beginner's guide - mutual funds-india infoline

BASICS OF MUTUAL FUNDS - INDIAINFOLINE.COM

MUTUAL FUNDS: AN OVERVIEW.........................................................................................................................3

TYPES OF MUTUAL FUNDS....................................................................................................................................4

Open-ended Funds.................................................................................................................................................4

Closed-ended Funds...............................................................................................................................................4

Interval Funds........................................................................................................................................................4

BY INVESTMENT OBJECTIVE:......................................................................................................................................4

Growth Funds.........................................................................................................................................................4

Income Funds.........................................................................................................................................................4

Balanced Funds......................................................................................................................................................5

Money Market Funds.............................................................................................................................................5

Load Funds.............................................................................................................................................................5

No-Load Funds.......................................................................................................................................................5

OTHER SCHEMES...................................................................................................................................................5

Tax Saving Schemes...............................................................................................................................................5

Special Schemes.....................................................................................................................................................5

BENEFITS OF INVESTING IN MUTUAL FUNDS:...............................................................................................6

NET ASSET VALUE (NAV).......................................................................................................................................7

CALCULATION OF NAV..............................................................................................................................................7

MUTUAL FUNDS IN INDIA (1964 - 2000)...............................................................................................................8

1999—YEAR OF THE FUNDS................................................................................................................................9

INDIAN SCENARIO....................................................................................................................................................9

BANKS V/S MUTUAL FUNDS.............................................................................................................................10

GLOBAL SCENARIO...............................................................................................................................................11

FUTURE SCENARIO................................................................................................................................................12

LIST OF VARIOUS FUNDS ALONG WITH ITS FUND MANAGERS.............................................................13

MUTUAL FUNDS AND THE BUDGET 1999-2000...............................................................................................14

INCOME RECEIVED FROM MUTUAL FUNDS..............................................................................................................14

TAX IMPLICATION FOR INCOME RECEIVED ON OPEN-END EQUITY ORIENTED SCHEME:............................................15

DIFFERENCE BETWEEN TDS AND DISTRIBUTION TAX.............................................................................................15

LONG TERM CAPITAL GAINS ARISING FROM SALE OF MUTUAL FUND UNITS...........................................................15

MUTUAL FUNDS AND THE BUDGET 2000-2001...............................................................................................16

Mutual Funds: Indiainfoline

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REGULATORY ASPECTS OF MUTUAL FUND.................................................................................................17

SCHEMES OF MUTUAL FUND............................................................................................................................17

RULES REGARDING ADVERTISEMENT..........................................................................................................18

INVESTMENT OBJECTIVES AND VALUATION POLICIES:..........................................................................18

GENERAL OBLIGATIONS....................................................................................................................................19

PROCEDURE FOR ACTION IN CASE OF DEFAULT:.......................................................................................19

RESTRICTIONS ON INVESTMENTS:.................................................................................................................19

FREQUENTLY ASKED QUESTIONS....................................................................................................................20

GLOSSARY.................................................................................................................................................................33

LIST OF BOOKS........................................................................................................................................................40


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MUTUAL FUNDS: AN OVERVIEW

A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is invested by the fund manager in different types of securities depending upon the objective of the scheme. These could range from shares to debentures to money market instruments. The income earned through these investments and the capital appreciation realized by the scheme are shared by its unit holders in proportion to the number of units owned by them (pro rata). Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed portfolio at a relatively low cost. Anybody with an investible surplus of as little as a few thousand rupees can invest in Mutual Funds. Each Mutual Fund scheme has a defined investment objective and strategy.A mutual fund is the ideal investment vehicle for today’s complex and modern financial scenario. Markets for equity shares, bonds and other fixed income instruments, real estate, derivatives and other assets have become mature and information driven. Price changes in these assets are driven by global events occurring in faraway places. A typical individual is unlikely to have the knowledge, skills, inclination and time to keep track of events, understand their implications and act speedily. An individual also finds it difficult to keep track of ownership of his assets, investments, brokerage dues and bank transactions etc. A mutual fund is the answer to all these situations. It appoints professionally qualified and experienced staff that manages each of these functions on a full time basis. The large pool of money collected in the fund allows it to hire such staff at a very low cost to each investor. In effect, the mutual fund vehicle exploits economies of scale in all three areas - research, investments and transaction processing. While the concept of individuals coming together to invest money collectively is not new, the mutual fund in its present form is a 20th century phenomenon. In fact, mutual funds gained popularity only after the Second World War. Globally, there are thousands of firms offering tens of thousands of mutual funds with different investment objectives. Today, mutual funds collectively manage almost as much as or more money as compared to banks.A draft offer document is to be prepared at the time of launching the fund. Typically, it pre specifies the investment objectives of the fund, the risk associated, the costs involved in the process and the broad rules for entry into and exit from the fund and other areas of operation. In India, as in most countries, these sponsors need approval from a regulator, SEBI (Securities exchange Board of India) in our case. SEBI looks at track records of the sponsor and its financial strength in granting approval to the fund for commencing operations.A sponsor then hires an asset management company to invest the funds according to the investment objective. It also hires another entity to be the custodian of the assets of the fund and perhaps a third one to handle registry work for the unit holders (subscribers) of the fund.In the Indian context, the sponsors promote the Asset Management Company also, in which it holds a majority stake. In many cases a sponsor can hold a 100% stake in the Asset Management Company (AMC). E.g. Birla Global Finance is the sponsor of the Birla Sun Life Asset Management Company Ltd.,


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which has floated different mutual funds schemes and also acts as an asset manager for the funds collected under the schemes.

TYPES OF MUTUAL FUNDS

Mutual fund schemes may be classified on the basis of its structure and its investment objective.

By Structure:

Open-ended Funds

An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. The key feature of open-end schemes is liquidity.

Closed-ended Funds

A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed. In order to provide an exit route to the investors, some close-ended funds give an option of selling back the units to the Mutual Fund through periodic repurchase at NAV related prices. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor.

Interval Funds

Interval funds combine the features of open-ended and close-ended schemes. They are open for sale or redemption during pre-determined intervals at NAV related prices.

By Investment Objective:

Growth Funds

The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a majority of their corpus in equities. It has been proven that returns from stocks, have outperformed most other kind of investments held over the long term. Growth schemes are ideal for investors having a long-term outlook seeking growth over a period of time.

Income Funds

The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures and Government securities. Income Funds are ideal for capital stability and regular income.


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Balanced Funds

The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. These are ideal for investors looking for a combination of income and moderate growth.

Money Market Funds

The aim of money market funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for Corporate and individual investors as a means to park their surplus funds for short periods.

Load Funds

A Load Fund is one that charges a commission for entry or exit. That is, each time you buy or sell units in the fund, a commission will be payable. Typically entry and exit loads range from 1% to 2%. It could be worth paying the load, if the fund has a good performance history.

No-Load Funds

A No-Load Fund is one that does not charge a commission for entry or exit. That is, no commission is payable on purchase or sale of units in the fund. The advantage of a no load fund is that the entire corpus is put to work.

OTHER SCHEMES

Tax Saving Schemes

These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws as the Government offers tax incentives for investment in specified avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction u/s 88 of the Income Tax Act, 1961. The Act also provides opportunities to investors to save capital gains u/s 54EA and 54EB by investing in Mutual Funds.

Special Schemes

Industry Specific Schemes Industry Specific Schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like InfoTech, FMCG, Pharmaceuticals etc.

Index Schemes Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50


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Sectoral Schemes Sectoral Funds are those, which invest exclusively in a specified industry or a group of industries or various segments such as 'A' Group shares or initial public offerings.

BENEFITS OF INVESTING IN MUTUAL FUNDS

Professional Management Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme.DiversificationMutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own.Convenient AdministrationInvesting in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.Return PotentialOver a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.Low CostsMutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors.LiquidityIn open-end schemes, the investor gets the money back promptly at net asset value related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the Mutual Fund.TransparencyYou get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook.Flexibility Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience.


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AffordabilityInvestors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy.Choice of SchemesMutual Funds offer a family of schemes to suit your varying needs over a lifetime.Well RegulatedAll Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.

Net Asset Value (NAV)

The net asset value of the fund is the cumulative market value of the assets fund net of its liabilities. In other words, if the fund is dissolved or liquidated, by selling off all the assets in the fund, this is the amount that the shareholders would collectively own. This gives rise to the concept of net asset value per unit, which is the value, represented by the ownership of one unit in the fund. It is calculated simply by dividing the net asset value of the fund by the number of units. However, most people refer loosely to the NAV per unit as NAV, ignoring the "per unit". We also abide by the same convention.

Calculation of NAV

The most important part of the calculation is the valuation of the assets owned by the fund. Once it is calculated, the NAV is simply the net value of assets divided by the number of units outstanding. The detailed methodology for the calculation of the asset value is given below.Asset value is equal to Sum of market value of shares/debentures+ Liquid assets/cash held, if any+ Dividends/interest accruedAmount due on unpaid assets Expenses accrued but not paidDetails on the above itemsFor liquid shares/debentures, valuation is done on the basis of the last or closing market price on the principal exchange where the security is tradedFor illiquid and unlisted and/or thinly traded shares/debentures, the value has to be estimated. For shares, this could be the book value per share or an estimated market price if suitable benchmarks are available. For debentures and bonds, value is estimated on the basis of yields of comparable liquid securities after adjusting for illiquidity. The value of fixed interest bearing securities moves in a direction opposite to interest rate changes Valuation of debentures and bonds is a big problem since most of them are unlisted and thinly traded. This gives considerable leeway to the AMCs on valuation and some of the AMCs are believed to take advantage of this and adopt flexible valuation policies depending on the situation.Interest is payable on debentures/bonds on a periodic basis say every 6 months. But, with every passing day, interest is said to be accrued, at the daily interest rate, which is calculated by dividing the periodic


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interest payment with the number of days in each period. Thus, accrued interest on a particular day is equal to the daily interest rate multiplied by the number of days since the last interest payment date. Usually, dividends are proposed at the time of the Annual General meeting and become due on the record date. There is a gap between the dates on which it becomes due and the actual payment date. In the intermediate period, it is deemed to be "accrued".Expenses including management fees, custody charges etc. are calculated on a daily basis.

MUTUAL FUNDS IN INDIA (1964 - 2000)

The end of millennium marks 36 years of existence of mutual funds in this country. The ride through these 36 years is not been smooth. Investor opinion is still divided. While some are for mutual funds others are against it. UTI commenced its operations from July 1964 .The impetus for establishing a formal institution came from the desire to increase the propensity of the middle and lower groups to save and to invest. UTI came into existence during a period marked by great political and economic uncertainty in India. With war on the borders and economic turmoil that depressed the financial market, entrepreneurs were hesitant to enter capital market.The already existing companies found it difficult to raise fresh capital, as investors did not respond adequately to new issues. Earnest efforts were required to canalize savings of the community into productive uses in order to speed up the process of industrial growth.The then Finance Minister, T.T. Krishnamachari set up the idea of a unit trust that would be "open to any person or institution to purchase the units offered by the trust. However, this institution as we see it, is intended to cater to the needs of individual investors, and even among them as far as possible, to those whose means are small."His ideas took the form of the Unit Trust of India, an intermediary that would help fulfill the twin objectives of mobilizing retail savings and investing those savings in the capital market and passing on the benefits so accrued to the small investors.UTI commenced its operations from July 1964 "with a view to encouraging savings and investment and participation in the income, profits and gains accruing to the Corporation from the acquisition, holding, management and disposal of securities." Different provisions of the UTI Act laid down the structure of management, scope of business, powers and functions of the Trust as well as accounting, disclosures and regulatory requirements for the Trust.One thing is certain – the fund industry is here to stay. The industry was one-entity show till 1986 when the UTI monopoly was broken when SBI and Canbank mutual fund entered the arena. This was followed by the entry of others like BOI, LIC, GIC, etc. sponsored by public sector banks. Starting with an asset base of Rs. 25 crore in 1964 the industry has grown at a compounded average growth rate of 27% to its current size of Rs. 90000 crore.


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The period 1986-1993 can be termed as the period of public sector mutual funds (PMFs). From one player in 1985 the number increased to 8 in 1993. The party did not last long. When the private sector made its debut in 1993-94, the stock market was booming.The opening up of the asset management business to private sector in 1993 saw international players like Morgan Stanley, Jardine Fleming, JP Morgan, George Soros and Capital International along with the host of domestic players join the party. But for the equity funds, the period of 1994-96 was one of the worst in the history of Indian Mutual Funds.

1999—YEAR OF THE FUNDS

Mutual funds have been around for a long period of time to be precise for 36 yrs but the year 1999 saw immense future potential and developments in this sector. This year signaled the year of resurgence of mutual funds and the regaining of investor confidence in these MF’s. This time around all the participants are involved in the revival of the funds ----- the AMC’s, the unit holders, the other related parties. However the sole factor that gave lifr to the revival of the funds was the Union Budget. The budget brought about a large number of changes in one stroke. An insight of the Union Budget on mutual funds taxation benefits is provided later.It provided centrestage to the mutual funds, made them more attractive and provides acceptability among the investors. The Union Budget exempted mutual fund dividend given out by equity-oriented schemes from tax, both at the hands of the investor as well as the mutual fund. No longer were the mutual funds interested in selling the concept of mutual funds they wanted to talk business which would mean to increase asset base, and to get asset base and investor base they had to be fully armed with a whole lot of schemes for every investor .So new schemes for new IPO’s were inevitable. The quest to attract investors extended beyond just new schemes. The funds started to regulate themselves and were all out on winning the trust and confidence of the investors under the aegis of the Association of Mutual Funds of India (AMFI) One cam say that the industry is moving from infancy to adolescence, the industry is maturing and the investors and funds are frankly and openly discussing difficulties opportunities and compulsions.

Indian Scenario

A lone UTI with just one scheme in 1964, now competes with as many as 400 odd products and 34 players in the market. In spite of the stiff competition and losing market share, UTI still remains a formidable force to reckon with.Last six years have been the most turbulent as well as exiting ones for the industry. New players have come in, while others have decided to close shop by either selling off or merging with others. Product innovation is now passé with the game shifting to performance delivery in fund management as well as service. Those directly associated with the fund management industry like distributors, registrars and transfer agents, and even the regulators have become more mature and responsible.The industry is also having a profound impact on financial markets. While UTI has always been a dominant player on the bourses as well as the debt markets, the new generation of private funds which have gained substantial mass are now seen flexing their muscles. Fund managers, by their selection


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criteria for stocks have forced corporate governance on the industry. By rewarding honest and transparent management with higher valuations, a system of risk-reward has been created where the corporate sector is more transparent then before.Funds have shifted their focus to the recession free sectors like pharmaceuticals, FMCG and technology sector. Funds performances are improving. Funds collection, which averaged at less than Rs100bn per annum over five-year period spanning 1993-98 doubled to Rs210bn in 1998-99. In the current year mobilization till now have exceeded Rs300bn. Total collection for the current financial year ending March 2000 is expected to reach Rs450bn. What is particularly noteworthy is that bulk of the mobilization has been by the private sector mutual funds rather than public sector mutual funds. Indeed private MFs saw a net inflow of Rs. 7819.34 crore during the first nine months of the year as against a net inflow of Rs.604.40 crore in the case of public sector funds. Mutual funds are now also competing with commercial banks in the race for retail investor’s savings and corporate float money. The power shift towards mutual funds has become obvious. The coming few years will show that the traditional saving avenues are losing out in the current scenario. Many investors are realizing that investments in savings accounts are as good as locking up their deposits in a closet. The fund mobilization trend by mutual funds in the current year indicates that money is going to mutual funds in a big way. The collection in the first half of the financial year 1999-2000 matches the whole of 1998-99. India is at the first stage of a revolution that has already peaked in the U.S. The U.S. boasts of an Asset base that is much higher than its bank deposits. In India, mutual fund assets are not even 10% of the bank deposits, but this trend is beginning to change. Recent figures indicate that in the first quarter of the current fiscal year mutual fund assets went up by 115% whereas bank deposits rose by only 17%. (Source: Thinktank, The Financial Express September, 99) This is forcing a large number of banks to adopt the concept of narrow banking wherein the deposits are kept in Gilts and some other assets which improves liquidity and reduces risk. The basic fact lies that banks cannot be ignored and they will not close down completely. Their role as intermediaries cannot be ignored. It is just that Mutual Funds are going to change the way banks do business in the future

BANKS V/S MUTUAL FUNDS

BANKS MUTUAL FUNDS

Returns Low Better

Administrative exp. High Low

Risk Low Moderate

Investment options Less More

Network High penetration Low but improving

Liquidity At a cost Better

Quality of assets Not transparent Transparent

Interest calculation Minimum balance between 10th. & Everyday


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30th. Of every month

Guarantee Maximum Rs.1 lakh on deposits None

GLOBAL SCENARIO

Some basic facts- The money market mutual fund segment has a total corpus of $ 1.48 trillion in the U.S. against a

corpus of $ 100 million in India. Out of the top 10 mutual funds worldwide, eight are bank- sponsored. Only Fidelity and Capital

are non-bank mutual funds in this group. In the U.S. the total number of schemes is higher than that of the listed companies while in India

we have just 277 schemes Internationally, mutual funds are allowed to go short. In India fund managers do not have such

leeway. In the U.S. about 9.7 million households will manage their assets on-line by the year 2003, such a

facility is not yet of avail in India. On- line trading is a great idea to reduce management expenses from the current 2 % of total

assets to about 0.75 % of the total assets. 72% of the core customer base of mutual funds in the top 50-broking firms in the U.S. are

expected to trade on-line by 2003. (Source: The Financial Express September, 99)Internationally, on- line investing continues its meteoric rise. Many have debated about the success of e- commerce and its breakthroughs, but it is true that this aspect of technology could and will change the way financial sectors function. However, mutual funds cannot be left far behind. They have realized the potential of the Internet and are equipping themselves to perform better.In fact in advanced countries like the U.S.A, mutual funds buy- sell transactions have already begun on the Net, while in India the Net is used as a source of Information. Such changes could facilitate easy access, lower intermediation costs and better services for all. A research agency that specializes in internet technology estimates that over the next four years Mutual Fund Assets traded on- line will grow ten folds from $ 128 billion to $ 1,227 billion ; whereas equity assets traded on-line will increase during the period from $ 246 billion to $ 1,561 billion. This will increase the share of mutual funds from 34% to 40% during the period. (Source: The Financial Express September ,99)Such increases in volumes are expected to bring about large changes in the way Mutual Funds conduct their business.Here are some of the basic changes that have taken place since the advent of the Net.

Lower Costs: Distribution of funds will fall in the online trading regime by 2003 . Mutual funds could bring down their administrative costs to 0.75% if trading is done on- line. As per SEBI


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regulations , bond funds can charge a maximum of 2.25% and equity funds can charge 2.5% as administrative fees. Therefore if the administrative costs are low , the benefits are passed down and hence Mutual Funds are able to attract mire investors and increase their asset base.

Better advice: Mutual funds could provide better advice to their investors through the Net rather than through the traditional investment routes where there is an additional channel to deal with the Brokers. Direct dealing with the fund could help the investor with their financial planning.

In India , brokers could get more Net savvy than investors and could help the investors with the knowledge through get from the Net.

New investors would prefer online : Mutual funds can target investors who are young individuals and who are Net savvy, since servicing them would be easier on the Net.

India has around 1.6 million net users who are prime target for these funds and this could just be the beginning. The Internet users are going to increase dramatically and mutual funds are going to be the best beneficiary. With smaller administrative costs more funds would be mobilized .A fund manager must be ready to tackle the volatility and will have to maintain sufficient amount of investments which are high liquidity and low yielding investments to honor redemption.

Net based advertisements: There will be more sites involved in ads and promotion of mutual funds. In the U.S. sites like AOL offer detailed research and financial details about the functioning of different funds and their performance statistics. a is witnessing a genesis in this area . There are many sites such as indiainfoline.com and indiafn.com that are doing something similar and providing advice to investors regarding their investments.

FUTURE SCENARIO

The asset base will continue to grow at an annual rate of about 30 to 35 % over the next few years as investor’s shift their assets from banks and other traditional avenues. Some of the older public and private sector players will either close shop or be taken over.Out of ten public sector players five will sell out, close down or merge with stronger players in three to four years. In the private sector this trend has already started with two mergers and one takeover. Here too some of them will down their shutters in the near future to come.But this does not mean there is no room for other players. The market will witness a flurry of new players entering the arena. There will be a large number of offers from various asset management companies in the time to come. Some big names like Fidelity, Principal, Old Mutual etc. are looking at Indian market seriously. One important reason for it is that most major players already have presence here and hence these big names would hardly like to get left behind.In the U.S. most mutual funds concentrate only on financial funds like equity and debt. Some like real estate funds and commodity funds also take an exposure to physical assets. The latter type of funds are preferred by corporate’s who want to hedge their exposure to the commodities they deal with. For instance, a cable manufacturer who needs 100 tons of Copper in the month of January could buy an equivalent amount of copper by investing in a copper fund. For Example, Permanent Portfolio Fund, a


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conservative U.S. based fund invests a fixed percentage of it’s corpus in Gold, Silver, Swiss francs, specific stocks on various bourses around the world, short –term and long-term U.S. treasuries etc.In U.S.A. apart from bullion funds there are copper funds, precious metal funds and real estate funds (investing in real estate and other related assets as well.).In India, the Canada based Dundee mutual fund is planning to launch a gold and a real estate fund before the year-end.In developed countries like the U.S.A there are funds to satisfy everybody’s requirement, but in India only the tip of the iceberg has been explored. In the near future India too will concentrate on financial as well as physical funds.The mutual fund industry is awaiting the introduction of DERIVATIVES In the coutyr as this would enable it to hedge its risk and this in turn would be reflected in it’s Net Asset Value (NAV). SEBI is working out the norms for enabling the existing mutual fund schemes to trade in Derivatives. Importantly, many market players have called on the Regulator to initiate the process immediately, so that the mutual funds can implement the changes that are required to trade in Derivatives.

LIST OF VARIOUS FUNDS ALONG WITH ITS FUND MANAGERS

Fund name Major Schemes Fund manager Telephone no. Website

Alliance Capital

Mutual Fund

1)Alliance ’95 Fund 2)Alliance Equity

Fund

3) Alliance Liquid

Income Fund

Samir Arora Vineet Udeshi

4960094 4975604

4978000

www.alliancecapital.c

om

Birla Mutual 1) Birla Advantage Fund 2) Birla Income Plus

Bharat Shah 8326000 8326100

8326200

www.birlamutual.com

Kothari Pioneer

Mutual Fund

1)Kothari Pioneer Prima Plus 2)Kothari Pioneer

Blue Chip

R.Sukumar 8240674 8240744 www.kotharipioneer.c

om

SBI Mutual Fund 1)SBI Magnum Multiplier Scheme’90 2)SBI Magnum

Taxgain Scheme

1993

3) SBI Magnum Bond

Fund

4) SBI Rising Income

Scheme

Ved Prakash Chaturvedi Sandeep Sabarwal

Mihir Vora

2185696 2180221-27 www.sbimf.com

Prudential - ICICI 1) Prudential ICICI Dileep Madgavkar 2679676 www.pruiciciamc.com

http://www.pruiciciamc.com/

http://www.sbimf.com/

http://www.kotharipioneer.com/

http://www.kotharipioneer.com/

http://www.birlamutual.com/

http://www.alliancecapital.com/

http://www.alliancecapital.com/


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Growth Plan 2) ICICI Premier

V.Kannan

DSP Merrill Lynch

Fund

DSP Merrill Lynch

Equity Fund

James Leighton 2884831 2884822 www.ml.com

Morgan Stanley Morgan Stanley

Growth Fund

Vinod Sethi 2096600 www.msgfindia.com

Tata Mutual Fund Tata Balanced Fund Shyam Bhat 2881190 www.tata.com/

mutualfund

Canbank Mutual Fund Canganga -------- 2693590 Canbank.cimbom1@c

anbank.gms.vsnl.net.i

n (e-mail)

Templeton Asset

Management Ltd.

Templeton India

Income Fund

Nilesh Shah and

Shobit Mehrotra

2886123 2886132 www.templeton.com

Unit Trust of India UTI MIP 94 (III) - -- -- -- -- - 2180221 www.unittrustofindia.c

om

LIC Mutual Fund LIC Dhanvarsha 9 V.Ramanan and

C.S.Madhavrao

- -- - -- - -- www.licindia.com

Mutual funds and the Budget 1999-2000

The Union Budget of India, 1999 presented in Parliament on February 27 has brought good things for mutual fund investors. The budget aims at making mutual funds tax friendly for the individual investor, resulting in large inflows into the capital markets through mutual funds.

Income Received From Mutual Funds

The Finance Bill has made income (i.e. dividends) received from all mutual funds tax free in the hands of investors. Effective April 1, 1999 (i.e. assessment year 2000-2001) investors need not pay any tax on dividend received from a mutual fund. For the investor it does not matter what kinds of mutual fund scheme they have invested in. Dividend whether received from equity, equity & debt or a debt scheme will all be tax-free for the investor. Since investors shall be receiving tax-free dividends, the benefits of section 80L will no longer be relevant to mutual funds. Section 80L allowed you to take a deduction of up to Rs. 15,000 (of which Rs.3,000 was specifically reserved for mutual funds) for dividends received from mutual funds together with income from other securities. Now that investors will receive tax-free dividends from mutual funds, Section 80L is no longer applicable to dividends from them.

http://www.licindia.com/

http://www.unittrustofindia.com/

http://www.unittrustofindia.com/

http://www.templeton.com/

mailto:[email protected]



http://www.tata.com/mutualfund

http://www.tata.com/mutualfund

http://www.msgfindia.com/

http://www.ml.com/


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While dividends in the hands of the investor are free from tax, mutual funds are now required to pay a "distribution tax" of 10%. For financial year 1999-2000, however, only distributions made after June 1, 1999 will be subject to the tax. The good news is that the distribution tax does not have to be paid on all types of mutual fund schemes. Effective April 1,1999, for a period of three years, open-end equity oriented schemes will be exempt from paying the distribution tax.

Tax implication for income received on open-end equity oriented scheme:

As per the Finance Bill, income distributed under the US-64 scheme and other open-ended equity oriented scheme of UTI and Mutual Funds would be exempt from the levy of this tax for a period of three financial years starting from 1.4.1999. An open-end equity oriented scheme is defined as one where more than 50% of the scheme's investible funds are invested in domestic equities. The 50% is computed taking the annual average of the monthly averages of the scheme's equity holdings. The monthly average, in turn, is calculated by taking the opening and closing percentage of a particular month's equity holdings.

Tax implication for income received from schemes other than open-end equity oriented scheme

By definition all schemes that are not open-end equity oriented schemes must pay a distribution tax. This tax has been fixed at 10%. In fact, the actual tax will be 11% since the mutual fund must pay a 10% surcharge as well.

Difference Between TDS and Distribution Tax

The distribution tax is different from "TDS" or tax deducted at source. In the case of TDS, the fund deducts tax and deposits it with the Government. This tax is deducted by the fund from income payable to the investor and the investor gets credit of the same while filing his annual return of tax. In cases where the investor is not liable to pay tax he may claim an exemption from TDS by filing a Form 15H with the fund. Distribution tax is, however, a tax that has to be paid by the fund, not the investor. It is not a direct tax paid by the investor therefore, he cannot file for exemption from distribution tax. Hence, while the dividend pay out will be tax-exempt in the hands of the investors, in all schemes where the mutual fund has to pay a distribution tax, the dividend pay out will be affected to that extent by the 11% distribution tax.

Long Term Capital Gains arising from sale of mutual fund units

As per the current provisions of the budget, long term capital gains arising from the sale of listed securities and shares as defined under the Securities Contracts (Regulation) Act, 1956 (SCRA) are now chargeable to tax at a maximum rate of 10 %. As per the earlier Income Tax law, long-term capital gains


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from shares and securities were taxed at 20 per cent after giving benefit of cost inflation indexation. The present budget capped capital gains tax at 10 per cent for securities as defined under Section 2(h) of SCRA and listed in recognised stock exchanges in India. The benefit of cost indexation, however, would not be available in such cases. That is, persons would have the option of either availing of cost indexation on the capital gains and paying 20 per cent capital gains tax or paying a flat rate of 10 per cent without cost indexation. As a result, the maximum capital gains tax payable has been capped at 10 per cent. The finance ministry is considering extending the benefit of the 10 % cap on long term capital gains tax to units of all mutual funds. Since the definition of securities in the SCRA Act does not include units issued by mutual funds, these do not get the benefit of the capping of capital gains tax. However, UTI may get this benefit as the SCRA definition includes all 'securities issued by a body corporate' and UTI is one by statute.

Important

The above is a general description of the tax laws. Tax laws may change in the future and the applicability of these laws may vary from person to person, depending on your particular circumstances. You should consult with your own tax advisor with respect to the tax benefits available from a mutual fund investment

Mutual funds and the Budget 2000-2001

Important measures1. Deletion of sections 54 EA and 54 EB of the Income Tax Act, 1961.

The above two sections provided relief from capital gains tax if investments were made in specified securities and locked in for a period of 3 years in the case of 54EA and 7 years in the case of 54EB. Mutual fund units were one of the specified securities and this resulted in a lot of money realised as profit from sale of securities being reinvested in the market through mutual funds. With the withdrawal of the exemption to mutual funds, investors have lost out on a very viable alternative for tax saving and funds also would be faced with the problem of ‘hot money’ as there would no longer be any lock in period for investments. It is estimated that 54EA investments formed approximately 15% of the corpus.

2. Increase in dividend tax from 10% to 20% for debt funds. The existing dividend tax payable by debt schemes has been doubled to 20%. This would lead to a reduction in returns available to investors by approximately 1.5% from the average of approximately 14%. This is expected to hurt retail investment in debt schemes and could lead to a pull out and reduced mobilisation. Two implications of this move could be:


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1. Reinvestment of dividends by investors; since capital gains would be taxed at a lower rate as compared to dividend, investors would prefer to reinvest dividend and earn long-term capital appreciation.

2. Switch over from debt to equity schemes; since open ended equity schemes are free from paying dividend tax, these schemes could attract some of the investment that is pulled out from debt schemes.

Instead of taxing debt schemes so as to bring parity between the banks and mutual funds, it is widely felt that the finance minister could have simply extended some of the benefits enjoyed by mutual funds to banks and FIs. The experience with mutual funds has in any case shown that turning dividends tax free in the hands of investors has simply improved collections, widened the tax base and reduced procedural delays

REGULATORY ASPECTS OF MUTUAL FUND

SCHEMES OF MUTUAL FUND

The asset management company shall launch no scheme unless the trustees approve such scheme and a copy of the offer document has been filed with the Board.

Every mutual fund shall along with the offer document of each scheme pay filing fees. The offer document shall contain disclosures which are adequate in order to enable the investors

to make informed investment decision including the disclosure on maximum investments proposed to be made by the scheme in the listed securities of the group companies of the sponsor.

No one shall issue any form of application for units of a mutual fund unless the form is accompanied by the memorandum containing such information as may be specified by the Board.

Every close ended scheme shall be listed in a recognized stock exchange within six months from the closure of the subscription

The asset management company may at its option repurchase or reissue the repurchased units of a close ended scheme.

A close-ended scheme shall be fully redeemed at the end of the maturity period. "Unless a majority of the unit holders otherwise decide for its rollover by passing a resolution".

The mutual fund and asset management company shall be liable to refund the application money to the applicants,-

(i) If the mutual fund fails to receive the minimum subscription amount referred to in clause (a) of sub-regulation (1);

(ii) If the moneys received from the applicants for units are in excess of subscription as referred to in clause (b) of sub-regulation (1).

The asset management company shall issue to the applicant whose application has been accepted, unit certificates or a statement of accounts specifying the number of units allotted to the applicant


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as soon as possible but not later than six weeks from the date of closure of the initial subscription list and or from the date of receipt of the request from the unit holders in any open ended scheme.

RULES REGARDING ADVERTISEMENT

The advertisement for each scheme shall disclose investment objective for each scheme. An advertisement shall be truthful, fair and clear and shall not contain a statement, promise or

forecast which is untrue or misleading. Advertisements shall not be so framed as to exploit the lack of experience or knowledge of the

investors. All advertisements issued by a mutual fund or its sponsor or asset management company, shall

state "all investments in mutual funds and securities are subject to market risks and the NAV of the schemes may go up or down depending upon the factors and forces affecting the securities market".

The advertisement shall not compare one fund with another, implicitly or explicitly, unless the comparison is fair and all information relevant to the comparison is included in the advertisement.

The offer document and advertisement materials shall not be misleading or contain any statement or opinion, which are incorrect or false.

INVESTMENT OBJECTIVES AND VALUATION POLICIES:

The moneys collected under any scheme of a mutual fund shall be invested only in transferable securities in the money market or in the capital market or in privately placed debentures or securitised debts.

Provided that moneys collected under any money market scheme of a mutual fund shall be invested only in money market instruments in accordance with directions issued by the Reserve Bank of India;

The mutual fund shall not borrow except to meet temporary liquidity needs of the mutual funds for the purpose of repurchase, redemption of units or payment of interest or dividend to the unit holders.

The mutual fund shall not advance any loans for any purpose. Every mutual fund shall compute and carry out valuation of its investments in its portfolio and

publish the same in accordance with the valuation norms specified in Eighth Schedule Every mutual fund shall compute the Net Asset Value of each scheme by dividing the net assets

of the scheme by the number of units outstanding on the valuation date. The Net Asset Value of the scheme shall be calculated and published at least in two daily

newspapers at intervals of not exceeding one week: The price at which the units may be subscribed or sold and the price at which such units may at

any time be repurchased by the mutual fund shall be made available to the investors.

GENERAL OBLIGATIONS

Every asset management company for each scheme shall keep and maintain proper books of accounts, records and documents, for each scheme so as to explain its transactions and to disclose


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at any point of time the financial position of each scheme and in particular give a true and fair view of the state of affairs of the fund and intimate to the Board the place where such books of accounts, records and documents are maintained.

The financial year for all the schemes shall end as of March 31 of each year. Every mutual fund or the asset management company shall prepare in respect of each financial

year an annual report and annual statement of accounts of the schemes and the fund as specified in Eleventh Schedule.

Every mutual fund shall have the annual statement of accounts audited by an auditor who is not in any way associated with the auditor of the asset management company.

PROCEDURE FOR ACTION IN CASE OF DEFAULT:

On and from the date of the suspension of the certificate or the approval, as the case may be, the mutual fund, trustees or asset management company, shall cease to carry on any activity as a mutual fund, trustee or asset management company, during the period of suspension, and shall be subject to the directions of the Board with regard to any records, documents, or securities that may be in its custody or control, relating to its activities as mutual fund, trustees or asset management company.

RESTRICTIONS ON INVESTMENTS:

A mutual fund scheme shall not invest more than 15% of its NAV in debt instruments issued by a single issuer, which are rated not below investment grade by a credit rating agency authorized to carry out such activity under the Act. Such investment limit may be extended to 20% of the NAV of the scheme with the prior approval of the Board of Trustees and the Board of asset management company

A mutual fund scheme shall not invest more than 10% of its NAV in unrated debt instruments issued by a single issuer and the total investment in such instruments shall not exceed 25% of the NAV of the scheme. All such investments shall be made with the prior approval of the Board of Trustees and the Board of asset management company.

No mutual fund under all its schemes should own more than ten per cent of any company's paid up capital carrying voting rights.

Transfers of investments from one scheme to another scheme in the same mutual fund shall be allowed only if, -

3. Such transfers are done at the prevailing market price for quoted instruments on spot basis.

4. The securities so transferred shall be in conformity with the investment objective of the scheme to which such transfer has been made.

A scheme may invest in another scheme under the same asset management company or any other mutual fund without charging any fees, provided that aggregate interscheme investment made by all schemes under the same management or in schemes under the management of any other asset


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management company shall not exceed 5% of the net asset value of the mutual fund.

The initial issue expenses in respect of any scheme may not exceed six per cent of the funds raised under that scheme.

Every mutual fund shall buy and sell securities on the basis of deliveries and shall in all cases of purchases, take delivery of relative securities and in all cases of sale, deliver the securities and shall in no case put itself in a position whereby it has to make short sale or carry forward transaction or engage in badla finance.

Every mutual fund shall, get the securities purchased or transferred in the name of the mutual fund on account of the concerned scheme, wherever investments are intended to be of long-term nature.

Pending deployment of funds of a scheme in securities in terms of investment objectives of the scheme a mutual fund can invest the funds of the scheme in short term deposits of scheduled commercial banks.

No mutual fund scheme shall make any investment in; Any unlisted security of an associate or group company of the sponsor; or Any security issued by way of private placement by an associate or group company of the sponsor; or The listed securities of group companies of the sponsor which is in excess of 30% of the net assets [of all the schemes of a mutual fund]

No mutual fund scheme shall invest more than 10 per cent of its NAV in the equity shares or equity related instruments of any company. Provided that, the limit of 10 per cent shall not be applicable for investments in index fund or sector or industry specific scheme.

A mutual fund scheme shall not invest more than 5% of its NAV in the equity shares or equity related investments in case of open-ended scheme and 10% of its NAV in case of close-ended scheme

Frequently Asked Questions

Why have mutual funds in India performed so poorly?Most investors associate mutual funds with Mastergain, Monthly Equity Plans of SBI Mutual Fund, UTI and Canbank Mutual Fund and of course Morgan Stanley Growth Fund. This is so because these funds truly had participation from masses, with a fund like Morgan Stanley having more than 1 million investors. Investors feel that after 5 years, Morgan Stanley Growth Fund units still trade below the original IPO price of Rs 10. It is incorrect to think that all mutual funds have performed poorly. If one looks at some income funds, they have come with reasonable returns. It is only the performance of equity funds, which has been poor.


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Their poor performance has been amplified by the closed end discounts ie units of these funds quoting at sharp discounts to their NAV resulting in an even poorer return to the investor.One must remember that a Mutual Fund does not provide assured returns and neither can it "manufacture" returns out of thin air. Returns provided by mutual funds are a function of the returns in the underlying asset class in which the fund invests. Good funds can beat returns in their asset class to some extent but that’s all. Eg take the case of a sector specific fund like a pharma fund which invests only in shares of pharmaceutical companies. If the Govt. comes with new regulation that severely restricts the pricing freedom of these companies resulting in negative outlook for the sector, the prices of all stocks in the sector could fall substantially resulting in a severe erosion in the NAV of the fund. No one can do anything about it. A good fund manager would probably sell part of the fund before prices fall too much and wait for an opportune time to reinvest at lower levels once the dust has settled. In that case, the NAV of the fund would fall to a lesser extent – but fall it will. If the investor in the fund has invested in some stocks in the sector on his own, in all probability, his personal investments may have depreciated to a larger extent.Let us extend this example to an analysis of the investment climate in the last 7 years. The stock markets have done very badly in the last seven years. The BSE Sensex crossed 3000 for the first time in early 1992. Since then it has gone up and come down several times but has remained in the same range. Effectively, for a seven-year investment period, the total return has been almost zero. The prices of many leading stocks of yesteryear have fallen by more than 50% in these seven years. If one considers the fact that the Sensex has been changed several times, with all the weak stocks having been weeded out, the effective returns on the old Sensex, existing in 1992, have been substantially negative. The following table gives some of the prices of stocks considered "blue chips" in 1992, in 1994 and the prices prevailing at present.Price in RsName of the Company

1992 high 1994 high Current price

Tata Steel 552 336 99Grasim Industries 650 793 137Century Textiles 490 550 28.6Reliance Industries 218 213 149Raymond 250 263 71Arvind Mills 353 290 27.65ICICI 290 197 55.4It is quite obvious that if a fund had invested in any of these shares in 1992 or subsequently in the 1994 boom, and if it remained invested in the share, then it would be confronting a huge fall in NAV. This is exactly what has happened. A similar table for prices of shares of Public Sector Undertakings (PSUs) is given below.Price in RsName of the Company

1994 high Present price


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MTNL 325 161HPCL 550 188Indian Oil n/a 251ONGC n/a 134.5SAIL 83 5.05Most mutual fund managers took some time to realize the changed circumstances wherein the open economy ushered in by the liberalization took the full impact of the global deflation in commodity prices. This problem was compounded further by the Asian crisis after which cheap imports from Asia caused severe pressure on profits. To add to this, most funds had invested some part of their portfolio in medium sized "growth" companies. Many of these companies have performed even worse than bigger ones and quite a few have seen share prices dip more than 90% from their 1994 highs. More important, funds could not sell these shares because of complete lack of liquidity with, at best, few hundred shares being traded every day. Meanwhile, shares of companies in sectors like consumer goods (FMCG) and software, were showing good growth and they went up rapidly in price. Most fund managers were unwilling to sell shares of erstwhile "blue chips" at low prices and buy shares of emerging "blue chips" at high prices. This resulted in poor performance and negative returns.One more issue is that the fund managers in many funds were not "professionally qualified and experienced". This is especially true of some of the funds floated by nationalized banks. Some of these individuals were transferred from the parent organization and did not really know much about investment management.Lastly, investors would do well to have a look at the investments, which they made on their own. In most cases, they would have done much worse than the mutual funds. We have received numerous requests for advice from individual investors on what to do about their own investments. If that were any indicator, investors would have done really badly. Is it true that globally mutual funds underperform benchmark indices? Why are smart money managers unable to do as well as the market? Or is it that they are not smart at all? What are the limitations of mutual funds?It is 100% true that globally, most mutual fund managers underperform the asset class that they are investing in. It is not true that the fund managers are dumb; this under performance is largely the result of limitations inherent in the concept of mutual funds. These limitations are as follows:Entry and exit costs: Mutual funds are a victim of their own success. When a large body like a fund invests in shares, the concentrated buying or selling often results in adverse price movements ie at the time of buying, the fund ends up paying a higher price and while selling it realizes a lower price. This problem is especially severe in emerging markets like India, where, excluding a few stocks, even the stocks in the Sensex are not liquid, let alone stocks in the NSE 50 or the CRISIL 500. So, there is simply no way that a fund can beat the Sensex or any other index, if it blindly invests in the same stocks as those in the Sensex and in the same proportion. For obvious reasons, this problem is even more severe for funds investing in small capitalization stocks. However, given the large size of the debt market, excluding UTI, most debt funds do not face this problem


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Wait time before investment: It takes time for a mutual fund to invest money. Unfortunately, most mutual funds receive money when markets are in a boom phase and investors are willing to try out mutual funds. Since it is difficult to invest all funds in one day, there is some money waiting to be invested. Further, there may be a time lag before investment opportunities are identified. This ensures that the fund underperforms the index. For open-ended funds, there is the added problem of perpetually keeping some money in liquid assets to meet redemptions.Fund management costs: The costs of the fund management process are deducted from the fund. This includes marketing and initial costs deducted at the time of entry itself, called "load". Then there is the annual asset management fee and expenses, together called the expense ratio. Usually, the former is not counted while measuring performance, while the latter is. A standard 2% expense ratio means that, everything else being equal, the fund manager underperforms the benchmark index by an equal amount.Cost of churn: The portfolio of a fund does not remain constant. The extent to which the portfolio changes is a function of the style of the individual fund manager ie whether he is a buy and hold type of manager or one who aggressively churns the fund. It is also dependent on the volatility of the fund size ie whether the fund constantly receives fresh subscriptions and redemptions. Such portfolio changes have associated costs of brokerage, custody fees, registration fees etc. which lowers the portfolio return commensurately.Change of index composition: World over, the indices keep changing to reflect changing market conditions. There is an inherent survivorship bias in this process, with the bad stocks weeded out and replaced by emerging blue chips. This is a severe problem in India with the Sensex having been changed twice in the last 5 years, with each change being quite substantial. Another reason for change index composition is Mergers & Acquisitions. The weightage of the shares of a particular company in the index changes if it acquires a large company not a part of the index. Tendency to take conformist decisions: From the above points, it is quite clear that the only way a fund can beat the index is through investment of some part of its portfolio in some shares where it gets excellent returns, much more than the index. This will pull up the overall average return. In order to obtain such exceptional returns, the fund manager has to take a strong view and invest in some uncommon or unfancied investment options. Most people are unwilling to do that. They follow the principle "No fund manager ever got fired for investing in Hindustan Lever" ie if something goes wrong with an unusual investment, the fund manager will be questioned but if anything goes wrong with the blue chip, then you can always blame it on the "environment" or "uncontrollable factors" knowing fully well that there are many other fund managers who have made the same decision. Unfortunately, if the fund manager does the same thing as several others of his class, chances are that he will produce average results. This does not mean that if a fund manager takes "active" views and invests in heavily researched "uncommon" ideas, the fund will necessarily outperform the index. If the idea does not work, it will result in poor fund performance. But if no such view is taken, there is absolutely no chance that the fund will outperform the index.Should an investor invest in a mutual fund despite its limitations or no?


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Yes. Investor should invest some part or their investment portfolio in mutual funds. In fact some investors may be better off by putting their entire portfolio in mutual funds. This is on account of the following reasons:

On their own, uninformed investors could perform much worse than mutual funds. Diversification of risks which is difficult for an investor to achieve with the small amount of

funds at his disposal Possibility of investing in small amounts as and when the investor has funds to invest Unquestioned service of transaction processing, tracking of investments, collecting

dividends/interest warrants etc. Debt funds in India offer exposure to a diversified portfolio of bonds/debentures, which is

possible, only if the investor is investing millions of rupees. Further, they offer easy liquidity and tax benefits. Debt funds thus offer a great proposition that is impossible for ordinary investors to replicate on their own. This proposition compares favorably against competing investments like small savings.

Investors require analytical capability and access to research and information and need to spend an enormous amount of time to make investment decisions and keep monitoring them. Some people have the inclination and the time to make better decisions than fund managers do, but the vast majority does not. Those who can are advised to invest some part of their money into funds, especially debt funds, to diversify their risk. They may also note that one of the objectives of this site is to help them improve the odds in their favor.

Are mutual funds safe? Are returns on mutual funds guaranteed by Government of India, or Reserve Bank or any other government body?Any mutual fund is as safe or unsafe as the assets that it invests in. There are two basic categories of mutual funds with others being variations or mixtures of these. Firstly, there are those that invest purely in equity shares (called equity funds or " growth funds") and secondly, there are those that invest purely in bonds, debentures and other interest bearing instruments called "income" or "debt" funds. The NAV of growth funds fluctuates in line with the fluctuation of the shares held by them. They can also witness face substantial erosion in value, which could be permanent in some cases. On the other hand, prices of debt instruments fluctuate to a much lesser degree and an income fund is extremely unlikely to face erosion in value – especially of the permanent kind. Most mutual funds have qualified and experienced personnel, who understand the risks of investing. But, nobody is immune from making mistakes. However, funds diversify the investment portfolio substantially so that default in any single investment (in the case of an income fund) will not affect the overall performance of a fund in a significant manner. In the event of default of a part of the portfolio, an income fund is extremely unlikely to face erosion in face value.Generally, mutual funds are not guaranteed by anybody. However, in the Indian context, some of the mutual funds have floated "guaranteed" or "assured" return schemes which guarantee a certain annual return or guarantee a buyback at a specified price after some time. Examples of these include funds floated by the UTI, Canbank Mutual Fund, SBI Mutual Fund, LIC Mutual Fund etc. Many of these funds have not earned returns that they promised and the asset management companies of the respective mutual


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funds or their sponsors have made good their promises. The biggest case pertains to the US 64, which never guaranteed any returns but is being bailed out by the Government due to the millions of individuals who have invested in it. Can the foreign mutual funds operating in India take investors money outside the country?A mutual fund and the company that manages it are 2 entirely different companies. Legally speaking, a mutual fund is a trust formed and registered under the Indian Trust Act. The sponsor asset management company is formally appointed by the trustees of the trust to manage money on their behalf eg DSP Merrill Lynch equity fund is a mutual benefit trust registered under the Indian Trust Act. The trustees have appointed DSP Merrill Lynch Asset Management Company Pvt. Ltd. to manage the funds in the trust and the company cannot touch one rupee from the trust except to the extent of the fees that it receives for managing the funds. Repatriation of money outside India comes under the purview of the Foreign Exchange Regulation Act, 1973 which specifies the situations in which money can be remitted outside India. Under the act, banks that repatriate money on behalf of their clients have to ensure compliance with various legal formalities and ensure that the entity, which remits money, is entitled to do so. Any failure or violation leads to serious consequences for both the remitter and the bank. Money collected by a mutual fund domestically is not allowed to be remitted outside India.Is mutual funds outperformance always good?Mutual fund performance of index may not always be a positive indicator. In several cases one notices that the funds performance is very lop sided and is driven by few scrips. In other words the fund manager has taken significantly higher risks and in the game of probability he would have made more money. But it is very likely that if his call had not been right, he would have under performed and lost badly. From an investor’s point of view, when he is looking at such out-performances in the past, he cannot derive confidence and comfort in the fund managers' ability to repeat the performance in future. As markets are not rational, there is no methodology in the world to scientifically predict stock prices. Therefore it is not possible for anyone to beat the market on a consistent basis and hence there is no guarantee that the fund manager would perform well all the while. How does one see through the marketing hype given out by mutual funds?It is amazing how fund marketers can come up with statistics to show how their particular fund has done extremely well. Standard techniques include the following:Defined period returns: Some period is depicted in which the particular fund outperformed others or some benchmark. One should look very carefully at start and end dates – they can always be chosen in a way that shows the fund in a favorable lightOutperformance vs performance: Sustained periods of low absolute performance are a cause for concern. It is all right to look at relative returns with respect to benchmark indices; but there is no sense if a particular fund produces absolute returns less than the deposit interest rates, even after a few years of existence.Promise of long term performance: Lack of performance is often explained away as temporary with promises of good performance in the long term. Few define what this "long term" is – 1 or 2 or 5 or 10 years. Do not forget that the longer the period, the longer is the uncertainty in between – in other words,


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would you want to wait for 10 years to get an uncertain 2% higher returns as compared to the certain returns that you get in say the Public Provident Fund.Rupee cost averaging: This is a term that has found its way into the marketing literature of all mutual funds. What it means is that if you put in a fixed amount of money every month in a fund, then, in months when the NAV is low, the investor gets more units which benefits him when the NAV rises. Do not forget the implicit assumption behind this – that the NAV will rise eventually. If it does not, you are no better off than by not buying.Equities are the best bet in the long run: Ask this to any investor who put money in the Sensex in 1992. After a long run of 7 years, the investor is down on his investment by 50%. He would have been better off by investing in other investment. What went wrong with US64?Basically, for a period of 2-3 years, the UTI distributed more dividend to the unitholders of US 64 than the return earned from the investments in the scheme. This reduced the value of the residual investments in the scheme. This problem was compounded by the persistent fall in the prices of shares, especially the shares of companies in basic commodity industries like cement, steel, manmade fibres etc. and shares of public sector units. Throughout this period, when the NAV of US 64 was going down, UTI kept increasing the sale and repurchase prices of US 64 units. The stock market collapse after the Pokhran II nuclear tests was the last straw, which resulted in the erosion of the scheme’s book reserves and a wide difference between the actual NAV and the sale/repurchase price. When this became known, it set a panic amongst investors of US 64. Many people felt that if there were large-scale redemptions, UTI would not be able to meet them without support of outside bodies like the RBI. Further, theoretically, if all investors wanted to redeem their US 64 units on the same day, the US 64 simply did not have the money to meet the redemptions on its own (due to the difference between NAV and the repurchase price).What went wrong with Morgan Stanley?Morgan Stanley raised large corpus (more than Rs 10bn) in around early 1994. The entire exercise in fund raising was centered on the hype of the fund being was the first fund promoted by an internationally acclaimed asset management company. It was marketed like any other public issue and fund investors rushed to invest in the scheme hoping to get superior returns. No one bothered to explain to them that Morgan Stanley AMC was a service provider - providing them the service of investment advice and management. No one explained to them that they were not investing in a share of a company – in fact the artificial gray market premium served to perpetrate this feeling.The IPO was a great success. It ensured that the name "Morgan Stanley" was now a part of the dreams of more than 1 million Indians. The fund raising exercise, unfortunately, coincided with the peak of stock market boom. Indian stock markets lack depth and are quite illiquid. The fund managers were compelled to invest in equities in a big hurry as a number of Foreign Institutional Investors were investing huge sums of money in the country resulting in a mad rush for equity stocks. The fund’s managers invested a considerable amount of money in smaller companies with low floating stock and low market capitalization, either through the secondary


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market or through private placements. These companies had experienced the highest appreciation in prices in the immediate past. The market position started changing from late 1994. The boom in the market made it possible for many companies to raise equity capital and literally hundreds of public/rights issues opened for subscriptions every week, many of them at high issue prices. There were also massive private placements of equity shares and GDR issues at huge premiums. There were very few companies which did not wash their hands in this great gravy train. This deluge of paper soaked up money and reduced the amount available for fresh investment both from resident Indians, domestic mutual funds and from foreign institutional investors.At this time, the RBI commenced on its tight money policy in a bid to control inflation from raising its head. Money supply tightened and bond yields started increasing dramatically. High industrial growth and tight money created a shortage for credit and rates started going sky high. Many corporates and banks started redeeming their holdings in the Unit Trust of India and other mutual funds. This put major pressure on the market, which was already showing signs of weakness. What followed was the great crash.And in this crash, the biggest losers were the smaller capitalization stocks. Many of these stocks lost more than 90% of their peak prices.Morgan Stanley AMC restructured the funds portfolio at big losses. As the NAV went below par, investors’ confidence was shattered. Being a closed-ended scheme the Morgan Stanley’s mutual fund unit is also listed on the stock markets. Crisis of confidence led to its price on the stock exchange crashing and it started quoting at a steep discount to its NAV. The fund started buying back units in order to reduce the discount and also to boost the NAV (buying back units at prices below the NAV results in a profit, which will reduce the NAV). Given its large corpus size no amount of buy back or otherwise support could help boost the investor confidence. Since then the equity markets have gone nowhere with the index still below the level at which the fund was invested. Most of the stocks in the Sensex have performed poorly with markets punishing commodity companies and companies with non-transparent Indian managements. To top it, many erstwhile bluechips have reported disastrous financial performances. Consequently, the NAV of MSGF mirrors this gory saga of the Indian markets. In fact, the fund invested considerable amount of money in FMCG, pharmaceutical and software companies at the right time which improved the NAV from 1998 onwards. How important is an AMC (Asset Management Company) behind a mutual fund?AMC controls the operations and functioning of a mutual fund. It is very critical to the performance of a mutual fund as it decides on the style of functioning, people who are going to manage the funds, the commitment to service quality and overall supervision. The financial strength and the commitment of the AMC sponsors to the business are very key issues. This is because most AMCs lose money in the first few years of operations. In most cases, these losses are much more than the capital requirements stipulated by SEBI. Hence, a sponsor which is financially weak or which cannot capital to the business either because of its inability or unwillingness will result in an unhealthy operation. There will be a tendency to cut corners and unwillingness to spend money to expand


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operations. This is the last place where high quality persons would want to remain and work. The AMC then remains stunted and the sponsors lose interest. The worst affected are the investors. This is exactly what has happened with some AMCs promoted by Indian business houses. This is also a problem that has afflicted some of the AMCs floated by nationalized banks. In these organizations, the traditional thinking is prevalent which can be summarized as "money is power". Since mutual fund business did not have access to too much money, a posting in the AMC became punishment postings for some personnel who were not doing well in the parent organization or who lost out in the organizational politics. The management of the banks also did not allow these AMCs to become independent viable businesses. The CEO’s of the AMCs did not have any clue of the mutual fund business and neither were they interested in it – the entire effort was spent in getting a posting back in the parent. The fund managers had no experience in the activity making a mockery of "professional management". The sad results are there to see. Some of the parents had to provide funds to bridge the gap in "assured return schemes". It looks extremely likely that some of these AMCs will no longer exist in a few years. How and against what should you benchmark the performance of a mutual fund?All mutual funds have different objectives and therefore their performance would vary. A mutual funds performance should be benchmarked against mutual funds of similar type or India infoline mutual fund index for a particular type. eg equity fund index, income fund index or balanced fund index or liquid fund index. One can also benchmark the fund against the Sensex or any other broadbased index for the particular asset class. One has to be very careful about choosing the comparison period. Ideally, one should compare the performance of equity or an index fund over a 1-2 year horizon. Any comparison over a shorter period would be distorted by short term, volatile price movements. Comparisons over a longer period need to be interpreted carefully by looking at other factors such as change in individuals managing the fund, one time investment successes etc. Similarly, the ideal comparison period for a debt fund would be 6-12 months while that for a liquid/money market fund would be 1-3 months. Apart from the entire period, one should also compare the performance in smaller intervals within the same period say intervals of one month duration.To make comparison meaningful, one has to compare the average annual compounded rate of return. This adjusts for comparisons of differing period and also facilitates comparison across different classes. The return also incorporates dividend payouts. Thus, for example, one can say that ABC income fund has given a compounded annual growth rate (CAGR) of 13% p.a. including dividends in the last 2 years while XYZ income fund has given a CAGR of 13.2% p.a. over the last 3 years.Apart from NAV, what other parameters can be compared across different funds of the same category?Apart from plain numerical comparison of NAV’s, several other things can be checked, eg correlation of changes in NAV with changes in portfolio composition and appreciation/depreciation in valuation of individual items, increase in the size of the corpus etc. In debt funds, it is useful to compare the extent to which the growth in NAV comes from interest income and from changes in valuation of illiquid assets like bonds and debentures. It is also useful to compare expense ratios of funds eg Birla Income Plus has


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an expense ratio of 1.7% which is one of the lowest expense ratios of all income funds in the industry – this means that, everything else being equal, the performance of that fund will be higher by 0.55% than other funds, which have an expense ratio of 2.25%. Last, but not the least, one has to compare the risk profile of two funds. For income funds, this could mean credit quality of the portfolio and the fluctuations in the NAV with periodic changes in the interest rate environment. For equity funds, it could mean the volatility of the NAV with the ups and downs in the market or the percentage exposure to smaller company shares etc. How different are styles of different mutual funds?Different mutual funds have very different investing styles. These styles are a function of the individuals managing the fund with the overall investment objectives and policies of the organization acting as a constraint. These are manifest in things like Portfolio turnover – Buy and hold strategy versus frequent investment changesKind of investments made – small versus large companies, multi baggers (investments which yield high gains) versus percentage players (investing in shares which will give small gains in line with the market), high quality – low yield bonds versus low quality – high yield bondsAsset allocations – Varying percentage of cash depending on aggressive views on markets The following examples serve to illustrate a few styles of equity fund managersSome fund managers are passive value seekers and some are value creators. The former type buys undervalued assets and patiently waits for the market to discover the value. The latter aggressively promote the undervalued stocks that they have bought. Some fund managers restrict themselves to liquid stocks while some thrive on illiquid stocks which offer themselves easily to large price changes.Some fund managers are masters of the momentum game and seek to buy stocks that are in market fancy. They attach lesser importance to fundamentals and believe that a rising stock price and favorable momentum indicators imply that fundamentals are changing. In effect, they are following the philosophy, " The trend is my friend". Other fund managers go more by deep fundamental analysis completely ignoring price movements. They do not mind price going down and are in fact happy to buy more.Some fund managers are growth investors ie they buy stocks with a high P/E using the forecasted growth to justify the high valuation. Others are value investors who buy shares with low P/E or P/BV multiples - typically companies rich with undervalued assets. When you buy a mutual fund unit what exactly do you buy?When you buy a mutual fund unit you are buying a part of the equity or debt portfolio owned by the mutual fund. In other words you are buying a part ownership of various companies and when you buy a debt mutual fund you are buying a part right to title to debt securities. In other words you step into the shoes of owners or lenders indirectly. The value of your part of the assets will fluctuate in line with the value of the individual components of the portfolio on the stock or the bond market.In effect, you are buying a bundle of services as follows:Investment management – which means investment advice and execution rolled into oneDiversification of investment risk – buying a larger basket of securities reduces the overall risk of investment


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Asset custody – which means registration and physical custody of assets, ensuring corporate actions like payment of dividend and interest, bonus, rights entitlements etcPortfolio information – which means calculating and disseminating ownership information like NAV, assets owned, etc on a periodic basisLiquidity – Ability to speedily disinvest assets and obtain disinvestment proceeds The mutual fund exploits economies of scale in research, execution and transaction processing to provide the first three services at low costs. The pooling of money makes it possible to offer the fourth service (since all investors are unlikely to exit at the same time). In addition, one also gets benefits like special tax concessions.What you do not get is a guaranteed way of making money. There is no way that a mutual fund can insulate the investor from the vagaries of the market place and ensure that he always makes money. In addition, one is implicitly taking the risk of bad service quality in any of the four elements above including investment management.What are load and no-load funds? Why are loads charged?Some asset management companies (AMCs) levy service charges for allowing subscribers entry into/exit from mutual fund schemes. The service charge is termed as entry/exit load and such schemes are called "load" schemes. In contrast, funds for which no entry/exit charge is levied are called no-load funds.The load is levied to cover the up-front cost incurred by the AMC in the process of marketing and selling the fund and other one-time transaction processing costs.Why is the buy and sell price different for some mutual fund units and same for others?Buying and selling prices are different for those mutual funds which have up front sales charges or entry loads. Usually, the selling price is the NAV while the buying price incorporates the service charge or the load. In case the fund is a no-load fund, there is no difference between the buying and selling prices. We have a detailed section on the characteristics of all mutual fund schemes, which tells you the exact load charged by respective funds. Where can one obtain information on the market price of specific mutual fund units?Buying and selling prices for units of open-ended mutual funds are declared every day. You can obtain this information on our website. Check out the section on mutual funds.Most closed-ended mutual funds are listed on the stock exchanges. The trading volume in some of the widely held mutual fund units is considerable. The latest NAV and market price information of closed-ended mutual funds is available on our website. All the above information is also available on the stock market page of popular newspapers. Why do returns from debt/income mutual funds fluctuate from period to period despite them being invested in fixed interest instruments?The returns differ from year to year on account of the following reasons:An income fund invests in instruments from which it earns two kinds of returns – The first comes from interest income. The second comes from any increase in the market price of invested instruments. The second component could also be negative when there is a fall in the market value of the invested instruments. The rise and fall in market prices of debt instruments is a function of the prevailing interest rates. Thus changes in interest rate environment cause fluctuations in returns.


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Secondly, income mutual funds invest in an array of instruments with different maturity. Whenever any debt instrument in which the fund has invested is redeemed, the redemption proceeds have to be reinvested in a fresh instrument(s). This fresh investment would earn a rate of return depending on the prevailing interest rate which could be higher or lower than that prevailing in the earlier period. Accordingly, the overall return of the portfolio will change.A third reason can be active view taking by the fund manager eg a fund manager can take a view that interest rates are expected to rise. Accordingly, he would disinvest a large part of his holdings and convert them into cash so as to avoid loss in the value of his holdings. If this view is wrong, he may end up having a low return on a large part of his portfolio, since cash is invested in low yielding money market avenues. On the other hand, if the view is right, the cash can be deployed in higher yielding instruments after interest rates rise, thus improving the overall return and more important avoiding the loss.There is a fourth reason, which is relevant only for open-ended income funds. Such funds have a fluctuating level of idle cash (depending on the level of fresh collections) which is typically invested in low yielding money market instruments. This causes change in the rate of return.Lastly, there is always the possibility of a credit loss for any income mutual fund ie losses arising out of default in any of the instruments in which the fund has invested. The fund will declare a low return in the period in which such losses show up.What are the risks associated in investing in income mutual funds and how should one find out about these?Income funds invest in a diversified portfolio of debt instruments which provide interest income. There is a possibility that some of these instruments are of low credit quality and the issuers of these instruments default in the payment of interest or principal. Such losses, called "credit losses", constitute an area of risk for income funds. The process of diversification mitigates this risk ie by the fund investing in a number of debt instruments. However, it should be noted that the funds returns could be eroded considerably if even 10% of the investments have credit quality problems. Also, the problem can be accentuated for investors who are investing for a short period if the losses show up in a particular period resulting in a short term decline in NAV. Investors can check the credit quality of the investment portfolio, which is published by most funds on a quarterly basis.The second area of risks comes from the fluctuations in the prices of the underlying instruments in which the fund invests. Any rise in interest rates will result in a fall in the value of the investments causing a dip in the NAV. The fall in value is maximum for longer dated instruments and negligible for short dated instruments. Hence, the risk is higher in a fund that has an investment portfolio with a higher average maturity. This can again be checked from the investment portfolio, which is published by the funds.Even if interest rates rise by 2-3%, the fall in NAV for most mutual funds is unlikely to exceed 5%. Similarly, a portfolio with as high as 10% of poor quality instruments will result in a fall in NAV by 10%. Regular interest income will take care of the losses in a few months. Thus, there is unlikely to be permanent erosion of capital in most reasonable circumstances. Hence, debt or income funds have a much lower risk than equity funds, which can have permanent erosion in value.


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Today’s environment is characterized by a deep industrial recession and consequent high level of defaults on loans provided by banking sector to industry. In such a scenario, it may be prudent to look at the credit quality aspect very carefully before investing in an income mutual fund. What are the tax benefits available for investing in mutual funds?The tax benefits for investing in mutual funds are as follows:Twenty percent of the amount invested in specified mutual funds (called equity linked savings schemes or ELSS and loosely referred to as "tax savings schemes") is deductible from the tax payable by the investor in a particular year subject to a maximum of Rs2000 per investor. This benefit is available under section 88 of the I.T. Act.Investment of the entire proceeds obtained from the sale of capital assets for a period of three years or investment of only the profits for a period of 7 years, exempts the asset holder from paying capital gains tax. This benefit is available under section 54EA and 54EB of the I.T. Act.The mutual fund is completely exempt from paying taxes on dividends/interest/capital gains earned by it. While this is a benefit to the fund, it is the indirect benefit of unitholders as well. This benefit is available to the mutual fund under section 10 (23D) of the I.T. Act. A mutual fund has to pay a withholding tax of 10% on the dividends distributed by it under the revised provisions of the I.T. Act putting them on par with corporates. However, if a mutual fund has invested more than 50% of its assets into equity shares, then it is exempt from paying any tax on the dividend distributed by it, for a period of three years, by an overriding provision. This benefit is available under section 115R of the I.T. Act.The investor in a mutual fund is exempt from paying any tax on the dividend received by him from the mutual fund, irrespective of the type of the mutual fund. This benefit is available under section 10(33) of the I.T. Act.The units of mutual funds are treated as capital assets and the investor has to pay capital gains tax on the sale proceeds of mutual fund units sold by him. For investments held for less than one year the tax is equal to 30% of the capital gain. For investments held for more than one year, the tax is equal to 10% of the capital gains. The investor is entitled to indexation benefit while computing capital gains tax. Thus if a typical growth scheme of an income fund shows a rise of 12% in the NAV after one year and the investor sells it, he will pay a 10% tax on the selling price less cost price and indexation component. This reduces the incidence of tax considerably. This concession is available under section 48 of the I.T. Act. The following calculations show this in more detail:Purchase NAV = Rs 10Sale NAV = Rs 11.2Indexation component = 8%Capital gains = 11.2 – 10(1.08)= 11.2 – 10.8= 0.4Capital gains tax = 0.4*0.1 = 0.04.If an investor buys a fresh unit in the closing days of March and sells it in the first week of April of the following year, he is entitled to indexation benefit for two financial years which close in the two March


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ending periods. This is termed as double indexation and lowers the tax even further especially for income funds. In the above example, the calculation would be as follows:Capital gains = 11.2 – 10(1.08)(1.08) = 11.2 – 11.7= -0.5Thus there would be no capital gains tax.

GLOSSARY

AdvisorThe organization employed by a mutual fund to give professional advice on the fund's investments and to supervise the management of its assets.Asked or Offering PriceThe price at which a mutual fund's shares can be purchased. The asked or offering price means the current net asset value (NAV) per share plus sales charge, if any. For a no-load fund, the asked price is the same as the NAV.Asset Allocation FundA fund that spreads its portfolio among a wide variety of investments, including domestic and foreign stocks and bonds, government securities, gold bullion and real estate stocks. This gives small investors far more diversification than they could get allocating money on their own. Some of these funds keep the proportions allocated between different sectors relatively constant, while others alter the mix as market conditions change.Automatic ReinvestmentA service offered by most mutual funds whereby income dividends and capital gain distributions are automatically invested into the fund by buying additional shares and thus building up holdings through the effects of compounding.Balanced FundA mutual fund that maintains a balanced portfolio, generally 60% bonds or preferred stocks and 40% common stocks.Bid or Sell PriceThe price at which a mutual fund's shares are redeemed (bought back) by the fund. The bid or redemption price means the current net asset value per share, less any redemption fee or back-end load.Bond FundA mutual fund whose portfolio consists primarily of corporate, municipal or U.S. Government bonds. These funds generally emphasize income rather than growth.Bond RatingSystem of evaluating the probability of whether a bond issuer will default. Standard and Poor's Corp. and Moody's Investors Services, among other firms, analyze the financial stability of both corporate and government bond issuers. Ratings range from AAA or Aaa (extremely unlikely to default) to D (currently


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in default). Bonds rated BBB or below by S&P or Baa or below by Moody's are not considered to be of investment grade. Mutual funds generally restrict their bond purchases to issues of certain quality ratings, which are specified in their prospectuses. Capital Appreciation FundA mutual fund that seeks maximum capital appreciation through the use of investment techniques involving greater than ordinary risk, such as borrowing money in order to provide leverage, short-selling and high portfolio turnover.Capital Gains DistributionsPayments (usually annually) to mutual fund shareholders of gains realized on the sale of portfolio securities.Capital GrowthA rise in market value of a mutual fund's securities, reflected in its net asset value per share. This is a specific long-term objective of many mutual funds.Certificate of DepositInterest-bearing, short-term debt instrument issued by banks and thrifts.Closed-End Investment CompanyAn investment company that offers a limited number of shares. They are traded in the securities markets, usually through brokers. Price is determined by supply and demand. Unlike open-end investment companies (mutual funds), closed-end funds do not redeem their shares.

Commercial PaperShort-term, unsecured promissory notes with maturities no longer than 270 days. They are issued by corporations, in denominations starting at $10,000, to fund short-term credit needs.

Common Stock FundAn open-end investment company whose holdings consist mainly of common stocks and usually emphasize growth.Confirm DateThe date the fund processed your transaction, typically the same day or the day after your trade date.Contingent Deferred Sales Charge (CDSC)A fee (or back-end load) imposed by certain funds on shares redeemed within a specific period following their purchase. These charges are usually assessed on a sliding scale, such as four percent to one percent of the amounts redeemed, with the fee reduced each year the units are held.CustodianThe bank or trust company that maintains a mutual fund's assets, including its portfolio of securities or some record of them. Provides safekeeping of securities but has no role in portfolio management.

Daily Dividend FundThis term applies to funds that declare their income dividends on a daily basis and reinvest or distribute monthly.


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Deferred Compensation PlanA tax-sheltered investment plan to which employees of state and local governments can defer a percentage of their salary.DistributorAn individual or a corporation serving as principal underwriter of a mutual fund's shares, buying shares directly from the fund, and reselling them to other investors.DiversificationThe policy of spreading investments among a range of different securities to reduce the risks inherent in investing.Rupee-Cost AveragingThe technique of investing a fixed sum at regular intervals regardless of stock market movements. This reduces average share costs to the investor, who acquires more shares in periods of lower securities prices and fewer shares in periods of high prices. In this way, investing risk is spread over time.

Exchange Privilege (Or switching privilege)

The right to transfer investments from one fund into another, generally within the same fund group, at nominal cost.Ex-Dividend DateThe date on which a fund's Net Asset Value (NAV) will fall by an amount equal to the dividend and/or capital gains distribution (although market movements may alter the fund's closing NAV somewhat). Most publications which list closing NAVs place an "X" after a fund’ name on its ex-dividend date.Expense Ratio

The ratio of total expenses to net assets of the fund. Expenses include management fees, 12(b)1 charges, if any, the cost of shareholder mailings and other administrative expenses. The ratio is listed in a fund's prospectus. Expense ratios may be a function of a fund's size rather than of its success in controlling expenses.

Fannie Mae (Federal Mortgage Association)An agency established by the federal government, but owned by private stockholders, which issues mortgage-backed certificates in $25,000 denominations. Timely payment of both interest and principal are insured. A growing number of mutual funds emphasize investments in these and other mortgage-backed securities.Fiscal YearAn accounting period consisting of 12 consecutive months.

Global FundA fund that invests in both Indian. and foreign securities.Growth Fund


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A mutual fund whose primary investment objective is long-term growth of capital. It invests principally in common stocks with significant growth potential.

Income Dividend Payment of interest and dividends earned on the fund's portfolio securities after operating expenses are deducted.Income FundA mutual fund that primarily seeks current income rather than growth of capital. It will tend to invest in stocks and bonds that normally pay high dividends and interest.Index FundA mutual fund that seeks to mirror general stock-market performance by matching its portfolio to a broad-based index, most often the Standard & Poor's 500-stock index.International FundA fund that invests in securities traded in markets outside India.Investment CompanyA corporation, partnership or trust that invests the pooled monies of many investors. It provides greater professional management and diversification of investments than most investors can obtain independently. Mutual funds, or "open-end" investment companies, are the most popular form of investment company. Investment ObjectiveThe financial goal (long-term growth, current income, etc.) that an investor or a mutual fund pursues.

Junk Bond A speculative bond rated BB or below by Standard & Poor's Corp. and Ba or below by Moody's Investor Service."Junk bonds" are generally issued by corporations of questionable financial strength or without proven track records. They tend to be more volatile and higher yielding than bonds with superior quality ratings. "Junk bond funds" emphasize diversified investments in these low-rated, high-yielding debt issues.

LoadA sales charge or commission assessed by certain mutual funds ("load funds,") to cover their selling costs. The commission is generally stated as a portion of the fund's offering price, usually on a sliding scale from one to 8.5%.Load FundA mutual fund that levies a sales charge up to 8.5%, which is included in the offering price of its shares, and is sold by a broker or salesman. A front-end load is the fee charged when buying into a fund; a back-end load is the fee charged when getting out of a fund.

Low-Load Fund


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A mutual fund that charges a small sales commission, usually 3.5% or less, for the purchase of its shares.

Management FeeThe amount a mutual fund pays to its investment adviser for services rendered, including management of the fund's portfolio. In general, this fee ranges from .5% to 1% of the fund's asset value.

Money Market FundA mutual fund that aims to pay money market interest rates. This is accomplished by investing in safe, highly liquid securities, including bank certificates of deposit, commercial paper, government securities and repurchase agreements. Money Market funds make these high interest securities available to the average investor seeking immediate income and high investment safety.Mortgage-Backed SecuritiesCertificates backed by pooled mortgages (e.g., Freddie Mac or Ginnie Mae). Issuing agencies buy mortgages from lending institutions and repackage them as securities that they sell to investors. They are generally issued in denominations of $25,000 or above. Yields, which stem from interest and principal on underlying mortgages, are generally higher than those of Treasury bonds that provide comparable liquidity and safety. A growing number of income mutual funds concentrate their holdings in these securities.Municipal Bond FundA mutual fund that invests in a broad range of short, intermediate or long-term tax-exempt bonds issued by states, cities and other local governments. The interest obtained from these bonds is passed through to shareholders free of tax. The objective of these funds is current tax-free income.Mutual FundAn open-end investment company that buys back or redeems its shares at current net asset value. Most mutual funds continuously offer new shares to investors.

Net Asset Value Per ShareThe current market worth of a mutual fund share. Calculated daily by taking the funds total assets securities, cash and any accrued earnings deducting liabilities, and dividing the remainder by the number of shares outstanding.No-Load FundA commission-free mutual fund that sells its shares at net asset value, either directly to the public or through an affiliated distributor, without the addition of a sales charge.

Option Income FundA fund that invests primarily in dividend-paying common stocks on which call options are traded on national securities exchanges. These funds seek high current return consisting of dividends, premiums from selling options, net short-term gains (including those from the exercising of options) and any profits from closing purchase transactions.


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Payable DateThe date on which distributions are paid to shareholders who do not want to reinvest them. This date can be anywhere from one week to one month after the Record Date.Payroll Deduction PlanAn arrangement between an employer and a mutual fund, authorized by the employee, through which a specified sum is deducted from an employee's salary to buy shares in the fund.

Portfolio Turnover RateThe rate at which the fund's portfolio securities are changed each year. If a fund's assets total $100 million and the fund bought and sold $100 million worth of securities that year, its portfolio turnover rate would be 100%. Aggressively managed funds generally have higher portfolio turnover rates than do conservative funds that invest for the long term. High portfolio turnover rates generally add to the expenses of a fund.ProspectusAn official document that each investment company must publish, describing the mutual fund and offering its shares for sale. It contains information required by the Securities and Exchange Commission.

Record DateThe date the fund determines who its shareholders are; "shareholders of record" who will receive the fund's income dividend and/or net capital gains distribution. Frequently the business day immediately prior to the Ex-Dividend Date.Redemption FeeA fee charged by a limited number of funds for redeeming, or buying back, fund shares.

Redemption PriceThe price at which a mutual fund's shares are redeemed (bought back) by the less expensive fund. The redemption price is usually equal to the current net asset value per share.

Regional FundA mutual fund that concentrates its investments within a specific geographic area, usually the fund's local region. The objective is to take advantage of regional growth potential before the national investment community does.Reinvestment Date (Payable Date)The date on which a share's dividend and/or capital gains will be reinvested (if requested) in additional fund shares.Reinvestment PrivilegeA service that most mutual funds offer whereby a shareholder's income dividends and capital gains distributions are automatically reinvested in additional shares.

Sector Fund


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A fund that operates several specialized industry sector portfolios under one umbrella. Transfers between the various portfolios can usually be executed by telephone at little or no cost.Series FundA mutual fund whose prospectus allows for more than one portfolio. Portfolios may be specialized (Sector Fund) or broad (growth stock, along with a money market portfolio). Management can create additional portfolios as it sees fit.Short SellingThe sale of a security which is not owned by the seller. The "short seller" borrows stock for delivery to the buyer, and must eventually purchase the security for return to the lender.

Short-Term Municipal Bond FundA fund that invests in municipal bonds with maturities not exceeding two years. See Municipal Bond Fund. Simplified Employee PensionAn alternative to a Keogh plan that allows employers who have not established qualified retirement plans to contribute to their employee’s Individual Retirement Accounts.

Specialty FundA mutual fund specializing in the securities of a particular industry or group of industries or special types of securities.Systematic Withdrawal PlansMany mutual funds offer withdrawal programs whereby shareholders receive payments from their investments. These payments are usually drawn from the fund’s dividend income and capital gain distributions, if any, and from principal only when necessary. UnderwriterThe organization that acts as the distributor of a mutual fund's shares to broker/dealers and the public.

A type of insurance contract that guarantees future payments to the holder, or annuitant, usually at retirement. The annuity's value varies with that of the underlying portfolio securities, which may include mutual fund shares. All monies held in the annuity accumulate tax-deferred.

Voluntary Plan

A flexible plan for capital accumulation, involving no specified time frame or total sum to be invested.

YieldIncome or return received from an investment, usually expressed as a percentage of market price, over a designated period. For a mutual fund, yield is interest or dividend before any gain or loss in the price per share.


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Zero Coupon BondBond sold at a fraction of its face value. It appreciates gradually, but no periodic interest payments are made. Earnings accumulate until maturity, when the bond is redeemable at full face value. Nonetheless, interest is taxable as it accrues. As a result, zero coupon bonds are often used for IRAs, Keoghs and other

tax-deferred retirement plans.

LIST OF BOOKS

Investment Policy and Performance of Mutual Funds

M.Jayadev

Mutual Funds Management and Working

Lalitb K. Bansal

Mutual Funds a Comprehensive Approach

Dr. Peeush Rajan Agrawal

Working at Mutual Fund Organization in India

P. Mohana Rao

How Mutual Funds Work

A. J. Friedman & Russ Wiles

The Future of Fund Management in India

Tushar Waghmare

Mutual Funds in India

S. Krishnamurti

beginner's guide - mutual funds-india infoline

Documents

openended funds

interval funds

growth funds

income funds

balanced funds

noload funds

basics of mutual funds

types of mutual funds