capital loss is to be set off against short term capital
gain or long term capital gain
Long term capital loss can only be set off against long term
capital gain.
Since long term capital gains arising out of equity-oriented
mutual fund units is exempt from tax, long term capital loss
arising out of such transactions is not available for set off.
156
Test understanding Accounting ,
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g g Valuation & Taxation
a) STT is applicable to Equity funds: True/False
b) NAV of Income funds are calculated upto __
decimals: 4/3/1
c) NAV of a scheme is nothing but its investmentportfolio: True/False
d) The difference between NAV and re-purchase price
is: Entry Load/Exit Load/Expense/Dividend stripping.
e) Wealth Tax is payable at applicable rates on equitymutual fund units: T/F
157
7 Test objectives: Investor Services
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7. Test objectives: Investor Services
Purchase and redemption transactions in MF
Investment plans and services
158
Eligibility to Invest
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Eligibility to Invest
Individual Investors
They invest for their personal benefit or the benefit of their
family.
Examples:
Resident Indian adult individuals, above the age of 18. They can
invest, either singly or jointly (not exceeding three names)
Minors i.e. persons below the age of 18: Since they are not legally
eligible to contract, they need to invest through their Parents/
Lawful guardians.
Hindu Undivided Families (HUFs): Here family members pool the
family money (inherited) for investments. The head of the
159
Eligibility to Invest
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Eligibility to Invest
Non-Resident Indians (NRIs) / Persons of Indian
origin (PIO) resident abroad. An Indian citizen, who is
working abroad, and his / her family residing abroad,
are typical NRIs who invest in India. Non-individual Investors: Here, the individuals who
sign the documents are investing on behalf of
organizations /institutions they represent, such as:
o Companies / corporate bodies, registered in India
160
Eligibility to invest
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Eligibility to invest
oRegistered Societies and Co-operative Societies
o Religious and Charitable Trusts
o Trustees of private trusts
o Partner(s) of Partnership Firms
o Association of Persons or Body of Individuals, whether
incorporated or not
o Banks (including Co-operative Banks and Regional Rural Banks)
and Financial Institutions and Investment Institutions
o Other Mutual Funds registered with SEBIo Foreign Institutional Investors (FIIs) registered with SEBI
o International Multilateral Agencies approved by the Government
of India
161
Eligibility to invest
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Eligibility to invest
oArmy/Navy/Air Force, Para-Military Units and other
eligible institutions
o Scientific and Industrial Research Organizations
o Universities and Educational InstitutionsThe following are not permitted to invest in mutual funds
in India:
o An individual who is a foreign national (unless of
course, the person is an NRI or PIO / OCI cardholder.
162
Eligibility to Invest
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Eligibility to Invest
O Any entity that is not an Indian resident, as per
FEMA(except when the entity is registered as FII with
SEBI, or has a sub-account with a SEBI-registered
FII).o Overseas Corporate Bodies (OCBs) i.e. societies /
trusts held, directly or indirectly, to the extent of over
60% by NRIs, or trusts where more than 60% of the
beneficial interests is held by such OCBs
163
KYC Requirement for MF investors
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KYC Requirement for MF investors
It is compulsory for all investments of Rs 50,000 and above tobe compliant with the regulatory requirements prescribed under
the Anti-Money Laundering Act, 1992 and SEBI circulars in this
regard. Broadly, mutual fund investors need the following
documents:
Proof of Identity
Proof of Address
PAN Card
Photograph
Where investment is made by a minor, KYC requirements have
to be complied with by the Guardian.In the case of investments by a Power of Attorney holder on
behalf of an investor, KYC requirements have to be complied
with,both, investor and PoA holder.
164
PAN requirement for Micro-SIPs
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PAN requirement for Micro SIPs
PAN Card is compulsory for all mutual fund investments.
Exception has been made for Micro-SIPs i.e. SIPs where annual
investment (12 month rolling or April-March financial year) does
not exceed Rs 50,000.
Micro-SIP investment by individuals, minors and sole-proprietoryfirms are exempted from the requirement of PAN card.
Instead,the investors (including joint holders) can submit any
one of the following PHOTO IDENTIFICATION documents
along withMicro SIP application:
165
Contd
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Contd.
Voter Identity Card
Driving License
Government / Defense identification card
Passport
Photo Ration Card
Photo Debit Card (Credit card not included because it may not
be backed up by a bank account).
Employee ID cards issued by companies registered with Registrar
of Companies) Photo Identification issued by Bank Managers of Scheduled
Commercial Banks / Gazetted Officer / Elected Representatives to
the Legislative Assembly / Parliament
166
Contd
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Contd.
Investors have to give a declaration stating that the
he does not have any existing Micro SIPs which
together with the current application will result in
aggregate investments exceeding Rs.50,000 in ayear.
167
Additional Documentation Requirementsapplicable
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applicable
forInstit
utional
Investors
For instance, a company / trust is eligible to invest under the
laws of the country, but the company¶s own incorporation
documents (Memorandum of Association and Articles of
Association or Trust Deed) may not have provided for such
investments. The company / trust cannot invest if its
incorporation documents do not provide for investments of this
type.
Similarly, in some states, permission of the Charity
Commissioner is necessary, before Religious and
CharitableTrusts can invest.
Authorisation for the investing institution to invest. This is typically
in the form of a Board Resolution.
Authorisation for the official to sign the documents on behalf of the
investing institution. This again is provided for in the Board
Resolution. 168
Demat Account
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Demat Account
Dematerialisation is a process whereby an investor¶s holding of
investments in physical form (paper), is converted into a digital
record. Benefit of holding investments in demat form is that
investors¶ purchase and sale of investments get automatically
added or subtracted from their investment demat account, without
having to execute cumbersome paperwork.
169
Demat Account
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Demat Account
The investor¶s benefits from a demat account are as follows:
Less paperwork in buying or selling the Units, and
correspondingly, accepting or giving delivery of the Units.
Direct credit of bonus and rights units that the investor is entitled
to, into the investor¶s demat account.
Change of address or other details need to be given only to the
Depository Participant, instead of separately to every company/
mutual fund where the investor has invested.
The investor also has the option to convert the demat units into
physical form. This process is called re-materialisation.
170
Payment Mechanism for purchase /
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additional pu
rch
ase Cheque / Demand Draft ( DD ) ± Application forms for
fresh investment / transaction slip for additional
purchase is normally accompanied by one of these
instruments. NRI / PIO applications need to be accompanied by
cheque drawn on an NRO account (for non-
repatriable investment) or NRE account (for
repatriable investment).
171
Payment Mechanism forh / ddi i l h
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purchase / additional purchase
Remittance can also be made directly to the bank account of the
scheme through Real Time Gross Settlement (RTGS) / National
Electronic Funds Transfer (NEFT) transfers (for transfers within
India) or SWIFT transfer (for transfers from abroad). While
RTGS transfers are instantaneous, NEFT transfers are batchedtogether in the banking system, and effected at various times
during the day. SWIFT transfers tend to pass through multiple
banks in different geographies, and multiple levels within the
same bank, resulting in delays.
172
Payment Mechanism forh / dditi l h
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purchase / additional purchase
Electronic Clearing Service (ECS) / Standing Instructions are a
convenient form of investment in a SIP. On the specified date,
each month, the bank will automatically transfer money from the
investor¶s account to the account of the mutual fund. The bank
accepts µStanding Instructions¶ (also called µDirect Debit¶) if both
investor and mutual fund have an account with the same bank. If
the two accounts are in different bank, then ECS is used.
173
Cut-off Time
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Cut off Time
In order to ensure fairness to investors, SEBI has
prescribed cut-off timing to determine the applicable
NAV.
The provisions, which are uniformly applicable for allmutual funds,are as follows:
174
Cut-off Time
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Cut off Time
Scheme Type Transaction Cut-off Time Applicable NAV
Liquid (if fund are
available for
utilisation on same
day)
Sale Received upto 12
noon
Closing NAV
of Day immediately
preceding the date
of application
Liquid (if funds are
available for
utilisation on same
day)
Sale Received after 12
noon
Closing NAV
of Day preceding
next business day
Liquid (if funds
are NOT available
for utilisation onsame day)
Sale Received any time
during the day
Closing NAV
of Day preceding
theday on which
funds are available
for utilization
175
Cut-off Time
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Cut off Time
Scheme Type Transaction Cut-off
Time
Applicable
NAV
Liquid Schemes Re-purchase Received
before 3
pm
Closing NAV
of Day
preceding nextbusiness day
Liquid Schemes Re-purchase Received
after 3 pm
Closing NAV
of next
business day
176
Cut-off TimeScheme Type Transaction Cut-off
Time
Applicable
NAV
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Time NAV
Schemes other
than Liquid
Schemes
(investment of
Rs 1 crore or
above)
Sale Received
any time during
the day
Closing NAV
of day funds
are available
for utilisation
Schemes other
than LiquidSchemes
(investment
uptoRs 1 crore)
Sale Application
Received upto 3pm with local
cheque / DD
Closing NAV
of dateapplication is
received
Schemes other
than Liquid
Schemes
(investment upto
Rs1crore)
Sale Application
Received after 3
pm with local
cheque / DD
Closing NAV
of next business
day
Schemes other
than Liquid
Schemes
(investment upto
Rs1crore)
Sale Application
received
With outstation
cheque / DD
(irrespective of
time)
Closing NAV
of day the
cheque / DD is
credited in the
bank account177
Cut-off Time
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Scheme Type Transaction Cut-off
Time
Applicable
NAV
Schemes other
than Liquid
Schemes
Re-purchase Application
Received upto 3
pm
Closing NAV
of same day
Schemes other
than Liquid
Schemes
Re-purchase Application
Received after 3
pm
Closing NAV
of next
business day
178
The cut-off timing is not applicable for NFOs and
International Schemes
Transactions through the StockExchange
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Exchange
Both National Stock Exchange (NSE) and Bombay
Stock Exchange (BSE) have extended their trading
platform to help the stock exchange brokers become
a channel for investors to transact in Mutual FundUnits. NSE¶s platform is called NEAT MFSS. BSE¶s
platform is BSE StAR Mutual Funds Platform.
Both platforms are open from 9 am to 3 pm on every
working day.
179
Dividend Payout, Growth andDividend Re Investment options
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Dividend Re-Investment options
The portfolio returns are the same for all three options.
However, they differ in the structure of cash flows and income
accruals for the unit-holder, and therefore, the Unit-holder¶s
taxability, number of units held and value of those units.
When a dividend is paid, the NAV of the units falls to that extent. Debt schemes need to pay an income distribution tax on the
dividend distributed. This tax payment too reduces the NAV
The reduced NAV, after a dividend payout is called ex-Dividend
NAV. After a dividend is announced, and until it is paid out, it is
referred to as cum-Dividend NAV.
180
Systematic InvestmentPlan(SIP)
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Plan(SIP)
SIP is an approach where the investor invests
constant amounts at regular intervals. A benefit of
such an approach, particularly in equity schemes, is
that it averages the unit-holder¶s cost of acquisition. Mutual funds make it convenient for investors to lock
into SIPs by investing through Post-Dated Cheques
(PDCs), ECS or standing instructions.
181
Systematic WithdrawalPlan(SWP)
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Plan(SWP)
Just as investors do not want to buy all their units at a
market peak, they do not want all their units
redeemed in a market trough. Investors can therefore
opt for the safer route of offering for repurchase,aconstant value of units.
Some schemes even offer the facility of transferring
only the appreciation or the dividend. Accordingly, the
mutual fund will re-purchase the appropriate number
of units of the unit-holder, without the formality of having to give a re-purchase instruction for each
transaction
182
SWP
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An investor may opt for SWP for several reasons: As discussed earlier, minimise the risk of redeeming all the units
during a market trough.
Meet liquidity needs for regular expenses.
Assuming the scheme is profitable, the re-purchase ensures
that some of the profits are being regularly encashed by theinvestor.
As discussed under Taxation, debt schemes are subject to
Income Distribution Tax. In such schemes, it would be more tax-
efficient to take money out of the scheme as a re-purchase(on
which there is no income distribution tax) as compared todividend (which would be liable to income distribution tax).
183
Systematic Transfer Plan(STP)
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y ( )
This is a variation of SWP. While in a SWP the constant amount
is paid to the investor at the pre-specified frequency, in a STP,
the amount which is withdrawn from a scheme is re-invested in
some other scheme of the same mutual fund. Thus, it operates
as a SWP from the first scheme, and a SIP into the secondscheme.
184
Triggers
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gg
It is not uncommon for investors to rue missed
opportunities of buying or selling because they could
not give the requisite instructions in time. This is
addressed through the trigger option that is availablefor some schemes.
185
Nomination
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Most investors like clarity about what would happen
to their unitholding, in the unfortunate event of their
demise. This clarity can be achieved by executing a
Nomination Form, where the nominee¶s name isspecified. If the nominee is a minor, then a guardian
too can be specified. In the case of joint holding,
every unit-holder will have to sign the nomination
form.
186
Pledge
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g
Banks, NBFCs and other financiers often lend money
against pledge of Units by the Unit-holder. This is
effected through a Pledge F orm executed by the unit-
holder/s (pledger/s).
Once Units are pledged, the Unit-holder/s cannot sell
or transfer the pledged units, until the pledgee gives
a no-objection to release the pledge.
187
Test understanding InvestorServices
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Services
a)Cut off guidelines are not applicable for:
NFOs/International Funds/Both of the above/ none of
the above
b) Investments in MFs can be made using :Cheques/DD, Remittance,ASBA, Any of the above
c) PAN card is compulsory for all MF investments above
Rs.50, 000 including SIPs: True/False
d)STP is a combination of SIP & SWP: True/False
e) Foreign nationals can invest in Indian MFs:
True/False
188
8. Test Objectives: Return, Risk, &Performance of Schemes
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Performance of Schemes
Understand the concept of return on Investment
Risks in Fund investing with focus on investors
Benchmarking of performance
189
Drivers of Returns in a Scheme
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The portfolio is the main driver of returns in a mutual
fund scheme.
The underlying factors are different for each asset
class. Equity Schemes: Securities Analysis Disciplines ±
Fundamental Analysis and Technical Analysis,a
passive fund maintains a portfolio that is in line with
the index it mirrors. Therefore, a passive fund
manager does not need to go through this process of
securities analysis
190
Contd
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Fundamental Analysis entails review of the
company¶s fundamentals viz. financial statements,
quality of management, competitive position in its
product / service market etc.
The analyst sets price targets, based on financial
parameters : Next slide
191
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Earnings per Share (EPS): Net profit after tax ÷ No. of equity
shares
This tells investors how much profit the company earned for
each equity share that they own.
Price to Earnings Ratio (P /E Ratio): Market Price ÷ EPS
When investors buy shares of a company, they are essentially
buying into its future earnings. P/E ratio indicates how much
investors in the share market are prepared to pay (to become
owners of the company), in relation to the company¶s earnings.
Book Value per Share: Net Worth ÷ No. of equity shares
This is an indicator of how much each share is worth, as per the
company¶s own books of accounts.
192
Contd
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Price to Book Value: Market Price ÷ Book Value per Share
An indicator of how much the share market is prepared to pay for
each share of the company, as compared to its book value.
Such financial parameters are compared across companies,
normally within a sector. Accordingly, recommendations aremade to buy / hold / sell the shares of the company.
The fundamental analyst keeps track of various companies in a
sector, and the uniqueness of each company, to ensure that
various financial indicators are understood in the right
perspective.
193
Technical Analysis
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Technical Analysts believe that price behaviour of a share, and
the volumes traded are a reflection of investor sentiment, which
in turn will influence future price of the share.
Technical Analysts therefore study price-volume charts (a
reason for their frequently used description as ³chartists´) of thecompany¶s shares to decide support levels, resistance levels
break outs etc.
It is generally agreed that longer term investment decisions are
best taken through a fundamental analysis approach, while
technical analysis comes in handy for shorter term speculativedecisions, including intra-day trading.
194
Investment Styles Growth andValue
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Value
G rowth investment style entails investing in high growth
stocks i.e. stocks of companies that are likely to grow much
faster than the economy. Many market players are interested in
accumulating such growth stocks. Therefore, valuation of these
stocks tends to be on the higher side. Further, in the event of amarket correction, these stocks tend to decline more.
Value investment style is an approach of picking up stocks
which are valued lower, based on fundamental analysis. The
belief is that the market has not appreciated some aspect of the
value in a company¶s share ± and hence it is cheap. When the
market recognizes the intrinsic value, then the price would shoot
up. Such stocks are also called value stocks.
195
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Investments of a scheme can thus be based on
growth, value or a blend of the two styles. In the initial
phases of a bull run, growth stocks deliver good
returns. Subsequently, when the market heats up,
value picks end up being safer.
196
Portfolio building approach Topdown and Bottom up
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down and Bottom up
T op down approach, the portfolio manager decides how to
distribute the investible corpus between countries (if it invests in
multiple geographies) and sectors. Thereafter, the good stocks
within the identified sectors are selected for investment. Thus
sector allocation is a key decision. Bottom-up approach does not assign too much importance to
the country-allocation and sector-allocation. If a stock is good, it
is picked for investment. The approach is therefore also called
stock picking. Stock selection is the key decision in this
approach; sector allocation is a result of the stock selection
decisions.
197
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Both approaches have their merit. Top down
approach minimizes the chance of being stuck with
large exposure to a poor sector. Bottom up approach
ensures that a good stock is picked, even if it belongs
to a sector that is not so hot.
Therefore, it can be said that equity returns are a
function of sector and stock selection.
198
Debt
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Investment in a debt security, as in the case of a loan, entails a
return in the form of interest (at a pre-specified frequency for a
prespecified period), and refund of a pre-specified amount at the
end of the pre-specified period.
The pre-specified period is also called tenor. At the end of thetenor, the securities are said to mature. The process of repaying
the amounts due on maturity is called redemption.
The return that an investor earns or is likely to earn on a debt
security is called its yield. The yield would be a combination of
interest paid by the issuer and capital gain (if the proceeds onredemption are higher than the amount invested) or capital loss
(if the proceeds on redemption are lower than the amount
invested)
199
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Securities issued by the Government are called Government
Securities or G-Sec or Gilt.
T reasury Bills are short term debt instruments issued by the
Reserve Bank of India on behalf of the Government of India.
Certificates of Deposit are issued by Banks (for 91 days to 1year) or Financial Institutions (for 1 to 3 years)
Commercial P apers are short term securities (from 3 months
upto 1 year) issued by companies
Cor porate Debentures : Issued by manufacturing Co¶s with
physical assets as secured instruments in the form of certificates.
200
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Since the government is unlikely to default on its obligations,
Gilts are viewed as safe. The yield on Gilt is generally the lowest
in the market. Since non-Government issuers can default, they
tend to offer higher yields. The difference between the yield on
Gilt and 240 the yield on a non-Government Debt security iscalled its yield spread.
The possibility of a non-government issuer defaulting on a debt
security i.e. its credit risk, is measured by Credit Rating
companies like CRISIL, ICRA, CARE and Fitch. They assign
different symbols to indicate the credit risk in a debt security.
201
Contd
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The possibility of a non-government issuer defaulting on a debt
security i.e. its credit risk, is measured by Credit Rating
companies like CRISIL, ICRA, CARE and Fitch. They assign
different symbols to indicate the credit risk in a debt security.
A rate linked to some other rate that may be prevailing in themarket, say the rate that is applicable to Gilt. Interest rates on
floating rate securities (also called floaters) are specified as a
³Base + Spread´. For example, 5-year G-Sec + 2%. This means
that the interest rate that is payable on the debt security would
be 2% above whatever is the rate prevailing in the market for
Government Securities of 5-year maturity.
202
The returns in a debt portfolio arelargely driven by interest rates
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and yield spreads. Interest Rates: An investor has invested in a debt security that
yields a return of 8%. Subsequently, yields in the market for
similar securities rise to 9%. It stands to reason that the security,
which was bought at 8% yield, is no longer such an attractive
investment. It will therefore lose value. Conversely, if the yields
in the market go down, the debt security will gain value. Thus,
there is an inverse relationship between yields and value of
such debt securities which offer a fixed rate of interest.
Debt analysts work with a related concept called modified
duration to assess how much a debt security is likely to fluctuatein response to changes in interest rates.
203
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In a floater, when yields in the market go up, the issuer pays
higher interest; lower interest is paid, when yields in the market
go down.
If the portfolio manager expects interest rates to rise, then the
portfolio is switched towards a higher proportion of floating rateinstruments; or fixed rate instruments of shorter tenor. On the
other hand, if the expectation is that interest rates would fall,
then the manager increases the exposure to longer term fixed
rate debt securities.
The calls that a fund manager takes on likely interest ratescenario are therefore a key determinant of the returns in a debt
fund ± unlike equity, where the calls on sectors and stocks are
important.
204
Contd.
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Yield Spreads: Suppose an investor has invested in the debt
security of a company. Subsequently, its credit rating improves.
The market will now be prepared to accept a lower yield spread.
Correspondingly, the value of the debt security will increase in
the market. A debt portfolio manager explores opportunities toearn gains by anticipating changes in credit quality, and
changes in yield spreads between different market benchmarks
in the market place.
205
Gold
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Gold is a truly international asset, whose quality can be
objectively measured. The value of gold in India depends on the
international price of gold (which is quoted in foreign currency),
the exchange rate for converting the currency into Indian
rupees, and any duties on the import of gold. Therefore, returns in gold as an asset class depends on:
Global price of gold: Gold is seen as a safe haven asset class.
Therefore, whenever there is political or economic turmoil, gold
prices shoot up.
Most countries hold a part of their foreign currency reserves ingold. Similarly, institutions like the International Monetary Fund
have large reserves of gold.
206
Gold
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Strength of the Rupee: Economic research into inflation and
foreign currency flows helps analysts anticipate the likely trend
of foreign currency rates.
When the rupee becomes stronger, the same foreign currency
can be bought for fewer rupees. Therefore, the same gold price(denominated in foreign currency), translates into a lower rupee
value for the gold portfolio. This pushes down the returns in the
gold fund. A weaker rupee, on the other hand, pushes up the
rupee value of the gold portfolio, and consequently the returns in
gold would be higher.
207
Real Estate
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Unlike gold, real estate is a local asset. It cannot be transported
± and its value is driven by local factors. Some of these factors
are:
Economic scenario :In the recent past, when there was
uncertainty about the economy, people preferred to postponereal estate purchases. Consequently, real estate prices
weakened. As the economy improves, real estate prices also
tend to keep pace.
Infrastructure development: Whenever infrastructure in an
area improves, real estate values go up.
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Real Estate
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Interest Rates: When money is cheap and easily available,
more people buy real estate. This pushes up real estate values.
Rise in interest rates therefore softens the real estate market.
The behaviour of real estate is also a function of the nature of
real estate viz. residential or commercial; industrial,infrastructural,warehouse, hotel or retail.
209
Contd.
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The portfolio is the most important driver of returns in
a scheme.
The factors that drive the return of some of the asset
classes were discussed here. The factors that causefluctuation in the returns of these asset classes, and
the schemes that invest in them, are discussed in a
later slides on risk drivers.
210
Measures of Return
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Simple Return
Annualized Returns,helps in comparing the returns of 2 diff
time periods
Compounded Return: What is compounding? Suppose you
place Rs 10,000 in a cumulative bank deposit for 3 years at 10%interest, compounded annually. The bank would calculate the
interest in each of the 3 years as follows:
Year Opening Balance(Rs) Interest Closing Balance
(Rs)
1 10,000 1,000 11,000
2 11,000 1,100 12,100
3 12,100 1,210 13,310
211
Contd
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Thus, at the end of the 3 year period, your principal of Rs 10,000
would have grown to Rs 13,310. If, on the other hand, the bank
had calculated interest on simple basis, it would have calculated
interest at Rs 1,000 for each of the 3 years, and given you Rs
13,000. Compounded Annual Growth Rate (CAGR):In the above
examples, if a dividend were paid, then that has not been
captured in any of the three kinds of returns calculated viz.
Simple, Annualised and Compounded.
The above three formulae are thus applicable only for growth
schemes, or for dividend schemes that have not paid a dividend
during the period for which return is being calculated.
212
CAGR
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Whenever a dividend is paid ± and compounding is to
be considered - the CAGR technique prescribed by
SEBI is used.
This calculation is based on an assumption that thedividend would be re-invested in the same scheme at
the ex-dividend NAV.
213
Risk in Mutual Fund Schemes Portfolio Risk :Investors invest in a mutual fund scheme, which
in turn invests in the market ± debt, equity, gold or real estate in
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, q y, g
varying mixes,depending on the nature of the scheme. There isno certainty regarding the performance of the market/s, where a
fund invests.
Valuation in the market may go up or go down. Accordingly, the
value of the portfolio and the NAV of the scheme fluctuate.
Portfolio Liquidity:When investments are liquid, there is atransparent market benchmark to its value. Further, these
investments can be sold to book profits or to generate liquidity
for the scheme.
SEBI has therefore laid down criteria to identify illiquid
investments, and also set a ceiling to the proportion of suchilliquid investments in the net assets of a scheme. The
prescribed ceiling is lower for open-ended scheme, which have
a greater need for liquidity because investors can offer their
units for re-purchase at any time.214
Contd
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In 2008 and 2009, when the global markets went into turmoil,
liquidity disappeared from the market. RBI had to step in to help
some mutual funds fulfil their obligations.
Liquid assets in the scheme: Schemes maintain a certainproportion of their assets in liquid form. This could be for either
of two reasons
They believe that the market is over-heated, and therefore
prefer to sell their investments and hold the proceeds in liquid
form, until the next buying opportunity comes up. They want to provide for contingencies such as impending
dividend payment or re-purchase expectations.
215
Liabilities in the scheme
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when a scheme purchases an investment, it is liable to pay for
it. Until the payment is made as per the stock exchange
settlement cycle, it will be a liability of the scheme. The practice
of taking liabilities beyond what is inherent to the normal
business of a mutual fund scheme is called leveraging.Internationally, such leveraged funds are commonly found.
Recognising the risks involved in such leveraging, SEBI
regulations stipulate that:
A mutual fund scheme cannot borrow more than 20% of its net
assets
The borrowing cannot be for more than 6 months.
216
Liabilities in the scheme The borrowing is permitted only to meet the cash flow needs of
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g p y
investor servicing viz. dividend payments or re-purchase
payments.
217
Use of Derivatives
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Derivatives are instruments whose value is derived
from the value of one or more underlying exposures.
The underlying could be a shares, exchange rate,
interest rate, commodity, precious metal, index,
weather, etc. The commonly known derivatives are
forwards, futures, options and swaps.
It is important to understand that these products
may be used for either of the following purposes:
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Use of Derivatives
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Hedging against risk: Some derivative contracts are structured
such that, when the market goes down the derivative contract
will earn money for the investor. Thus, the derivative contract
can make up for a decline in the value of the investment
portfolio of a mutual fund scheme. This is a useful riskmanagement approach.
Re-balancing the portfolio: A mutual fund scheme that wants
to vary the weightage of a sector, say, pharma, in its portfolio,
can do so through derivatives, without having to sell some non-
pharma companies¶ shares, and buying some pharmacompanies¶ shares.
This can be an economical way of managing the investment
exposures.
219
Use of Derivatives
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Leveraging is taking large positions with a small outlay of funds.
This point is explained in the context of Gold Futures in Unit 10,
where, based on an initial investment of Rs 15,000, exposure is
taken to gold worth Rs 300,000 i.e. 20 times the value of the initial
investment.
If a mutual fund decides to use its corpus of, say, Rs 1,000 crore,
to take exposures of 20 times that amount viz. Rs 20,000 crore,
then a huge risk is being taken. Even if the investments were to
decline in value by 5%, the loss would be Rs 20,000 crore X 5%i.e. Rs 1,000 crore, effectively wiping out the capital of the scheme.
Mutual funds are permitted to use derivatives for hedging against
risk or re-balancing the portfolio, but not for leveraging.
220
Use of Derivatives
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Investment in derivatives would have to be
specifically permitted in the Offer Document. If not
already provided for in the offer document, approval
of investors would need to be taken, before the
scheme can invest in derivatives.
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Risk in Equity Funds
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Generic:
Equity markets seek to reflect the value in the real economy. In
performing this role, the following significant risks come up:
The real economy goes through cycles. For a few years until
2008, the economy was booming. Then things startedchanging. 2009 was gloomy. However, during 2010 an
economic recovery is being seen.
In the long run, equity markets are a good barometer of the real
economy ± but in the short run, markets can get over-optimistic
or over-pessimistic, leading to spells of greed and fear.
222
Risk in Equity Funds
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Portfolio Specific: Sector funds suffer from concentration
risk - the entire exposure is to a single sector. If that sector
does poorly, then the scheme returns are seriously affected.
Diversified equity funds, on the other hand, have exposure
to multiple sectors. Thus, even if a few sectors perform poorly,other better performing sectors can make up. Diversified equity
funds are therefore less risky than sector funds
Thematic funds are a variation of sector funds. Here the
investment is as per a theme, say, infrastructure. Multiple
sectors,such as power, transportation, cement, steel, contractingand real estate are connected to infrastructure. Thus, a thematic
fund tends to have wider exposure than a sector fund, but a
narrower exposure than a diversified fund.
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Risk in Equity Funds
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Mid cap funds invest in mid cap stocks, which are less
liquid and less researched in the market, than the frontline
stocks.
Therefore, the liquidity risk is high in such portfolios. Further,
since they are intrinsically not as strong as the frontline stocks,they become riskier during periods of economic turmoil.
224
Risk in Equity Funds
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Contra funds take positions that are contrary to the market.
Such an investment style has a high risk of misjudgements.
Dividend yield funds invest in shares whoseprices
fluctuate less, but offer attractive returns in the form of
dividend. Such funds offer equity exposure with lower downside. Arbitrage funds are categorized as equity funds because
they invest in equity. In reality, the risks are arbitraged (i.e.
cancelled out), normally between the cash market and the F&O
market.
Therefore, the risk in this category of funds turns out to be thelowest among equity funds ± even lower than diversified equity
funds. The returns too are lower ± more in line with money
market returns, rather than equity market returns.
225
Risk in Equity Funds
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However, one should not forget the basis risk in an
arbitrage fund ± the risk that both cash and F&O
position on a company cannot be reversed at the
same time. During the time gap between unwinding
of the two positions, the market can move adverse to
the scheme.
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Risk in Debt Funds
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Generic: Unlike equity, debt securities are repayable on
maturity. Thus, whatever the imperfections in the market, a
solvent issuer will still repay the amount promised, on maturity.
This assured value on maturity makes debt a lot safer than
equity.
Policies of the government and RBI are unpredictable, and
these too influence interest rates. A fund manager taking a
wrong call on the direction of interest rates can seriously affect
the scheme performance.
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Risk in Debt Funds
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Portfolio Specific: Short maturity securities suffer lesser
fluctuation in value, as compared to the ones with longer tenor.
Therefore, liquid schemes, which invest in securities of upto 91
days maturity, have the lowest risk amongst all kinds of
schemes.
Greater the proportion of longer maturity securities in the
portfolio, higher would be the fluctuation in NAV.
228
Risk in Balanced Funds
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Balanced funds invest in a mix of debt and equity. It is rare for
both debt and equity markets to fare poorly at the same time.
Since the performance of the scheme is linked to the
performance of these two distinct asset classes, the risk in the
scheme is reduced.
M onthly I ncome P lan, it is possible that losses in the equity
component eat into the profits in the debt component of the
portfolio. If the scheme has no profits to distribute, then no
dividend will be declared. Thus, the investor may not get the
monthly income implicit in the name Monthly Income Plan.
229
Risk in Balanced Funds
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Some schemes switch a large part of their portfolio between
debt and equity, depending on their view on the respective
markets. This kind of scheme is called flexible asset allocation
scheme. These are risky for investors, because there is always
the risk that the fund manager takes a wrong asset allocation
call.
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Risk in Gold Funds
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Gold does well when the other financial markets are
in turmoil. Similarly, when a country goes into war,
and its currency weakens, gold funds give excellent
returns.
These twin benefits make gold a very attractive risk
proposition.
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Risk in Real Estate Funds
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Every real estate asset is different. Valuation of real estateassets is therefore highly subjective.
Real estate transactions suffer the curse of black money.
Transparency is therefore an issue.
Real estate is a less liquid asset class. The intermediation chain
of real estate agents is largely unorganized. Transaction costs, in the form of stamp duty, registration fees etc
are high.
Regulatory risk is high in real estate, as is the risk of litigation and
other encumbrances.
The transparency level is low even among the real estatedevelopment and construction companies. Many are family
owned and family-driven. Poor corporate governance standards
increase the risks in investing in their securities.
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Measures of Risk
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Fluctuation in returns is used as a measure of risk. Therefore, to
measure risk, generally the periodic returns (daily / weekly /
fortnightly / monthly) are first worked out, and then their
fluctuation is measured.
Variance: Suppose there were two schemes, with monthlyreturns as follows:
Scheme 1: 5%, 4%, 5%, 6%. Average=5%
Scheme 2: 5%, -10%, +20%, 5% Average=5%
Although both schemes have the same average returns, the
periodic (monthly) returns fluctuate a lot more for Scheme 2.Variance measures the fluctuation in periodic returns of a
scheme, as compared to its own average return.
233
Measures of Risk
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Standard Deviation: Like Variance, Standard Deviation toomeasures the fluctuation in periodic returns of a scheme in
relation to its own average return. Mathematically, standard
deviation is equal to the square root of variance.
Standard deviation as a measure of risk is relevant for both debt
and equity schemes.
Beta:There are two kinds of risk in investing in equities ±
systematic risk and non-systematic risk.
Systematic risk is integral to investing in the market; it cannot be
avoided. For example, risks arising out of inflation, interest
rates, political risks etc.
Non-systematic risk is unique to a company; the non-systematic
risk in an equity portfolio can be minimized by diversification
across companies. For example, risk arising out of change in
management, product obsolescence etc.234
Measures of Risk
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Since non-systematic risk can be diversified away, investors
need to be compensated only for systematic risk. This is
measured by its Beta.
Beta measures the fluctuation in periodic returns in a scheme,
as compared to fluctuation in periodic returns of a diversifiedstock index over the same period.
The diversified stock index, by definition, has a Beta of 1.
Companies or schemes, whose beta is more than 1, are seen
as more risky than the market. Beta less than 1 is indicative of a
company or scheme that is less risky than the market.
Beta as a measure of risk is relevant only for equity schemes.
235
Measures of Risk
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Modified Duration: As seen earlier, this measures the
sensitivity of value of a debt security to changes in interest rates.
Higher the modified duration,higher the interest sensitive risk in
a debt portfolio.
Weighted Average Maturity: While modified duration capturesinterest sensitivity of a security better, it can be said that longer
the maturity of a debt security, higher would be its interest rate
sensitivity. Extending the logic, weighted average maturity of
debt securities in a scheme¶s portfolio is indicative of the interest
rate sensitivity of a scheme.
236
Benchmarks and Performance
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Benchmarks:Mutual fund schemes invest in the market for the
benefit of Unitholders.
How well did a scheme perform this job? An approach to assess
the performance is to pre-define a comparable ± a benchmark ±
against which the scheme can be compared. A credible benchmark should meet the following requirements:
It should be in synch with the investment objective of the
scheme i.e. the securities or variables that go into the
calculation of the benchmark should be representative of the
kind of portfolio implicit in the scheme¶s investment objective.
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Benchmarks and Performance
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The benchmark should be calculated by an independent agency
in a transparent manner, and published regularly. Most
benchmarks are constructed by stock exchanges, credit rating
agencies, securities research houses or financial publications.
Gaps between the scheme performance, and that of thebenchmark, are called tracking errors. An index fund manager
would seek to minimize the tracking error.
For other schemes, choice of benchmark is subjective. The
benchmark for a scheme is decided by the AMC in consultation
with the trustees. Offer document of the scheme has to mention
the benchmark.
238
Benchmarks and Performance
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At a later date, the fund may choose to change the benchmark.
This could be for various reasons. For instance, the investment
objective of the scheme may change, or the construction of the
index may change, or a better index may become available in
the market. AMCs can change the benchmark in consultation
with the trustees.
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Benchmarks for equity schemes
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The following aspects of the investment objective drive the
choice of benchmark in equity schemes:
Scheme type:
A sector fund would invest in only the concerned sector; while
diversified funds invest in all sectors. Therefore, diversified fundsneed to have a diversified index, like BSE Sensex or S&P CNX
Nifty or BSE 200 or BSE 500 or CNX 100 or S&P CNX 500 as a
benchmark; sectoral funds select sectoral indices like BSE
Bankex, BSE FMCG Index, CNX Infrastructure Index and CNX
Energy Index.
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Underlying Exposure:
Arbitrage funds invest in equities, but their underlying exposure
is not to the equity market. The reason for this seemingly
contradictory statement is that arbitrage funds take opposite
positions in the cash and F&O markets. Apart from varioustechnical factors, funding cost drives the spread between the
two markets. Therefore, the benchmark for an arbitrage fund is
generally a short term money market index, although these are
categorized as equity schemes.
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Benchmarks for debt schemes
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As per SEBI guidelines, the benchmark for debt (and balanced
schemes) should be developed by research and rating agencies
recommended by AMFI. CRISIL, ICICI Securities and NSE have
developed various such indices. NSE¶s MIBOR (Mumbai Inter-
Bank Offered Rate) is based on short term money market. NSE
similarly has indices for the Government Securities Market.
These are available for different variations such as Composite,
1-3 years, 3-8 years, 8+ years, Treasury Bills index etc.
ICICI Securities¶ Sovereign Bond Index (I-Bex) is again
calculated based on government securities.
243
Benchmarks for debt schemes
Sub indices catering to three contiguous maturity buckets The
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Sub-indices catering to three contiguous maturity buckets. Thethree sub-indices are:
o Si-Bex (1 to 3 years),
o Mi-Bex (3 to 7 years) and
o Li-Bex (more than 7 years)
CRISIL gives out the values of CRISIL Gilt Bond Index and the AAA Corporate Bond Index. Some of its other debt indices are:
o CRISIL CompBEX - Composite Bond Index
o CRISIL LiquiFEX - Liquid Fund Index
o CRISIL STBEX - Short-Term Bond Index
o CRISIL Debt Hybrid Index ± 60:40
CRISIL Debt Hybrid Index ± 75:25
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Benchmarks for other schemes
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Balanced Funds: These invest in a mix of debt and equity.
Therefore a blend of an equity and debt index can be
considered. For instance, a balanced scheme with asset
allocation of about 65% in equity and balance in debt, can use a
synthetic index that is calculated as 65% of BSE Sensex and
35% of I-Bex. CRISIL has also created some blended indices.
CRISIL MIPEX is suitable for Monthly
Income Plans; CRISIL BalanCEX can be considered by
balanced funds.
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Benchmarks for other schemes
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International Funds: The benchmark would depend on where
the scheme proposes to invest. Thus, a scheme seeking to
invest in China might have the Chinese index, Hang Seng as a
benchmark. S&P 500 may be appropriate for a scheme that
would invest largely in the US market. A scheme that seeks to
invest across a number of countries, can structure a synthetic
index, that would be a blend of the indices relevant to the
countries where it proposes to invest.
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Absolute & Relative Returns: One can also do relative
comparison viz. how did a scheme perform vis-à-vis its
benchmark or peer group. Such comparisons are called relative
return comparisons.
247
Risk-adjusted Returns
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Relative returns comparison is one approach to evaluating the
performance of the fund manager of a scheme. A weakness of
this approach is that it does not differentiate between two
schemes that have assumed different levels of risk in pursuit of
the same investment objective. Therefore, although the two
schemes share the benchmark, their risk levels are different.Evaluating performance, purely based on relative returns, may
be unfair towards the fund manager who has taken lower risk
but generated the same return as a peer.
An alternative approach to evaluating the performance of the
fund manager is through the risk reward relationship. Theunderlying principle is that return ought to be commensurate
with the risktaken. A fund manager, who has taken higher risk,
ought to earn abetter return to justify the risk taken.
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Risk-adjusted Returns
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Such evaluations are conducted through Risk-adjusted Returns.
There are various measures of risk-adjusted returns.
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Sharpe Ratio The Sharpe Ratio (also known as Reward-to-Volatility-Ratio)
indicates the excess return per unit of risk associated with the
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indicates the excess return per unit of risk associated with theexcess return. The higher the Sharpe Ratio, the better the
performance.
S = { r ± rf } / SD
S = Sharpe ratio
r = Portfolio return
rf = Risk free rate
SD = Portfolio volatility/Standard Deviation
Sharpe Ratio does not refer to the market portfolio or any other benchmark. Actually, the implicit benchmark is the risk-free rate
of return.
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Sharpe Ratio
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Thus, if risk free return is 5%, and a scheme with standard
deviation of 0.5 earned a return of 7%, its Sharpe Ratio would
be (7% - 5%) ÷ 0.5 i.e. 4%.
Care should be taken to do Sharpe Ratio comparisons between
comparable schemes.
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Treynor Ratio
The Treynor Ratio (sometimes called Reward-to-Volatility-
Ratio) also relates excess return to risk; but systematic risk
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Ratio) also relates excess return to risk; but systematic risk
instead of total risk is used. The higher the Treynor Ratio,
the better the performance under analysis.
T = { r ± rf } / b
T = Treynor Ratio
r = Portfolio return
rf = Riskfree rate
b = Portfolio beta.
Like the Sharpe Ratio, T does not quantify the value added
of active portfolio management. It is a ranking criteria only.
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Treynor Ratio
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Thus, if risk free return is 5%, and a scheme with Beta of 1.2
earned a return of 8%, its Treynor Ratio would be (8% - 5%) ÷
1.2 i.e. 2.5%.
Higher the Treynor Ratio, better the scheme is considered to be.
Since the concept of Beta is more relevant for diversified equity
schemes, Treynor Ratio comparisons should ideally be
restricted to such schemes.
253
Alpha
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Non-index schemes have a level of return which is in line with its
higher or lower beta as compared to the market. Let us call this
the optimal return.
The difference between a scheme¶s actual return and its optimal
return is its Alpha ± a measure of the fund manager¶s
performance. Positive alpha is indicative of out-performance by
the fund manager; negative alpha might indicate
underperformance.
Since the concept of Beta is more relevant for diversified equity
schemes, Alpha should ideally be evaluated only for such
schemes
254
Alpha
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Such quantitative measures are useful pointers.
However, blind belief in these measures, without an
understanding of the underlying factors, is
dangerous.
255
Test understanding
1 Fundamental analysis is a evaluation of the strength of the
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1. Fundamental analysis is a evaluation of the strength of thecompany¶s price-volume charts.
a. True
b. False
2. In a top-down approach, sector allocation precedes stock
selectiona. True
b. False
3. Which of the following is a truly international asset class
a. Real Estate
b. Equity
c. Debt
d. Gold
256
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9.Test objectives: Scheme selection
U d t d h t l t MF h
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Understand how to select a MF scheme
Source of data to track MF performance
258
Scheme Selection
H d i t l t b t th i h ?
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How does an investor select between the various schemes?
Broadly, this flows from the asset allocation. Equity funds will
help in equity exposure; gold funds will help in gold exposure
etc.
As a structured approach, the sequence of decision making is
as
follows:
Step 1 ± Deciding on the scheme category
Step 2 ± Selecting a scheme within the category
Step 3 ± Selecting the right option within the scheme
259
Scheme Selection
While deciding between schemes to invest in, a few principles to
keep in mind:
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keep in mind:
Equity Funds: While investing in equity funds, a principle to
internalize is that markets are more predictable in the long term,
than in the short term. So, it is better to consider equity funds,
when the investment horizon is adequately long.
The role of various broad equity scheme categories in aninvestor¶s portfolio is as follows:
Active or Passive :An investor in an active fund is bearing a
higher cost for the fund management, and a higher risk.
Therefore, the returns ought to be higher i.e. the scheme should
beat the benchmark, to make the investor believe that choice of active scheme was right. This, in no way, meansthat the higher
return that ought to happen, will happen. Hence, the risk in
such investments.
260
Scheme Selection
Investors who are more interested in the more modest objective
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Investors who are more interested in the more modest objective
of having an equity growth component in their portfolio, rather
than the more aggressive objective of beating the equity market
benchmark, would be better off investing in an index fund.
Open-ended or Close-ended:The significant benefit that open-
ended funds offer is liquidity viz. the option of getting back the
current value of the unit-holding from the scheme.
A close-ended scheme offers liquidity through a listing in a stock
exchange.
Open-end schemes are also subject to the risk of large
fluctuations in net assets, on account of heavy sales or re-purchases. This can put pressure on the fund manager in
maintaining the investment portfolio.
261
Scheme Selection
Diversified Sector or Thematic :The critical difference between
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Diversified, Sector or Thematic :The critical difference between
the two is that the multi-sector exposure in a diversified fund
makes it less risky. Further, in an actively managed diversified
fund, the fund manager performs the role of ensuring higher
exposure to the better performing sectors.
Diversified funds should be part of the core portfolio of every
investor. Investors who are comfortable with risk can invest in
sector funds. Further, an investor should have the skill to make
the right sector choices, before venturing into sector funds.
Some investors are more comfortable identifying promising
investment themes (for example, infrastructure), rather thanspecific sectors (like cement, steel etc.). Such investors can
decide on investment themes they would like to buy.
262
Scheme Selection
Large cap v/s Mid cap / Small Cap: Funds: When industry
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Large-cap v/s Mid-cap / Small Cap: Funds: When industry
scenario is difficult, the resource strengths of largecap front-line
stocks help them survive; many mid-cap / small cap companies
fall by the way side during economic turmoil, because they lack
the resources to survive. It can therefore be risky to invest in
mid-cap / small cap funds during periods of economic turmoil. As the economy recovers, and investors start investing in the
market, the valuations in front-line stocks turn expensive. At this
stage, the mid-cap / small cap funds offer attractive investment
opportunities.
263
Scheme Selection
Growth or Value funds :As seen in the previous unit in the
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Growth or Value funds : As seen in the previous unit, in the
initial phases of a bull run, growth funds tend to offer good
returns. Over a period of time, as the growth stocks get fully
valued, value funds tend to perform better. Investments in value
funds yield benefits over longer holding periods. In a market
correction, the Growth funds can decline much more than valuefunds.
Fund Size: The size of funds needs to be seen in the context of
the proposed investment universe. Thus, a sector fund with net
assets of Rs 1,000 crore, is likely to find investment challenging
if the all the companies in the sector together are worth onlyabout Rs 10,000 crore. On the other hand, too small a fund size
means that the scheme will not benefit from economies of scale.
264
Scheme Selection
Portfolio Turnover: Frequent churning of the portfolio would
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Portfolio Turnover : Frequent churning of the portfolio would
not only add to the broking costs, but also be indicative of
unsteady investment management.
Arbitrage funds: These are not meant for equity risk exposure,
but to lock into a better risk-return relationship than liquid funds
± and ride on the tax benefits that equity schemes offer.
265
Scheme Selection
Domestic Equity v/s International Equity funds: When an
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Domestic Equity v/s International Equity funds: When an
Indian investor invests in equities abroad, he is essentially
taking two exposures:
An exposure on the international equity market
An exposure to the exchange rate of the rupee. If the investor invests in the US, and the US Dollar becomes stronger during
the period of his investment, he benefits; if the US Dollar
weakens (i.e. Rupee becomes stronger), he loses.
266
Scheme Selection
Debt Funds:Debts funds are less risky than equity funds
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Debt Funds:Debts funds are less risky than equity funds.
Regular Debt Funds v/s MIPs: MIP has an element of equity in
its portfolio. Investors who do not wish to take any equity
exposure, should opt for a regular debt fund.
Open-end Funds v/s FMP: FMP is ideal when the investor¶s
investment horizon is in synch with the maturity of the scheme,
and the investor is looking for a predictable return that is
superior to what is available in a fixed deposit.
267
Contd
Gilt Funds v/s Diversified Debt Funds: Diversified debt funds
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Gilt Funds v/s Diversified Debt Funds: Diversified debt funds
invest in a mix of government securities (which are safer) and
non-government securities (which offer higher yields, but are
subject to credit risk). A diversified mutual fund scheme that
manages its credit risk well can generate superior returns, as
compared to a Gilt Fund.
Long-Term Debt Fund v/s Short Term Debt Fund:Asyields in
the market goes down, debt securities gain in value. Therefore,
long term debt funds would be sensible in declining interest rate
scenarios. However, if it is expected that interest rates in themarket would go up, it would be safer to go with Short Term
Debt Funds.
268
Contd
Money Market Funds / Liquid Schemes:An investor seeking
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Money Market Funds / Liquid Schemes: An investor seeking
the lowest risk ought to go for a liquid scheme. However, the
returns in such instruments are lower.
Regular Debt Funds v/s Floaters: Regular debt funds aresubject to the risk of fluctuations in NAV. Since floating rate debt
securities tend to hold their values, even if interest rates
fluctuate, the NAV of floaters tend to be steady. When the
interest rate scenario is unclear, then floaters are a safer option.
Similarly, in rising interest rate environments, floaters can be
considered as an alternative to short term debt funds and liquidfunds.
269
Contd
Balanced Fund:* He can invest in a mix of equity schemes and
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Balanced Fund: He can invest in a mix of equity schemes and
debt schemes
He can invest in a balanced scheme, which in turn invests in a
mix of equity and debt securities.The first option obviously
implies more decisions on scheme selection that the investor
would need to take. But the benefit is that the investor has a
wide array of scheme options, within both equity and debt
scheme categories. Further, the investor would be in a position
to work towards a mix of debt and equity that is most
appropriate for him.
270
Contd
How to select a Scheme within a Scheme Category? All the
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How to select a Scheme within a Scheme Category? All the
35+ AMCs that are permitted to do business in India, meet the
minimum eligibility criteria set by law. Different AMCs have
different approaches, styles and value systems in doing
business. An investor has to be comfortable with the AMC,
before investing in any of its schemes.
Fund Age: A fund with a long history has a track record that can
be studied. A new fund managed by a portfolio manager with a
lack luster track-record is definitely avoidable.
271
Contd
Tracking Error: In Index funds lower TE is better In
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Tracking Error: In Index funds, lower TE is better.In
Gold ET,how well they track Gold prices needs to be
looked at.
Regular Income Yield in Portfolio:Regular Incomes
are aeen as a more stable source of income thancapital gains.
272
Which is a better option within a Scheme?
Dividend Payout: Investors looking for regular
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Dividend Payout: Investors looking for regular
returns can consider this option.No surplus to
distribute, no dividend. Hence SWP may a better
option in such cases.SWP may have STT( in equity
funds) or capital gains tax implications( Equity & Debtschemes)
In debt funds , DDT is deducted by the AMC and the
Tax free div is paid.Low tax bracket investor v/s high
tax bracket investor needs to be considered.
273
Sources of data to track MF Performance
Credence Analytics
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Credence Analytics
CRISIL
Lipper
Morning Star
Value Research
274
Test understanding Scheme Selection1. Equity markets are more predictable in the long term than the
short.T
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a. True
b. False
2. Arbitrage funds are meant to give better equity risk exposure
a. True
b. False
3. The comparable for a liquid scheme is
a. Equity schemeb. Balanced Scheme
c. Gilt Fund
d. Savings Bank account275
Contd
4. Which of the following aspects of portfolio would an investor in
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g p p
debt scheme give most importance
a. Sector selection
b. Stock selection
c. Weighted Average Maturityd. Number of securities in portfolio
5. Mutual fund ranking and rating amount to the same.
a. True
b. False
276
10.Test Objectives- Selectingthe Right Investment products
for Investors
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for Investors Identify Financial and Physical Assests
277
Financial and Physical Assets
An investor who buys land, building, a painting or gold can touch and feel them The investor can
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gold can touch and feel them. The investor can
choose to build a house in the land, stay in the
building, display the painting and make jewellery out
of the gold. Such assets are called physical assets.
An investor who buys shares in a company is entitledto the benefits of the shareholding ± but this
entitlement cannot be touched or felt. The paper on
which the share certificate is printed can be touched
and felt, but that paper is only evidence supportingthe benefit that the investor is entitled to. The benefit
itself is intangible. Such assets are called financial
assets.278
The implication
Comfort: The investor in a physical asset draws
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Comfort: The investor in a physical asset draws
psychological comfort from the fact that the asset is
in the investor¶s possession, or under the investor¶s
control in a locker.
The value encashment in a financial asset, on theother hand, can depend on the investee company.
What if the company closes down? What if the bank
or mutual fund scheme goes bust? These are issues
that bother investors.
279
The implications Unforeseen events:The comfort of investors in
physical assets is tempered by an understanding of
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p y p y g
consequences of unforeseen events. A physical
asset is completely gone, or loses substantial value,
when stolen, or if there is a fire, flood or such other
hazard.The investor can always go the investee organization
i.e. company or bank or mutual fund where the
money is invested, and claim the entitlement, based
on records of the investee company and other
documentary evidence. Dematerialisation makes
these processes a lot simpler.
280
Economic Context
Investor¶s money in land, or gold does not benefit the
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y , g
economy. On the other hand, money invested in
financial assets can be productive for the economy.
The money that the government mobilizes through
issue of government securities can go towardsvarious productive purposes.
Similarly, mutual fund schemes that invest in
securities issued by companies are effectively
assisting in building the nation and the economy.
281
Contd
Gold and real estate are two physical assets, where a
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p y ,
significant portion of investor wealth is blocked.
282
Gold Physical or Financial?
Gold suffers one of the highest risks of loss through
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g g
theft. Storage in bank lockers too costs money. The
exposure to gold as a financial asset can be taken in
different forms:
Gold ETF
Gold Sector Fund
Gold futures contracts are traded in commodity
exchanges like the National Commodities Exchange
(NCDEX) and Multi-Commodity Exchange (MCX).
283
Contd
Gold deposit schemes are offered by some banks.
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p y
This is like a fixed deposit in gold. An investor
depositing gold into a Gold deposit scheme is given a
receipt promising to pay back the same quantity of
gold (or its equivalent value) on maturity.
Wealth Tax is applicable on gold holding (beyond the
jewellery meant for personal use). However, mutual
fund schemes (gold linked or otherwise) and golddeposit schemes are exempted from Wealth Tax.
284
Real Estate Physical or Financial?
The ticket size i.e. the minimum amount required for investing in real estate is high The investment would
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investing in real estate is high. The investment would
run into lakhs of rupees, even to buy agricultural land.
Unless the budget is very high, and the value of
properties bought are very low.
Once purchased, vacant land can be encroached
upon by others.
Real estate is an illiquid market. Investment in
financial assets as well as gold can be converted into
money quickly and conveniently within a few days ata transparent price.
285
Contd
Once a deal is executed, the transaction costs, such
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as stamp duty and registration charges, are also
high. At times, these regulatory processes are also
non-transparent and cumbersome.
When property is let out, there is a risk that thelessee may lay his own claim to the property
(ownership risk) or be unable to pay the rent (credit
risk).
It is for these reasons that real estate investors prefer to invest through Real estate mutual funds.
286
Fixed Deposit or Debt Scheme
Several investors are comfortable only in placing
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money in bank deposits; they do not invest in debt
schemes, partly because of lack of awareness.
In the event that a bank fails, the deposit insurance
scheme of the government comes to the rescue of small depositors. Upto Rs 1 lakh per depositor in a
bank (across branches) will be paid by the insurer.
The depositor can also prematurely close the deposit
at any time.
287
Contd
Mutual fund debt schemes are superior to bankdeposits in the following respects:
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p g p
With a bank deposit, the depositor can never earn a
return higher than the interest rate promised. In a
mutual fund scheme, no return is guaranteed ±
however it is possible to earn returns that are muchhigher than in a bank deposit.
Interest earned in a bank deposit is taxable each
year. However, if a unit holder allows the investment
to grow in a mutual fund scheme (which in turn isexempt from tax), then no income tax is payable on
year to year accretions.
288
Contd..
Mutual funds offer various facilities to make it easy
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for investors to move their money between different
kinds of mutual fund schemes. These are not
available with a bank deposit.
289
New Pension Scheme
Pension Funds Regulatory and Development
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Authority (PFRDA) is the regulator for the New
Pension Scheme. Two kinds of pension accounts are
envisaged:
Tier I (Pension account), is non-withdrawable.
Tier II (Savings account) is withdrawable to meet
financial contingencies. An active Tier I account is a
pre-requisite for opening a Tier II account.
290
Contd
They can allocate their investment between 3 kinds
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of portfolios:
Asset Class E: Investment in predominantly equity
market instruments
Asset Class C: Investment in Debt securities other
than Government Securities
Asset Class G: Investments in Government Securities.
291
Contd
Investors can also opt for life-cycle fund. With this
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option, the system will decide on a mix of
investments between the 3 asset classes, based on
age of the investor.
The 3 asset class options are managed by 6 PensionFund Managers (PFMs). The investors¶ moneys can
thus be distributed between 3 portfolios X 6 PFMs =
18 alternatives.
292
Test Understanding-Selecting the RightInvestment products for investors
1. More than 50% of the wealth of Indians is held inphysical assets
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p y
a. True
b. False
2. Gold Futures are superior to ETF Gold as a vehiclefor life-long investment in gold.
a. True
b. False
3. As regards wealth tax, ETF Gold is superior tophysical gold.
a. True
b. False 293
Contd4. The New Pension Scheme is regulated by
a. SEBI
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b. IRDA
c. PFRDA
d. AMFI
5. An investor under the new pension scheme can
choose which of the following asset classes
a. Equities
b. Corporate debt
c. Government Securities
d. Any of the above
294
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11.Test Objectives-Helping Investors with Financial Planning
* Understand Basics of Financial Planning
* Define and describe Wealth Cycle and
Life Cycle in Financial Planning
295
What is Financial Planning?
Everyone has needs and aspirations. Most needs and
aspirations call for a financial commitment. Providing for thiscommitment becomes a financial goal. Fulfilling the financial
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g g
goal sets people on the path towards realizing their needs
and aspirations.
For example, a father wants his son, who has just passed
his 10th standard Board examinations, to become a doctor.
This is an aspiration. In order to realize this, formal
education expenses, coaching class expenses, hostel
expenses and various other expenses need to be incurred
over a number of years. The estimated financialcommitments towards these expenses become financial
goals.
296
Contd
Financial planning is a planned and systematic
h t id f th fi i l l th t ill
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approach to provide for the financial goals that will
help people realise their needs and aspirations, and
be happy.
297
Assessment of Financial Goals
The financial goals related to making the son a
d t ll f it t i d f b t 6
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doctor, call for commitments over a period of about 6
years ± 2 years of undergraduate studies, coaching
class expenses for preparing for the medical
entrance exams, followed by the medical educationand hostel expenses.
298
Further Value Equation
The formula A = P X (1 + i)n, where,
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A = Rupee requirement in future
P = Cost in today¶s terms
i = inflation
n = Number of years into the future, when the expense
will be
Incurred.
299
Investment Horizon
The year-wise financial goals statement throws up
th i t t h i
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the investment horizon.
In most cases, the investor would have some regular
income out of which part of the expenses can be met.
So the investments being considered now need tofund only the balance of the financial goals.
300
Assessing the Fund Requirement
Suppose the investor is comfortable about meeting
R 100 000 f th h Th b l
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Rs 100,000 of the expense each year. The balance
would need to be provided out of investments being
made today. How much is that investment
requirement? This can be calculated using a variation of the
formula used earlier i.e. P = A ÷ (1 + r) n,
301
Financial Planning Objectives andBenefits
The objective of financial planning is to ensure that
the right amo nt of mone is a ailable at the right
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the right amount of money is available at the right
time to meet the various financial goals of the
investor. This would help the investor realize his
aspirations and experience happiness.
An objective of financial planning is also to let the
investor know in advance, if some financial goal is
not likely to be fulfilled.
302
Contd Thanks to advance information available through
financial planning, timely corrective actions can be
taken such as:
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taken, such as:
Reviewing what is a ³need´ and what is a ³desire´ that
can be postponed for the more desirable objective of
realizing the aspiration of son becoming a doctor.* Moving to a smaller house, or a house in a less
expensive locality, to release more capital.
Improving the future annual savings by economizing
on expense, or taking up an extra part-time job, or influencing the spouse to take up employment for
some time.
303
Contd..
It also helps the financial planner, because the
process of financial planning helps in understanding
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process of financial planning helps in understanding
the investor better, and cementing the relationship
with the investor¶s family. This becomes the basis for
a long term relationship between the investor and thefinancial planner.
304
Need for Financial Planners
Most investors are either not organized, or lack the
ability to make the calculations described above A
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ability to make the calculations described above. A
financial planner¶s service is therefore invaluable in
helping people realize their needs and aspirations.
Even if the investor knows the calculations, theknowledge of how and where to invest may be
lacking. The financial planner thus steps in to help
the investor select appropriate financial products and
invest in them.
305
Contd
Taxation is another area that most investors are
unclear about Financial planners who are
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unclear about. Financial planners who are
comfortable with the tax laws can therefore help the
investor with tax planning, so as to optimize the tax
outflows. Financial planners can also help investors in planning
for contingencies. This could be through advice on
insurance products, inheritance issues etc.
The financial planner thus is in a position to adviseinvestors on all the financial aspects of their life.
306
Alternate Financial Planning Approaches
The financial plan detailed above is a ³goal-oriented
financial plan´ a financial plan for a specific goal
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financial plan ± a financial plan for a specific goal
related to the aspiration to make the son a doctor.
An alternate approach is a ³comprehensive financialplan´ where all the financial goals of a person are
taken together, and the investment strategies worked
out on that basis.
307
Contd
Establish and Define the Client-Planner Relationship
G th Cli t D t D fi Cli t G l
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Gather Client Data, Define Client Goals
Analyse and Evaluate Client¶s Financial Status
Develop and Present Financial Planning
Recommendations and / or Options
Implement the Financial Planning Recommendations
Monitor the Financial Planning Recommendations
308
Life Cycle and Wealth Cycle in FinancialPlanning
Life Cycle:These are the normal stages that people
go through viz :
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go through, viz.:
Childhood :During this stage, focus is on education in
most cases. Children are dependents, rather than
earning members.
Young Unmarried:The earning years start here. A few
get on to high-paying salaries early in their career.
Others toil their way upwards.
309
Contd
Equity SIPs and Whole-life insurance plans are great
ways to force the young unmarried into the habit of
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ways to force the young unmarried into the habit of
regular savings, rather than lavish the money away.
This is the right age to start investing in equity.
Young Married: A cushion of assets created duringthe early earning years can be a huge confidence
booster while taking up the responsibilities
associated with marriage.
310
Contd
Where only one spouse is working, life insurance to
provide for contingencies associated with the earning
spouse are absolutely critical
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spouse are absolutely critical.
Term insurance (where premium is lower)
possibilities have to be seriously explored andlocked
into.
Married with Young Children: Insurance needs ± both
life and health - increase with every child.
The financial planner is well placed to advise on a
level of insurance cover, and mix of policies thatwould help the family maintain their life style in the
event of any contingency.
311
Contd
Expenses for education right from pre-school to
normal schooling to higher education is growing
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normal schooling to higher education is growing
much faster than regular inflation.
Adequate investments are required to cover this.
312
Contd
Married with Older Children:The costs associated
with helping the children settle i e cost of housing
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with helping the children settle i.e. cost of housing,
marriage etc are shooting up. If investments in
growth assets like shares and real estate, are started
early in life, and maintained, it would help ensure thatthe children enjoy the same life style, when they set
up their independent families.
313
Contd
Pre-Retirement:By this stage, the children should
have started earning and contributing to the family
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have started earning and contributing to the family
expenses. Further, any loans taken for purchase of
house or car, or education of children should have
been extinguished. The family ought to plan for their retirement ± what kind of lifestyle to lead, and how
those regular expenses willbe met.
314
Contd
Retirement: At this stage, the family should have
adequate corpus the interest on which should help
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adequate corpus, the interest on which should help
meet regular expenses. The need to dip into capital
should come up only for contingencies ± not to meet
regular expenses. Besides the corpus of debt assets to cover regular
expenses, there should also be some growth assets
like shares, to protect the family from inflation during
the retirement years.
315
Wealth Cycle
This is an alternate approach to profile the investor.
The stages in the Wealth Cycle are:
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The stages in the Wealth Cycle are:
Accumulation: This is the stage when the investor
gets to build his wealth. It covers the earning years of
the investor i.e. the phases of the life cycle fromYoung Unmarried to Pre-Retirement.
316
Contd
Transition: Transition is a phase when financial goals
are in the horizon. E.g. house to be purchased,
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are in the horizon. E.g. house to be purchased,
children¶s higher education / marriage approaching
etc. Given the impending requirement of
funds,investors tend to increase the proportion of their portfolio in liquid assets viz. money in bank,
liquid schemes etc.
317
Inter-Generational Transfer
During this phase, the investor starts thinking about
orderly transfer of wealth to the next generation, in
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orderly transfer of wealth to the next generation, in
the event of death.
The financial planner can help the investor understand various inheritance and tax issues, and
help in preparing Will and validating various
documents and structures related to assets and
liabilities of the investor.
318
Contd
Reaping / Distribution:This is the stage when the
investor needs regular money. It is the parallel of
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esto eeds egu a o ey t s t e pa a e o
retirement phase in the Life Cycle.
Sudden Wealth:Winning lotteries, unexpectedinheritance of wealth, unusually high capital gains
earned ± all these are occasions of sudden wealth,
that need to be celebrated. However, given the
human nature of frittering away such sudden wealth,the financial planner can channelize the wealth into
investments, for the long term benefit of the investor¶s
family.319
Test understanding-Financial Planning
Today¶s costs can be translated into future requirement
of funds using the formula:a. A = P X (1 + i)n
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( )
b. A = P / (1 + i)n
c. P = A n X (1 + i)
d. P = A n X (1 + i)
2. Providing funds for a daughter¶s marriage is an
example of
a. Goal-oriented Financial Plan
b. Comprehensive Financial Plan
c. Financial goal
d. None of the above320
Contd
3. According to the Certified Financial Planner ± Board
of Standards (USA), the first stage in financial
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( ), g
planning is
a. Analyse and Evaluate Client¶s Financial Status
b. Establish and Define the Client-Planner Relationship
c. Gather Client Data, Define Client Goals
d. Develop and Present Financial Planning
Recommendations and / or Options
321
Contd4. Investor can get into long term investment
commitments in
a. Distribution Phase
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a. Distribution Phase
b. Transition Phase
c. Inter-generational Phase
d. Accumulation Phase
5. Distribution phase of Wealth Cycle is a parallel of
Retirement phase of Life Cycle
a. True
b. False
322
What is life cycle stage to financial
planning?Life cycle
Stages
Features Priority / Investment
Childhood Period of dependency which Long term investment of money
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stage lasts till the full time
education.
received in the form of gifts.
Unmarried
stage
Still dependent & relatively
lower income.More risk
taking ability.
Main need is to protect
themselves against any
disability.Investment for long
term plans.
Young married
stage- Bothpartners earn
Sufficient surplus to
save.Housing, insurance &consumer finance need.
To secure income loss of any
partner with medium to longterm investments.
Contd«323
Contd
Young married
stage- one
partner earn
Less potential to save.Two or
more dependence.Life
assurance of earning
member is must.
Medium to long term
investments.Pension
provision needed.
Young married
ith hild
Expenditure rises with faster
t Child ¶ d ti
Consumer finance needs are
hi h P tf li f th &
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with children rate.Children¶s education,
holidays & consumer finance.
high.Portfolio for growth &
long term.
Married with
older children
Individuals are in mid
career.Improved finances.
Loan repayment
needs.Equity,debt &pension/Health insurance
Post family/ Pre
retirement stage
Independent children.Last
chance to ensure adequate
income after retirement.
Contribution to health
insurance and pension
products.
Retirement stage 1)Low pension.
2)Relatively low pension.
3)Sufficient pension.
1)Continue to work.
2)Produce additional income.
3)Preserve savings.324
12.Test Objectives-RecommendingModelPortfolios and Financial Plans
Define and Describe risk profiling
Understand Asset Allocation
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Understand Asset Allocation
The steps involved in developing a model portfolio
325
Risk Profiling
Need for Risk Profiling:Various schemes have
different levels of risk.
Similarly there are differences between investors
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Similarly, there are differences between investors
with respect to the levels of risk they are comfortable
with (risk appetite). At times there are also
differences between the level of risk the investorsthink they are comfortable with, and the level of risk
they ought to be comfortable with.
Risk profiling is an approach to understand the risk
appetite of investors - an essential pre-requisite toadvise investors on their investments.
326
Contd
The investment advice is dependent on
understanding both aspects of risk:
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Risk appetite of the investor
Risk level of the investment options being considered.
327
Factors that Influence the Investors RiskProfile
Factor Influence on Risk Appetite:
F amily Information
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y
Earning Members :Risk appetite increases as the
number of earning members increases
Dependent Members: Risk appetite decreases as the
number of dependent members increases
Life expectancy :Risk appetite is higher when life
expectancy is longer
328
Contd Personal Information:
Age: Lower the age, higher the risk that can be taken
Employability :Well qualified and multiskilled
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p y y q
professionals can afford to take more risk
Nature of Job :Those with steady jobs are better
positioned to take risk Psyche: Daring and adventurous people are better
positioned mentally, to accept the downsides that
come with risk
329
Contd
F inancial Information:
Capital base :Higher the capital base, better the ability
to financially take the downsides that come with risk
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to a c a y ta e t e do s des t at co e t s
Regularity of Income :People earning regular income
can take more risk than those with unpredictable
income streams.
330
Risk Profiling Tools
Some AMCs and securities research houses provide
risk profiling tools in their website. Some banks and
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other distributors have proprietary risk profilers.
These typically revolve around investors answering a
few questions, based on which the risk appetite scoregets generated.
While such tools are useful pointers, it is important to
understand the robustness of such tools before using
them in the practical world.
331
Asset Allocation
The Role of Asset Allocation:The distribution of aninvestor¶s portfolio between different asset classes is
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called asset allocation.
With a prudent asset allocation, the investor does not
end up in the unfortunate situation of having all theinvestments in an asset class that performs poorly.
332
Asset Allocation Types
At an individual level, difference is made betweenStrategic and Tactical Asset Allocation.
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Strategic Asset Allocation is the ideal that comes
out of the risk profile of the individual. Risk profiling
is key to deciding on the strategic asset allocation.The most simplistic risk profiling thumb rule is to have
as much debt in the portfolio, as the number of years
of age. As the person grows older, the debt
component of the portfolio keeps increasing. This is
an example of strategic asset allocation.
333
Contd
Tactical Asset Allocation is the decision thatcomes out of calls on the likely behaviour of the
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market. An investor who decides to go overweight on
equities i.e. take higher exposure to equities,
because of expectations of buoyancy in industry andshare markets, is taking a tactical asset allocation
call.
334
Model Portfolios
Since investors¶ risk appetites vary, a single portfoliocannot be suggested for all. Financial planners often
k i h d l f li h ll i i
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work with model portfolios ± the asset allocation mix
that is most appropriate for different risk appetite
levels.
335
Contd
Young call centre / BPO employee with nodependents : 50% diversified equity schemes
( f bl th h SIP) 20% t f d 10% ld
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(preferably through SIP); 20% sector funds; 10% gold
ETF, 10% diversified debt fund, 10% liquid schemes.
Young married single income family with two school
going kids: 35% diversified equity schemes; 10%
sector funds; 15% gold ETF, 30% diversified debt
fund, 10% liquid schemes.
336
Contd
Single income family with grown up children who areyet to settle down: 35% diversified equity schemes;
15% ld ETF 15% ilt f d 15% di ifi d d bt
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15% gold ETF, 15% gilt fund, 15% diversified debt
fund, 20% liquid schemes.
Couple in their seventies, with no immediate family
support:15% diversified equity index scheme; 10%
gold ETF, 30% gilt fund, 30% diversified debt fund,
15% liquid schemes.
337
Test understanding-Recommendingmodel portfolios & Financial Plans
1. Risk appetite of investors is assessed through
a. Risk Appetizers
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b. Asset Allocators
c. Risk Profilers
d. Financial Plan
2. The objective of asset allocation is risk management
a. True
b. False
338
Contd3. The asset allocation that is worked out for an investor
based on risk profiling is calleda. Tactical Asset Allocation
b Fi d A t All ti
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b. Fixed Asset Allocation
c. Flexible Asset Allocation
d. Strategic Asset Allocation
4. Model portfolios are a waste of time for financial
planners
a. True b. False
5. How much equity would you suggest for a young wellsettled unmarried individual
a. 100% b. 80% c. 60% d. 40%339
All the Best !!!!!!
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Thank You