financial services mutual funds (1)

8/12/2019 Financial Services Mutual Funds (1)

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INTRODUCTION

Mutual funds have become a hot favorite of millions of people all over the world.

The driving force of mutual funds is the safety of the principal guaranteed plus the

added advantage of capital appreciation together with the income earned in the

form of interest or dividend. People prefer mutual funds to bank deposits, the

insurance and even bonds because with a little money, they can get into the

investment game. One can own a string of blue chips like ITC, TISCO, Reliance

etc., through mutual funds. Thus, mutual funds act as a gateway to enter into big

companies hitherto inaccessible to an ordinary investor with his small investment.

Mutual Funds refer to a fund, managed by an investment company with the

financial objective of generating high Rate of Returns. These asset

management or investment management companies collects money from the

investors and invests those money in different Stocks, Bonds and other

financial securities in a diversified manner. Before investing they carry out

thorough research and detailed analysis on the market conditions and market

trends of stock and bond prices. These things help the fund managers to

speculate properly in the right direction.


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WHAT IS MUTUAL FUND

To in simple words, a mutual fund collects the saving from small investors, invest

them in government and other corporate securities and earn income through

interest and dividends, besides capital gains, Its works on the principle of small

drop of water makes a big ocean. For instance, if one has Rs1000 to invest, it may

not fetch very much on its own. But, when it is pooled with Rs.1000 each from a

lot of other people, then, one could create a big fund large enough to invest in a

wide varieties of share and debentures on a commanding scales thus, to enjoy the

economics of large scale on operations. Hence a mutual fund is nothing but a form

of collective investment. It is formed by the coming together of a number of

investors who transfer their surplus fund to professionally qualified organization to

manage it. Each fund is divided into a small fraction called unites of equal value.

Each investor is allocated unites in portions to the size of his investment. Thus,

every investor, whether big or small, will have stake in fund. Hence, mutual funds

enable millions of small and large investors who emerge to participate in and

derive the benefit of the capital market growth. It has emerged as a popular vehicle

of creation of wealth due to high return, lower cost and diversified risk.


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DEFINITION

According to Weston J. Ferd and Brigham, Eugene, F., Unit trusts are

Corporationswhich accept dollars from savers and then use these dollars to buy

stocks, long term bonds, and short term debt instruments issued by business or

governments units, these corporationspool funds and thus reduce risk by

diversification. Thus mutual funds are corporations which pool funds by selling

their own shares and reduce risk by diversification.


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HISTORY

The first mutual funds were established in Europe. One researcher credits a Dutch

merchant with creating the first mutual fund in 1774. The first mutual fund outside

the Netherlands was the Foreign & Colonial Government Trust, which was

established in London in 1868. It is now theForeign & Colonial Investment

Trust and trades on the London stock exchange.

Mutual funds were introduced into the United States in the 1890s. They became

popular during the 1920s. These early funds were generally of the closed-end type

with a fixed number of shares which often traded at prices above the value of the

portfolio.

The first open-end mutual fund with redeemable shares was established on March

21, 1924. This fund, the Massachusetts Investors Trust, is now part of the MFS

family of funds.However, closed-end funds remained more popular than open-end

funds throughout the 1920s. By 1929, open-end funds accounted for only 5% of

the industry's $27 billion in total assets.

After thestock market crash of 1929,Congresspassed a series of acts regulating

securities markets in general and mutual funds in particular. The Securities Act of

1933 requires that all investments sold to the public, including mutual funds, be

registered with the Securities and Exchange Commission and that they provide
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fast-growing retirement plans, specifically in401(k) and otherdefined contribution

plans and inindividual retirement accounts (IRAs), all of which surged in

popularity in the 1980s. Total mutual fund assets fell in 2008 as a result of

thecredit crisis of 2008.

In 2003, the mutual fund industry was involved in ascandal involving unequal

treatment of fund shareholders. Some fund management companies allowed

favored investors to engage inlate trading, which is illegal, ormarket timing,

which is a practice prohibited by fund policy. The scandal was initially discovered

by then-New York State Attorney GeneralEliot Spitzer and resulted in

significantly increased regulation of the industry.

At the end of 2011, there were over 14,000 mutual funds in the United States with

combined assets of $13 trillion, according to theInvestment Company

Institute (ICI), a trade association of investment companies in the United States.

The ICI reports that worldwide mutual fund assets were $23.8 trillion on the same

date. Mutual funds play an important role in U.S. household finances and

retirement planning. At the end of 2011, funds accounted for 23% of household

financial assets. Their role in retirement planning is particularly significant.

Roughly half of assets in 401(k) plans and individual retirement accounts were

invested in mutual funds.
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SCOPE OF MUTUAL FUND

As stated earlier, a mutual fund is nothing but a pool of the investor funds. The

special feature of a mutual fund is that the contributors and the beneficiaries of the

fund are one and the same class of people i.e. investors. Nobody else can claim that

fund. Since the investors themselves contribute to the pool of fund and enjoy it and

its fruits, the term mutualhas been employed.

The important features of mutual funds are the following:

(1) A mutual fund belongs to those who have contributed to that fund and thus, the

ownership of the fund lies in the hands of the investor.

(2) Since all investors cannot take part in the management of the fund, it is left in

the hands of investment professionals who earn a fee for their services.

(3) The pool of funds collected is invested in a portfolio of marketable securities.

(4) The investors share in the fund is represented by units just like shares in the

case of share capital of a company. The unit value depends upon the value of the

portfolio held by the fund. Hence, the value changes almost every day and it is

called Net Asset Value.


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STRUCTURE

In the US, a mutual fund is registered with theSecurities and Exchange

Commission (SEC) and is overseen by a board of directors (if organized as a

corporation) orboard of trustees (if organized as a trust). The board is charged with

ensuring that the fund is managed in the best interests of the fund's investors and

with hiring the fund manager and other service providers to the fund.

Thefund manager, also known as the fund sponsor or fund management

company,trades (buys and sells) the fund's investments in accordance with the

fund's investment objective. A fund manager must be aregistered investment

advisor.Funds that are managed by the same fund manager and that have the same

brand name are known as a "fund family" or "fund complex".

Mutual funds are not taxed on their income and profits as long as they comply with

requirements established in the U.S. Internal Revenue Code. Specifically, they

must diversify their investments, limit ownership of voting securities, distribute a

high percentage of their income and capital gains (net of capital losses) to their

investors annually, and earn most of the income by investing in securities and

currencies.
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Mutual funds pass taxable income on to their investors by paying out dividends

and capital gains at least annually. The characterization of that income is

unchanged as it passes through to the shareholders. For example, mutual fund

distributions of dividend income are reported as dividend income by the investor.

There is an exception: net losses incurred by a mutual fund are not distributed or

passed through to fund investors but are retained by the fund to be able to offset

future gains.Mutual funds may invest in many kinds ofsecurities. The types of

securities that a particular fund may invest in are set forth in the fund's prospectus,

which describes the fund's investment objective, investment approach and

permitted investments. The investment objective describes the type of income that

the fund seeks. For example, a "capital appreciation" fund generally looks to earn

most of its returns from increases in the prices of the securities it holds, rather than

from dividend or interest income. The investment approach describes the criteria

that the fund manager uses to select investments for the fund.

A mutual fund's investmentportfolio is continually monitored by the

fund'sportfolio manager or managers.Hedge funds are not considered a type of

(unregistered) mutual fund. While they are another type of collective investment

vehicle, they are not governed by the Investment Company Act of 1940 and are not

required to register with the Securities and Exchange Commission (though many

hedge fund managers must register as investment advisers)
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INVESTMENT

Mutual Funds Investment has become a subject of great importance in the

present context, especially when all the investors are keen to diversify their

investment to maintain a balance between Investment Return and Investment

Risk. For gaining the Diversified Investment Solution and the liquidity

advantage, any person needs to invest in Mutual Funds. But, before investing

their hard earned money one needs to carry out sincere research on the

performance of those mutual funds, he is considering to invest in.


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The things that one needs to consider before deciding on any particular mutual

fund are the following:

Performance of the Fund and the Rate of Returns Investment Psychology of the Mutual FundRisk AdjustmentFund Management


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be significantly different from net asset value. It may be at a "premium" to net

asset value (meaning that it is higher than net asset value) or, more commonly, at a

"discount" to net asset value (meaning that it is lower than net asset value). A

professional investment manager oversees the portfolio, buying and selling

securities as appropriate.

At the end of 2011, there were 634 closed-end funds in the United States with

combined assets of $239 billion.

INCOME FUNDSAs the name suggest,these funds aims at generating and distributing regular

income to the members on a periodical basis. It concentrates more on the

distributing regular income and it also sees that the average return is higher than

that of the income from bank deposits.

The investors are assured of regular income at periodic intervals,say half-yearly or

yearly or so on.

The main objective of this type of fund is to declare regular dividends and not

capital appreciation.


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SPECIALISED FUNDSBesides the above, a larger number of specialized funds are in existence in abroad.

They offer special schemes so as to meet the specific needs of specific catagories

of people like pensioners, widows etc. There are also fund for investment in

securities of specified areas. For instance, Japan Fund, South Korea Fund, and etc.

In fact these funds open door for foreign investors to invest on domestic securities

of these countries.

Again some certain Funds may be confined to one particular sector or industry like

fertilizer, automobiles, petroleum, etc. These Funds carry heavy risk since the

entire investment is in one industry. But, there are high risk taking investors who

preferthis type of Fund. Of course, in such cases the reward may commensurate

with the risk taken. At times, it may be erratic. The best example of this type is the

petroleum industry funds in the USA.


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RISKS IN MUTUAL FUNDS

Mutual funds are not free from risks. It is so because basically the mutual funds

also invest their funds in the stock market on shares which are volatile in nature

and are not free from risk. Hence, the following are risk inherent in their dealings:

(i) Market RisksIn general, there are certain risks associated with every kind of investment in

shares. They are called market risks. These market risks can be reduced, but not

eliminated even by a good investment management. The prices of shares are

subject to wide price fluctuations depending upon market condition over which

nobody has control.

(ii) Scheme RisksThere are certain risks inherent in the scheme itself. It all depends upon the nature

of the scheme. For instance, in a pure growth funds scheme, risks are greater

because if one expects more returns as in the case of growth scheme, one has to

take more risks.

(iii) InvestmentRisksWhether the Mutual Funds makes money in shares or loses depends upon the

investment expertise of the ASSET MANAGEMENT COMPANY (AMC). If the


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RISKS VS RETURN


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SEMI GUIDELINES ON MUTUAL FUND

The SEBI has laid down the following conditions for the use of Mutual funds:

(i) Mutual funds should use only those mutual funds that reflect the assetallocation of the fund.

(ii) The period of comparison of returns should be identical for the fund and themutual fund.

(iii) If the schemes offer document indicial a benchmark for returncomparisons,the same should be the scheme.

(iv) Growth funds with more than 60% in equity should always use any of thestandard indices like Sensex, NSE Nifty, BSE 100 and Crisil 500. These indices

should be used consistently throughout. Changes can happen only when asset

allocation of the fund has changed significant, and trustees approve the change.

(v) Income funds with more than 60% in the debt should use a bond marketindex on bench mark.

(vi) Balanced Funds can make use of tailor benchmarks that combine equity andbond index returns in the same proportion as in the asset allocation of the fund.

(vii) Money market funds can made use of a money market funds(viii)Can made use of a money market instrument or the combination of suchinstruments as benchmarks.


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CONTROVERSY

Critics of the fund industry argue that fund expenses are too high. They believe

that the market for mutual funds is not competitive and that there are many hidden

fees, so that it is difficult for investors to reduce the fees that they pay. They argue

that the most effective way for investors to raise the returns they earn from mutual

funds is to invest in funds with low expense ratios.

Fund managers counter that fees are determined by a highly competitive market

and, therefore, reflect the value that investors attribute to the service provided. In

+addition, they note that fees are clearly disclosed.


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Rendering Expertise Investment Service At a Low CostThe management of the fund is generally assigned to professionals who are well

trained and have adequate experience in the field of investment. The investment

decisions of these professionals are always backed by informed judgement and

experience.

Providing Better Service

A mutual fund is able to command vast resources and hence it is possible for it to

have an in depth study and carry out research on corporate securities. Each fund

maintains a large research team which constantly analyses the companies and the

industries and recommends the funds to buy or sell a particular share. Thus,

investments are made purely on the basis of a research.

Offering Tax BenefitsCertain funds offer tax benefits to its customer. Thus, apart from dividends, interest

and capital appreciation, investors also stand to get the benefit of tax concession.

Introducing Flexible Investment ScheduleSome mutual funds have permitted the investors to exchange their units from one

scheme to another & this flexibility is a great boon to investors. Income Units can


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be exchanged for growth units depending upon the performance of the funds. One

cannot derive such flexibility in any other investments.

Providing Greater Affordability and LiquidityEven very small investors can afford to invest in mutual funds. They provide an

attractive and cost effective alternative to direct purchase of shares. Units can be

sold to the fund at any time at the NAV and thus quick access to liquid cash is

assured.

Supporting Capital MarketMutual Funds play a vital role in supporting the development of capital markets.

The Mutual funds make the capital market active by means of providing a

sustainable domestic source of demand for capital market instrument. In other

words the savings of the people are directed towards investment in capital markets

through these mutual funds. Thus, funds serve as a conduit for dis-intermediating

bank deposits into stocks, shares and bonds. Mutual funds also provide a valuable

liquidity to the capital market, and thus, the capital is made very active and stable.


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Promoting Industrial DevelopmentThe economic development of any country or nation depends upon its industrial

advancement and agricultural development. All industrial development units have

to raise their funds by resorting to the capital market by the issue of shares and

debentures. The mutual funds not only create a demand for these capital market

instruments but also supply a large source of funds to the market, and thus, the

industries are assured for capital requirement.

Reducing Market Cost Of New IssuesThe mutual fund helps to reduce the marketing cost of the new issues. The

promoters used to allot a major share of the initial public offering to the mutual

funds and thus they are saved from the marketing cost of such issue.


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THE ADVANTAGES OF INVESTING IN A MUTUAL FUND

The advantages of investing in a Mutual Fund are:

1. Professional ManagementThe investor avails of the services of experienced and skilled professionals who are

backed by a dedicated investment research team which analyses the performance

and prospects of companies and selects suitable investments to achieve the

objectives of the scheme.

2.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.

3. Convenient AdministrationInvesting in a Mutual Fund reduces paperwork and helps you avoid many

problems such as bad deliveries, delayed payments and unnecessary follow up with


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brokers and companies. Mutual Funds save your time and make investing easy and

convenient.

4. 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.

5. 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.

6. LiquidityIn open-ended schemes, you can get your money back promptly at net asset value

related prices from the Mutual Fund itself. With close-ended schemes, you can sell

your units on a stock exchange at the prevailing market price or avail of the facility

of direct repurchase at NAV related prices which some close-ended and interval

schemes offer you periodically.


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7. 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.

8. FlexibilityThrough 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.

9. Choice of SchemesMutual Funds offer a family of schemes to suit your varying needs over a lifetime.

10.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.


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DISADVANTAGES /LIMITATIONS OF MUTUAL FUNDS

The main limitations or disadvantages of mutual funds are as follows:

Mutual funds are subject to market risk.No guarantee of returns.Diversification of portfolio doesn't maximize returns.Selecting right financial securities is not easy.Cost management not proportional to performance.Unethical practices may creep in.

Now let's discuss above limitations of mutual funds one by one.

1. Subject to market risk

Mutual fund investments are subject to market risk involved. This caution

(warning) can be checked with the offer document where it is clearly mentioned as

follows:

"Mutual Fund investments are subject to market risks. Please read the offer

document carefully before investing."


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2. No guarantee of returns

Mutual funds do not give any guarantee of the returns for the investments made in

its various schemes.

3. Diversification of portfolio doesn't maximize returns

Mutual fund helps to diversify the portfolio. However, though the diversification of

portfolio helps in minimization of risk, these do not results in maximization of

returns to the investors.

4. Selecting right financial securities is not easy

It's difficult task for a mutual fund manager to select appropriate and suitable

financial securities for investment to generate higher returns.

5. Cost management not proportional to performance

Mutual fund managers are one of the highest-paid executives in the finance

domain. Furthermore, the fee paid to the Asset Management Company (AMC) is

no way related to the performance of these funds.

6. Unethical practices may creep in

Mutual fund managers may follow unethical (corrupt) practices to boost the

performance of the various fund-related schemes.


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FUTURE OF MUTUAL FUNDS IN INDIA

Financial experts believe that the future of Mutual Funds in India will be very

bright. It has been estimated that by March-end of 2010, the mutual fund industry

of India will reach Rs 40,90,000 crore, taking into account the total assets of the

Indian commercial banks. The estimation was based on the December 2004 asset

value of Rs 1, 50,537 crore. In the coming 10 years the annual composite growth

rate is expected to go up by 13.4%. Since the last 5 years, the growth rate was

recorded as 9% annually. Based on the current rate of growth, it can be forecasted

that the mutual fund assets will be double by 2010.

Indian Mutual Funds Future - Growth Facts

In the past 6 years, Mutual Funds in India have recorded a growth of 100 %. In India, the rate of saving is 23 %. In the future, there lies a big scope for the Indian Mutual Funds industry to

expand.

Several asset management companies which are foreign based are now

entering the Indian markets.

A number of commodity Mutual Funds will be introduced in the future. TheSEBI (Securities Exchange Board of India) has granted the permission for

the same.


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The SEBI is lending its full support for the promotion of the mutual fundsindustry directly or indirectly.

More emphasis is put on the effective Mutual Funds governance. Mutual funds provide wide range of products so as to meet the diverse needs

of the investing public. The investors have a good choice to meet their

different expectations like security, growth and liquidity.

There is also enough scope for the Indian Mutual funds to enter into the

semi-urban and rural areas.

Financial planners will play a major role in the Mutual Funds market byproviding people with proper financial planning.

A three year dividend tax exemption from UTI and equity dominated Openended Mutual Funds.

A full Income tax exemption for all income from the UTI and mutual fundsin the hands of the investors.


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CONCLUSION

Amutual fundbrings together a group of people and invests their money instocks, bonds, and other securities.

The advantages of mutual are professionalmanagement,diversification,economies of scale,simplicity and liquidity.

The disadvantages of mutual fund are high costs, over-diversification,possible tax consequences, and the inability of management to guarantee a

superior return.

There are many, many types of mutual funds. You can classify funds basedon asset class, investing strategy, region, etc.

Mutual funds have lots of costs.

Costs can be broken down into ongoing fees (represented by theexpense

ratio) and transaction fees (loads).

The biggest problems with mutual funds are their costs and fees. Mutual funds are easy to buy and sell. You can either buy them directly from

the fund company or through a third party.

Mutual fund ads can be very deceiving.
http://www.investopedia.com/terms/m/mutualfund.asphttp://www.investopedia.com/terms/d/diversification.asphttp://www.investopedia.com/terms/e/economiesofscale.asphttp://www.investopedia.com/terms/e/expenseratio.asphttp://www.investopedia.com/terms/e/expenseratio.asphttp://www.investopedia.com/terms/l/loadfund.asphttp://www.investopedia.com/terms/l/loadfund.asphttp://www.investopedia.com/terms/e/expenseratio.asphttp://www.investopedia.com/terms/e/expenseratio.asphttp://www.investopedia.com/terms/e/economiesofscale.asphttp://www.investopedia.com/terms/d/diversification.asphttp://www.investopedia.com/terms/m/mutualfund.asp


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ABBREVATIONS

MFS- Mutual Funds

MMMFS-Money Market Mutual FundsAMC - Asset Management CompanySEBI- Securities Exchange Board of IndiaUSAUnited States of America.IRA- Individual Retirement AccountsSEC-Securities and Exchange CommissionIPO- Initial Public Offering.
http://en.wikipedia.org/wiki/Securities_and_Exchange_Commissionhttp://en.wikipedia.org/wiki/Securities_and_Exchange_Commissionhttp://en.wikipedia.org/wiki/Securities_and_Exchange_Commission


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REFERENCES

Books Referred:

1. Book-Financial Markets and Services.Author- Gordon &Natrajan

Edition- Fifth revised Edition 2009

Publisher- Himalaya publishing house.

2. Book-Indian EconomyAuthor-Misra S.K Puri V.K

Edition- 28thEdition (October 2010)

Publisher-Himalaya publishing house.

Websites

www.google.com www.wikipedia.com www.mutualfunds.in
http://www.google.com/http://www.wikipedia.com/http://www.wikipedia.com/http://www.google.com/

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