MUTUAL FUND

Topic-7

Chapter-8 Outline What is a mutual fund Benefits of investing in MF Structure of MF History of MF Terminology associated with MF The Mutual Fund Family Types of Mutual Fund Schemes How to invest in a mutual fund scheme Rights of a Mutual Fund holder Precautions to be taken while investing in

mutual funds

A Mutual Fund is a trust that pools the savings of a number of investors who share a common investment objective

The Money thus collected is invested by the fund manager in different types of securities depending upon the objectives of the scheme

These could range from shares and debentures to money market instruments.

Professional Management: Diversification Convenient Management Return Potential Low Costs Liquidity Transparency Flexibility Affordability Choice of Schemes Well regulated

Professional Management: Mutual Funds provides 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 objective of the scheme.

Fund Management is a separate department where there is an expert fund manager at the top and a research team to help him take decisions regarding when and where to invest.

The actual buying and selling of the various securities-both equity and debt-is done by the dealers in the fund management department.

Diversification: Mutual Funds invest in a number of

companies across a broad cross-section of industries and sectors.

This diversification reduces the risk because all the stocks will not decline at the same time and in the same proportion; some may do well at the same time than others are not.

Convenient Management: Investment in a mutual fund reduces paper work

and helps you to avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save time and make investing easy and convenient.

Return Potential: Over medium to long-term, mutual funds have the

potential to provide a higher return as they invest in a diversified basket of selected securities. The experience of many mutual fund schemes indicate that if the fund manager is capable of managing the portfolio efficiently, then over a medium to long term the return will be considerably more than the level of inflation.

Low Costs: Mutual Funds are a relatively less expensive way to invest compared to

directly investing in the Capital markets because the benefits of economies of scale in brokerage, custodial and other fees translate into lower costs for investors.

Liquidity: In an open-ended scheme, unit holders can redeem their units from

the fund house anytime, by paying a small fee called an exit load, in some cases. Even with close-ended schemes, one can sell the units on a stock exchange at the prevailing market price. Besides, some close-ended and interval schemes allow direct repurchase of units at NAV related prices from time to time.

Transparency : Regulations for mutual funds have made the industry very transparent.

You can track the investments that have been made on your behalf and the specific investments made by the mutual fund scheme to see where your money is going. In addition to this, you get regular information on the value of your investment

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.

Affordability Investors 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 Schemes Mutual Funds offer a family of schemes to suit your

varying needs over a lifetime. 

Well regulated: India mutual funds are regulated by the Securities and Exchange Board of India, which helps provide comfort to the investors. Sebi forces transparency on the mutual funds, which helps the investor make an informed choice. Sebi requires the mutual funds to disclose their portfolios at least six monthly, which helps you keep track whether the fund is investing in line with its objectives or not.

A Mutual Fund is set up in the form of a trust. The three-tier structure of a mutual fund is as follows:

SponsorTrustee Company/ Board of TrusteesAsset Management Company (AMC)

Sponsors: The trust is established by a sponsor or more than one sponsor who is like a promoter of a company.

The sponsor establishes the mutual fund and registers it with SEBI

Sponsor appoints the trustees, the custodian and the Asset Management Company in accordance with SEBI regulations.

Sponsor has to contribute at least 40% of the net worth of the AMC

Trustee:The trustee of the Mutual Fund hold its property for the benefit of the unit holders. They are the first level regulators of the mutual fund and are governed by the provisions of the Indian Trust Act, 1908

Asset Management Company:The Asset Management Company (AMC) approved by the SEBI manages the funds by making investments in various types of securities. The trustees, on the advice of sponsors usually appoint the AMC. Therefore the AMC is either appointed by the sponsors or by the trustees on the advice of the sponsors. The AMC is a private limited company in which sponsors and their joint venture partners are the shareholders. The minimum net worth of an AMC has to be Rs. 10 crores at all times. The trustees sign the investment management agreement with the AMC, which spells out the functions of the AMC

The custodian, who is registered with SEBI, holds the physical securities of the various schemes of the fund in its custody. The depositors hold the securities which are in electronic form (dematerialized). The trustees are vested with the general power of superintendence and direction over the AMC. They monitor the performance and compliance of SEBI regulations by the mutual fund.

All Mutual Funds are required to be registered with SEBI before they launch any scheme.

The mutual fund industry started in India in a small way with the UTI Act creating what was effectively a small savings division within the RBI.

Over a period of 25 years this grew fairly successfully and gave investors a good return, and therefore in 1987-1993, as the next logical step, public sector banks and financial institutions were allowed to float mutual funds and their success emboldened the government to allow the private sector to foray into this area.

SBI was the first non-UTI fund set up in 1987. During 1993-1996, the mutual fund industry was

opened to private sector players. The success of the public sector mutual funds emboldened the government to allow the private sector to foray into this area.

The private sector mutual funds also brought with it new innovations in products and marketing strategies

In the year 1992, SEBI Act was passed. The objectives of SEBI are to protect the interests of investors in securities and to promote the development of the securities market and to regulate it.

A mutual fund is a common investment vehicle where the assets of the funds belong directly to the investors.

Investors‟ subscriptions are accounted for by the fund not as liabilities or deposits but as unit capital.

On the other hand , the investments made on behalf of the investors are reflected on asset side of the mutual fund scheme‟s balance sheet.

There are however , liabilities of mainly short term nature that are also part of the balance sheet.

The funds‟ total net assets are therefore defined as assets minus liabilities. As there are many investors in a fund, it is common practice for mutual

funds to compute the share of each investor on the basis of value of Net Assets per Unit, commonly known as the Net Asset value (NAV).

NAV = Net Assets of the scheme/Number of outstanding units = (Market value of investments+ Receivables+ other Accrued income +

other Assets- Accrued Expenses –other payables-other liabilities)/ No of Outstanding units.

Load FundsMutual Funds incur various expenses on marketing, distribution, advertising, portfolio churning, fund manager's salary etc. Many funds recover these expenses from the investors in the form of load. These funds are known as Load Funds. A load fund may impose following types of loads on the investors:

Entry Load - Also known as Front-end load, it refers to the load charged to an investor at the time of his entry into a scheme.

Exit Load - Also known as Back-end load, these charges are imposed on an investor when he redeems his units (exits from the scheme). Exit load is deducted from the redemption proceeds to an outgoing investor.

Note: From 1ST August 2009 SEBI removes Entry Load on Mutual Funds

To bring about uniformity in determination of sale and repurchase price of mutual fund units applicable for investors, it has been decided by SEBI that a uniform method should be used by all mutual funds.

Applicable load as a percentage of NAV would be added to NAV to calculate sale price and would be subtracted from NAV to calculate repurchase price.

The following formulae should be used: Sale Price = Applicable NAV × (1+ Entry Load, if any) Repurchase Price = Applicable NAV × (1- Exit Load, if any)

It is commonly believed that mutual funds with low NAV are cheap or undervalued and mutual funds with high NAV are expensive /overvalued and hence should be avoided.

The amount of your investment remaining unchanged, between two funds with identical portfolios, a low NAV would mean a higher number of units held and consequently a high NAV would mean lower number of units held.

But under both circumstances, the product of the number of units and the applicable NAV, which is the value of your investment, would be identical.

It is the stocks in a portfolio that determine returns from a fund, the value of the NAV being immaterial.

When one sells those units, the return will be the same as that of another scheme, which has performed similarly.

The 'cost' of a scheme in terms of its NAV has nothing to do with returns.

The only instance where a higher NAV may adversely affect you is where a dividend has to be received.

So from whichever angle you see it, the NAV makes no difference to returns.

Mutual fund schemes have to be judged on their performance.

And the simplest way to do this is to compare returns over similar periods.

Type of Mutual Fund

Schemes

StructureInvestment Objective

Other Schemes

Open Ended Funds

Close Ended Funds

Growth Funds

Income Funds

Guilt Funds

Floating Rate Funds

Index Schemes

Tax savings funds

Exchange traded funds

Type of Mutual Fund

Schemes

Investment Objective

Other Schemes

Fixed Maturity Plans

Balanced Funds

Money Market Funds

Gold exchangeTraded funds

Sector funds

Value funds

Open-end FundsAn open-ended fund gives the investors an option to redeem and buy units at any time from the fund. These schemes do not have a fixed maturity period. They can conveniently buy and sell units at NAV related prices which are declared on a daily basis. The key feature of open-end schemes is liquidity.

Closed-end FundsA close-ended fund or scheme on the other hand has a stipulated maturity period e.g. 5-7 years. In closed-ended funds, the investors have to wait till given maturity date to redeem their units to the fund. However, to provide liquidity, it is mandatory for closed-ended funds to get themselves listed on a stock exchange within six months from the closure of the subscription. The units of a close ended scheme may be converted to open ended scheme, if the offer document of such scheme discloses the option and the period of such conversion or the unit-holders are provided with an option to redeem their units in full.

Fund according to Investment Objective: A scheme can also be classified as growth

fund, income fund, or balanced fund considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:

Growth / Equity Oriented Scheme The aim of growth funds is to provide capital

appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks.

Income / Debt Oriented Scheme 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, Government securities and money market instruments. Such funds are less risky compared to equity schemes. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.

Gilt Fund These funds invest exclusively in government

securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.

Floating Rate funds:A floating rate fund is a fund

that by its investments in floating rate instruments seeks to provide stable returns with low level of interest rate risk and volatility. For example the UBS Floating Rate Fund invests primarily in

Floating rate debentures and bonds

Fixed Maturity Plans: Fixed maturity plans, or FMPs as they are

popularly called, are close-ended funds with a fixed tenure and invest in a portfolio of debt products whose maturity coincides with the maturity of the product.

Balanced Fund The aim of balanced funds is to provide both

growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.

Money Market or Liquid Fund These funds are also income funds

and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc.

Index Funds Index Funds replicate the portfolio of a particular

index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms.

Tax Savings Funds: These schemes offer tax rebates to the investors

under specific provisions of the Income Tax Act, 1961 as the government offers tax incentives for investment in specified avenues e.g. equity linked savings schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest predominately in equities.

Exchange Traded Funds: The basic idea of any mutual fund is to pool money from a

large number of investors so that a large number of securities can be purchased efficiently. Each investor therefore gains the advantage of being well diversified, without the time and expense of having to purchase the individual securities. Exchange traded mutual funds are just another variation on this theme--except that they trade on a stock market like an ordinary stock.

Gold exchange-traded fund (or GETF) is an exchange-traded fund (ETF) that aims to track the price of gold. Gold exchange-traded funds are traded on the major stock exchanges including Zurich, Mumbai India), London, Paris and New York. There are also close-end funds and exchange traded notes that aim to track the price of gold. Only some of these hold any physical gold.

Sector Funds: Sector mutual funds are those mutual funds that restrict

their investments to a particular segment or sector of the economy. Also known as thematic funds, these funds concentrate on one industry such as infrastructure, banking, technology, energy, real estate, power heath care, FMCG, pharmaceuticals etc. The idea is to allow investors to place bets on specific industries or sectors, which have strong growth potential

Value Funds: Value funds are those mutual funds that tend to focus on

safety rather than growth, and often choose investments providing dividends as well as capital appreciation. They invest in companies that the market has overlooked, and stocks that have fallen out of favour with mainstream investors, either due to changing investor preferences, a poor quarterly earnings report, or hard times in a particular industry

1. Identify your Investment Goals: Financial Goals vary based on age, lifestyle, financial

independence, family commitments, and level of income and expenses , among many other factors. Therefore the first step is to identify the goals and the time horizon of meeting these goals.

One may have immediate goals, such as making a down payment on a home, paying for a

wedding, or creating an emergency fund. One may also have long-term goals, like paying for college or retirement.

Establishing goals will help assess how much money you need to invest, how much your investments must

earn, and when you will need the money.

2. Choose the right Mutual Fund: The most important thing is to choose the right mutual

fund schemes to suit your requirements. There are variety of schemes available with every mutual

fund. The offer document of the scheme tells you its objectives and provides other details like the track record of the other schemes managed by the same fund manager.

Some factors to evaluate before choosing a particular mutual fund are the track record of the performance of the fund over the last few years in relation to the appropriate benchmark and similar kinds of funds in the category.

3. Diversify into Mutual Funds and Schemes: Investing in many schemes of just one mutual fund may

not meet all the investment needs. Investments must be diversified in various good performing funds. One should consider investing in a combination of schemes to achieve a specific goal.

4. Invest Regularly: The best approach is to invest a fixed amount at specific intervals, say

every month. By investing a fixed sum each month you get the benefit of rupee cost averaging i.e. you buy fewer units when the price is higher and more units when price is low, thus bringing down your average cost per unit. This is a disciplined investment strategy followed by investors all over the world. This strategy is called systematic investment plan (SIP). Those who have lump sum money can invest higher amounts and those who want to save every month can invest in SIP.

5. Start Early: It is desirable to start investing early and stick to a regular investment

plan. If you start now, you will make more than if you wait and invest later. The power of compounding lets you earn income on income and your money multiplies at a compounded rate of return.

6. Implementation/investing Money: To invest money in mutual funds Fill up the forms of the relevant mutual fund scheme. Forms are available with AMC’s distributors. Cheque needs to be enclosed along with the application form and

submit to AMC You will receive account statement giving details about the units

allotted, sale price at which you have invested money and other details.

6. Monitoring the Investing: The investment once made, have to be

monitored regularly. Although we will have invested in good performers, any financial plan which is not reviewed or re-balanced is a waste. Monitoring could be done 6 monthly or annually. Poor performing investments should be sold and shifted to good performers.

Rupee Cost Averaging is an effective Rupee Cost Averaging is an effective market-timer mechanism that market-timer mechanism that eliminates eliminates the need to time the markets the need to time the markets

The The amount invested per month is amount invested per month is constantconstant, , one buys more units when one buys more units when the price is lowthe price is low and and fewer units when fewer units when the price is highthe price is high

As a result the As a result the average unit cost will average unit cost will always be less than the average sale always be less than the average sale price per unit,price per unit, irrespective of the market irrespective of the market rising, falling or fluctuating rising, falling or fluctuating

Actual Average NAV = (11.34 + 11.01 + 12.05 + 13.13 + 13.67 + 15.81 + 16.78 + 18.28 + 18.71 + 21.48 + 21.49 + 21.77) / 12

= Rs.16.29. NAV for Rahul = (4,000 * 12) / (352.73 +

363.31 + 331.95 + 304.65 + 292.61 + 253.00 + 238.38 + 218.82 + 213.79 + 186.22 + 186.13 + 183.74)

= Rs.15.36

Systematic Investment Plan (SIP) offers Systematic Investment Plan (SIP) offers convenience to investor, as it can be set-convenience to investor, as it can be set-up as direct periodic and automatic up as direct periodic and automatic withdrawals from bank accounts withdrawals from bank accounts

The Systematic Investment Plan The Systematic Investment Plan puts puts the investment process on the auto the investment process on the auto pilot modepilot mode and leaves the investor to and leaves the investor to live life in peace without worrying about live life in peace without worrying about security of his/her future. security of his/her future.

Proponents of Rupee Cost Averaging argue Proponents of Rupee Cost Averaging argue that since average price using SIP is less that since average price using SIP is less than actual average of price (NAV) , hence it than actual average of price (NAV) , hence it is always advisable to invest via SIP . is always advisable to invest via SIP .

However the correct tool to compare the However the correct tool to compare the performance of two different investment performance of two different investment strategies strategies ie lump sum investment vs ie lump sum investment vs SIP is not average price (NAV) but SIP is not average price (NAV) but comparing internal rate of return of comparing internal rate of return of both strategies. The strategy with both strategies. The strategy with higher realized IRR performed betterhigher realized IRR performed better. .

1. Receive statement of accounts within 6 weeks from the date your request is received by the Mutual Fund

2. Receive information about the investment policies, objectives, financial position and general affairs of the scheme

3. Receive dividend within 30 days of their declaration, receive redemption proceeds within 10 days from the date of the valid redemption

4. If an investor fails to claim the dividend or redemption proceeds, he has the right to claim it up to a period of 3 years from the due date at the then prevailing NAV. After the expiry of this period, investors will be eligible to receive the amount at the NAV prevailing at the end of the 3rd year.

5. Vote in accordance with the regulations to:

a) Approve or Disapprove any change in the fundamental investment policies of the scheme, which are likely to modify the scheme or affect the interest of the unit holder. The dissenting unit holder has a right to redeem the investment.

b) Change the Asset Management Company c) Wind up the schemes

6. Inspect the documents of the mutual fund specified in the scheme’s offer document.

End of the Slide