sourav's sip on sbi mutual fund(introduction)
TRANSCRIPT
INTRODUCTION
ABOUT SBI MUTUAL FUND
SBI Funds Management is a joint venture between State Bank of India, the
country’s largest bank and Societe Generale Asset Management (France), one
of the world’s leading fund management companies. With over 20 years of rich
experience in fund management, SBI Funds Management Pvt. Ltd. Is one of the
largest investment management firms in India managing investment mandates
of over 46 Lakh investors. With a network of over 130 points of acceptance
spread across India our vast family of investors in expanding faster and further.
SBI Mutual Fund has won the prestigious CNBC TV 18 Crisil Mutual Fund of
the year Award 2007, apart from winning five awards for scheme performance.
SB Mutual Fund has also won the Most Preferred Brand of Mutual Fund at the
CNBC Awaaz Consumer Awards in 2006 and 2007. But above all, it is the trust
of over 46 Lakh investors that eggs us on deliver innovative and stable
investment services, day after day. It is the driving force for our team of
investment experts to develop arid deliver products that help investors like you
achieve their financial objectives.
1
CHAPTER-I
THE CONCEPT
AND
ROLE OF MUTUAL FUNDS
2
MUTUAL FUNDS OPPORTUNITY
Most appropriate investment opportunity for small un estors.
Birth of Mutual Funds U. S. A.
Good Alternative to Direct Investing.
Size in USA> Bank Deposits.
Financial Intermediary.
UTI only player between 1964 — 87.
Helps in the wowth of Capital Markets.
CONCEPT OF MUTUAL FUND
A common pool of money into which investors place their contributions to be
invested in accordance with a stated objective
The ownership of the fund is joint or mutual.
The fund belongs to all investors.
Ownership is proportionate to contribution made by one.
ADVANTAGES OF INVESTING THROUGH MUTUAL FUNDS OVER DIRECT
INVESTMENTS
Portfolio Diversification
Professional Management
Reduction / Diversification of Risk
Liquidity
Flexibility & Convenience
Reduction in Transaction cost
Safety of regulated environment
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DISADV&NTAUES OF INVESTING THROUGH MUTUAL FUNDS OVER DIRECT
INVESTMENTS
No control over cost
No Tailor made portfolios
Managing a Portfolio funds.
INDUSTRY PROFILE
ASSETS UNDER MANAGEMENT (Rs. In Crs)
TYPES OF MUTUAL FUND
Mutual fluids can be classified as:
Close ended / Open ended funds
Load fund I No-load funds
Tax-exempt / Non-tax exempt funds
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CLOSE ENDED FUNDS
Close ended fund:
o Initial public offer
o Investor cannot buy units later on from NW
o Get listed on the stock exchange
o Traded on stock exchange at a discount / premium to NAy
o Redemption of units on expiry date
o Unit capital constant
o Close ended funds may allow buy back of units option
OPEN ENDED FUNDS
OPEN ENDED FUND:
o Units available for sale / purchase at all times at NAV based prices
o Units capital variable
o Fresh subscriptions may be discontinued
o Any time redemptions always allowed, except .when there is
lock in period.
LOAD FUNDS
Load is one time fee payable by the investor when they enter / exit an
open-eiided scheme.
Loads are charged to recover initial issue expenses including
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marketing & selling expenses, brokerage, advertising costs. Such expenses not to
exceed 6%
SEBI prescribes ceiling on Recurring Expenses.
There can be entry load or exit load or both
Entity load is also called front-end load
Exit load is also called Back-end load or Deferred load
NO LOAD FUNDS & IMPACT OF LOADS
In a no load fund, marketing and selling expenses are absorbed by the AMC and the
investor buys and sells units at NAy price.
Return on investment to the investor is reduced because of the loads
o When the investor buys a unit from the MFs, he pays more than NAy (NAY +
Entry load)
o When the investor sells the unit to the MF, he gets less than NAY (NAY - Exit
load)
EXAMPLE ON LOADS AND RETURNS
ROI with Loads
Amount invested = 11+0.22 = Rs.11.22
Amount received = 12- 0.12 = Rs.11.88
Gain = Rs.0.66
ROI = (0.66 x 100)/11.22 = 5.88%
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EXAMPLE ON LOADS AND RETURNS
ROI without loads
Amount invested = Rs. 11
Amount received = Rs. 12
Gain = Rs.1
ROI =(1 x 100)/11 = 9.09%
CONTINGENT DEFERRED SALES CHARGE (CDSC)
Exit Charge may vary depending upon the holding period.
if Exit Charge varies with the holding period it is called contingent
deferred sales charge (CDSC) and it may vary as shown under.
Redemption during the first five years from the date of purchase
MUTUAL FUNDS CLASSIFIED ASP CLASS (NATURE) OF
INVESTMENTS
Equity Funds
Bond Funds
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First Year Maximum CDSC 4%
Second Year Maximum CDSC 3%
Third Year Maximum CDSC 2%
Fourth Year Maximum CDSC 1%
Fifth Year Nil
Money Market Funds
MUTUAL FUNDS CLASSIFIED AS PER INVESTMENT OBJECTIVES
Growth Funds
Income Funds
Value Funds
MUTUAL FUNDS CLASSIFIED AS PER RISK PROFILES
High Risk Funds
Moderate Risk Funds
Low Risk Funds
RISK RETURN HEIRARCHY OF DIFFERENT FUNDS
Risk High
Sector Funds
Diversified Equity Funds
Index Funds
Balanced Funds
Debt Funds
Gilt Funds
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Risk Low MMMF
Low Return High Return
MONEY MARKET FUNDS
Invest in securities of less than I year maturity
High liquidity & safety of principal
Low risk and low returns
GILT FUNDS
Invest only in Government Securities of over 1 year maturity
Risk and return low but higher than that of MMF
No default risk but carry interest rate risk
C Fund values drop when interest rates go up & rise when interest rates go down
DEBT FUNDS & TYPES
Invest in corporate bonds and government securities
Risk higher than that of gilt funds
Aims at regular income distribution and not at capital appreciation
Types of Debt Funds:
o Diversified Debt Funds
o Focused Debt Funds
o High yield Debt Funds
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o Assured return Debt Funds
o Fixed Term Plan Series
EQUITY FUNDS & TYPES
Invest in equity and equity related instruments
High risk and aim at capital appreciation
Types of equity funds
o Aggressive growth funds
o Growth funds
o Value funds
o Specialty funds:
Sector funds
Foreign securities funds
Mid-Cap or Small-Cap equity funds
EQUITY FUNDS & TYPES
Diversified equity finds
ELSS funds
Equity index funds
Equity income or dividend yield fund
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TYPES OF HYBRID FUNDS
Balanced Funds :Seek to provide regular income &
capital appreciation
Growth & Income Funds :Seek to provide high dividend and
Capital appreciation
Asset Allocation Funds :Flexible asset allocation between
debt, equity & MM.
OTHER FUNDS
Commodity Funds : Invest in commodity stocks
Real Estate Funds : Invest th stocks of real estate
Exchange Traded Funds : Trade like a single stock on the stock
exchange
Fund of Funds : Invest in other Mutual Fund schemes
EXCHANGE TRADED FUNDS
It tracks the market index & trades like a single stock.
Unlike Index Funds, unit price varies during the day as per market movements.
FTP’S are bought & sold through market makers who give a two way quote.
(Ask & Bid).
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Benefit of holding a single share & diversification & cost efficiency of an index.
Market makers allow exchange of units for the underlying shares.
FUND OF FUNDS
Fund of f invest in other mutual fund schemes of the same AMC/other AMC’S.
It does not invest directly in capital markets.
Greater diversification
Higher expenses.
12
CHAPTER-II
FUND STRUCTURE
AND
CONSTITUENTS
13
MUTUAL FUND STRUCTURE
Mutual funds in U.S. are setup as investment companies
Mutual funds in UK. are either Unit Trusts (Trust) or Investment Trust (Companies)
Mutual funds are public trusts under the Indian Trusts Act, 1882
Mutual fund is a 3 tier structure:
o Sponsor
o Trustee and
o AMC
Mutual funds invest
o In capital market instruments
o On behalf of investors
All gains and losses of funds are shared by the unit holders
MF is a pass-through structure and it has tax implications
CONSTITUENTS OF A MUTUAL FUND
1. Sponsor
2. Trustees
3. Asset Management Company
4. Custodian / Depository Participant
5, R&T Agent
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6. Distributors
7. Banker
ROLE OF SPONSOR
Sponsor is a person who sets up a Mutual Fund
Sponsor settles the Trust and executes Trust Deed
Sponsor contributes to the initial capital of the Trust
Sponsor appoints the Board of Trustees
Sponsor appoints Asset Management Company
Sponsor contributes minimum 40% of net worth of AMC
WHO CAN BE A SPONSOR?
Criteria of a Sponsor are
o Positive net worth
o Minimum 5 years’ track record
o History of positive after tax profit for 3 out of 5 years including fifth year
o Net worth more than contribution for AMC
o ‘Fit and Proper’ person
BOARD OF TRUSTEES & ROLE
Trustees appointed by the Sponsor with SEBI approval
At least two third trustees must be independent
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The trustees have a fiduciary responsibility towards unit holders
Trustees not liable for acts done in good faith and if they have exercised adequate due
diligence
Trustees oversee the functioning of AMC
Trustees approve each MF scheme floated by AMC
The investments in MF’s are held by the trustees
Trustees receive fees for their services.
Obligation to undertake general & specific due diligence.
WHO CAN BE A TRUSTEE?
Eligibility Conditions
Person of high repute and integrity
Not guilty of moral turpitude
Not convicted for economic offence under securities laws
Not a part of AMC e.g. Director, Employee or Officer of AMC
One can be trustee of two MF’s if approved by Board of Trustees of both the mutual
funds.
ASSET MANAGEMENT COMPANY
Constituted as a company under the Indian companies Act
Minimum Net worth of Rs.l0 crores for AMC
Minimum contribution of sponsor: 40% of share capital of AMC
At lest 50% of directors of AMC to be independent
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AMC can do only the following businesses.
o Asset management services
o Portfolio management services
o Portfolio Advisory services
AMC can be terminated/changed with the consent of
o Majority of Trustees or
o At least 75% majority of unit holders
ROLE OF AMC
AMC is the fund Manager for managing Mutual fund Assets
AMC floats different MF schemes
AMC accountable to the Trustees
AMC charges Asset Management Fees subject to ceiling prescribed by
SEBI.
Asset management Agreement between AMC and Trustee
OBLIGATIONS OF AMC
Limit of 5% of aggregate purchase and sales of securities under all its scheme per
broker per quarter
As far as possible AMC to avoid services of its sponsor.
All security transactions with a sponsor and his associates to be disclosed.
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Disclosure of transactions with a company which has invested more than 5% of NAV
in any scheme.
CUSTODIAN / DEPOSITORY / PARTICIPANT
Custodian /DP:
o Appointedby Board of Trustees
o Keep record & account of securities I Investments
o Collects benefits tinder securities
o Sponsor & custodian I DP cannot be the same entity
o Registered with RBI
REGISTRAR & TRANSFER AGENT
o Registrar & Transfer Agent:
o Issues, redeems, transfers units of MF schemes
o Keeps unit holders accounts up to date
o Registered with RB!
MERGER OF TWO AMC’S
Merger of 2AMC’S:
o Approval of Trustees of both AMC’S required
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o SEBI approval required
o Approval of High Court also required
o Unit holders are informed and given option to exit without load
TAKE OVER OF AMC / SCHEME OF AMC
Take over of AMC by new sponsor
o Trustees approval required
o SEBI clearance required
o Unit holder to be informed
Merger of two schemes of different AMC’S
o Scheme of one mutual fund taken over by another mutual fund
Trustees approval required
SEBI approval required
Unit holders to be informed
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CHAPTER-III
LEGAL
&
REGULATORY
FRAME WORKS
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REGULATORS IN INDIA
SEBI is capital market regulator with legal powers
o SEBI regulates Mutual Funds.
o All Mutual Fund’s to be registered with SEBI
RBI is money market regulator
SEBI is regulator for liquid funds investing in MM instruments
MOF supervisory body for RBI & SEBI
Security appellate tribunal setup in 2003 to hear appeal against SEBI decisions
Registrar of companies (ROC) ensures compliance by AMC & by trustee company
with the Indian Companies Act 1956
ROC supervised by department of company affairs (DCA)
DCA frames and modifies regulations relating to the companies
DCA is a part of company law board
CLB is a part of ministry of law and justice
Company law board carries out judicial proceedings for offences under companies
act
Mutual fund trustees accountable to public trustees
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Public trustee reports to charity commissioner
UTI set up under L act 1963
SELF REGULATORY ORGANISATIONS
SROs are second tier in the regulatory structure
SRO is an association of market participants
Approval of SRO given by MOF
All stock exchanges are SROs and are supervised by SEBI
Close ended funds listed on SE observe listing agreement requirements of SE’s
AMFI was incorporated in 1995 and is not an SRO
Role of AMFI
o To promote interest of MF ’s & unit holders
o To set ethical, commercial & professional standards
o To increase public awareness of MF industry
ROLE OF AMFI
To promote interest of ME’s & unit holders
Interact with the regulator
To create public awareness
To set ethical, commercial & business standards
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To promote best business practices and formulate code of conduct for persons
engaged in the activities of MF and for the AMC ’s
To implement the certification programme.
INVESTORS RIGHTS & OBLIGATIONS
Right of proportionate ‘beneficial’ ownership
Right to timely service
Right to information e.g. NAV calculation, unit pricing
Right to approve changes in fundamental attributes of the scheme
Right to wind up a close ended scheme with 75% majority of unit holders
Right to terminate the AMC with 75% majority of unit holders
INVESTOR RIGHTS TO SERVICES
Investor to be informed about change in fundamental attributes of the scheme eg.
from no load fund to load fund or change in pricing norms for purchase / sale of units
Open ended fund must reopen within 30 days after the offer period
Nomination facility allowed
Redemption proceeds to be sent to investor within 10 working days otherwise penal
interest at the rate specified by SEBI for the fill period
Annual holding statements and transaction statements to be sent to investors
Dividend warrants to be dispatched within 30 days of dividend declaration by MF
1 Mandatory portfolio disclosure for half-year period to unit holders within I month
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Investor’s right to inspect documents such as
o Trust deed,
o AMC agreement
o Balance sheets of MF schemes and
o Balance sheet of AMC
LEGAL LIMITATION TO INVESTOR RIGHTS
Investors can’t sue the trust
Investor can sue the trustee
Sponsor of fund not responsible for shortfall in non assured scheme
Prospective investors can’t sue the trustees/AMC/Custodians
INVESTOR’S OBLIGATIONS & COMPLAINT REDRESSAL
Investor should:
o Read offer documents
o Understand risk factors
o Monitor performance of investments
o To submit PAN details
Complaint Redressal
o Through SEBI intervention. Complaints can be made to
AMC /Trustees / SEBI
Investors cannot seek redressal under companies act since fund
investor are neither share holders nor depositors in AMC
24
CHAPTER-IV
FUND DISTRIBUTION
&
SALES PRACTICE
25
WHO CAN INVEST IN A MUTUAL FUND SCHEME
Residents
o Resident Individuals / HUF
o Indian companies
o Partnership firms
o Indian trusts/ Charitable institutions
o Insurance companies
o Banks
o Financial Institutions
o NBFC s
o Provident funds
o Mutual funds
Non residents
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o NRI’ s & Persons of Indian origin
o Overseas corporate bodies (OCB s)
Foreign Entities
o FII ’s registered with SEBI
Foreign nationals cannot invest in MF
DIFFERENT DISTRIBUTION CHANNELS
1. Direct marketing by sales officers through
a. Mailers
b. Call centers
c. Branch networks
DISTRIBUTION CHANNELS TYPES
2. Individual agents as distributors and advisors
3. Institutional intermediaries
o Fund distribution companies
o Finance companies
Investment Advisory companies
o Banks and institutions
o Post offices
o Brokers and sub-brokers
o Private sector MF prefer established fund distribution COS as fund distributors.
27
AMFI REGISTERED DISTRIBUTORS
AMFI Registration no.(ARN) card necessa before selling
As on 3l/3/2005,
o 49837 candidates passed AMFI certification test
o out of which 30028 candidates registered with AMFI
Out of 30038 AMFI registered candidates,
o Individuals are 24850
o Corporate are 1946
o Corporate employees are 3232
AGENT’S COMMISSION
Commission can be paid upfront or trail commission
Market practice
o 1.5 to 25% for Equity funds
o 0.25 to 1.25% for Debt funds
o Still lower for liquid funds
o Higher commission for ELSS
AMFI has prohibited parting / sharing of commission (see AMFI
Guidelines & Norms for Intermediaries [AGNI]. SEBI CIR of 2002.
SEBI does not prescribe any ceiling on commission
PROCESS OF EFFECTIVE SELLING OF M F SCHEMES PRESCRIBED
FOR DISTRIBUTORS
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Know the important characteristics of scheme
Know your client profile (age, risk tolerance, income level, etc.)
Understand client’s needs (investment objective, return expectation,
o cash flow requirement, etc.)
Assist in making the right choice
Encourage regular investment & commitment to invest
Personalized post sales service
AMFI CODE OF ETHICS FOR MF’S
Funds to be managed in the interest of unit holders
Unit holders to be treated equally & fairly
Ensure meaningful disclosures
Avoid conflict of interest
Ensure segregate accounting
Stick to ethical standards and fairness in dealings
High standards of care, diligence, services and disclosure
announcements
SEBI ADVERTISEMENT CODE FOR MF’S
No promises in the future without resources hacked guarantee
Standard measures to compare such as Annual Yield, CAGR etc.
Annualized yields for at least one, three, five years & since launch
For less than I year performance, Absolute return without
Annualisation
Past gains may not repeat in future
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Risk factors prominently stated
No celebrities
No add-ons during offer period
Appropriate benchmark to be chosen
Any ranking of thud to be explained
CHAPTER-V
ACCOUNTING
VALUATION
TAXATION
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ACCOUNTING
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MUTUAL FUND ACCOUNTING
Knowledge of MF accounting vital
Separate Balance Sheet for each scheme of ME
MFs to follow Accounting Policies laid down by SEBI (Mutual Funds) Regulations,
1996
Unit holder’s subscriptions accounted
o not as liabilities or deposits
o but as unit capital at face value
Investments made by the fund appear on asset side in the balance sheet
All assets of the scheme belong to investors
NAV CALCULATIONS
Net Assets = Assets Liabilities
o Assets = Market value of investments + Receivables + Accrued
Incomes + Other Assets
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o Liabilities = Accrued expenses + Payablcs + Liabilities
NAV of a Unit = Net Assets of the Scheme
Number of units outstanding
DISCLOSING NET ASSET VALUE OF A UNIT
Data on which NAv is calculated is called valuation date
Open ended funds are required to compute and disclose NAy daily
Close ended Funds can compute NAV’s every week NAV calculation has to consider
up to date transactions
DISCLOSING NET ASSET VALUE OF A UNIT
All income, expenditure to be accounted up to date of valuation
Non accrual of small amounts not affecting NAV by more than 1% permitted
Non-recorded transactions should not affect NAV calculation by more than 1%
If NAV is more than 1% AMC to
o Pay excess difference.
o Recover excess paid.
ALLOCATION / DE-ALLOCATION OF UNITS
For all valid applications received before the cut-off time, units are allotted / cancelled
based on NAV at the end of the same day
For valid application received after the cut-off time, units are allotted I cancelled
based upon NAV of the next business day.
The above rule does not apply to liquid fund schemes
CUT-OFF TIME
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The cut-off time for all mutual fund schemes except liquid fund schemes is 3 pm
For liquid fund schemes valid application received up o I p.m. are allotted units based
on NAV of the previous day
For liquid fund schemes valid application received up to 1 p.m. are allotted units
based on NAV of the same day
For repurchases under liquid funds the cut-off time is 10a.m. instead
Of 1pm.
NAV’s are required to be rounded off up to 4 decimal places for liquid funds & up to
2 decimal places for other finds
FACTORS AFFECTING NET ASSET VALUE OF A UNIT
NAV is affected by 4 set of factors:
o Purchase & sale of investment securities
o Valuation of all investment securities held
o Other assets and liabilities
o Units sold or redeemed
PRICING OF A FUND UNIT
SEBI regulations on pricing of mutual fund units
o For open ended funds
Repurchase price not lower than 93% of NAV
Sale price cannot be more than 107% of NAV
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Difference between the repurchase and sale price of a unit
cannot be more than 7%
CHARGES IN A MF
Mutual funds can recover two types of expenses
o Initial issue expenses
o Recurring expenses
Initial issue expenses
o Effective April 04’ 2006 allowed up to 6% for close ended finds only
o Close ended funds cannot charge entity loads
o Open ended Rinds can recover initial expenses through entry load
MAXIMUM RECURRING EXPENSES
Recurring expenses cannot exceed the following regulatory limits
Average Weekly Assets For equity funds For Bond Funds
For first Rs.100crs. 2.50% 2.25%
For next Rs300crs 2.25% 2.00%
For next Rs.300crs. 2.00% 1.75%
On the balance average weekly
assets
1.75% 1.50%
Fund of Funds Max-0.75%
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ASSET MANAGEMENT FEES
AMC changes asset management fees
o Limits on AMC fees as per SEBI regulations:
125% of the 1st Rs.100 crs of weekly average net assets
1.00% of the weekly average net assets in excess of Rs.l00 crs
AMC may change additional 1% of weekly average net assets
for ‘ Load’ funds
Assets management fees are not in addition to but a part of recurring expenses
Assets management fees are usually lower for debt funds as compared to equity funds
and are disclosed in OD
AMORTIZATION OF INITIAL EXPENSES
Close ended funds do not charge initial expenses of fund but amortize the same over a
period of years
Initial expenses amortized on a weekly basis over the period of the scheme. e.g. for a
yr scheme, amortized over 260 weeks
Investor exiting before expiry of period of scheme will be charged unrecovered initial
issue expenses
Conversion of close ended hinds into open ended funds allowed only after recovery of
unrecovered initial expenses
Un-amortized portion added for NAV calculation as other asset but no AMC fee on
this amount
AMORTISATION AN EXAMPLE
Assume close ended fund of five years collects Rs.100 cores and
incurs initial issue expenses of Rs.5 cores.
36
Units issued = 10 corers
Investment = 95 corers
Initial NAV = 95 + ((260/260)*5 ) 10
10
After 4 weeks let the market value of investments 98 crs
NAV = 98 + ((256/260)*5)
10 =10.29
INITIAL ISSUE EXPENSES IMPACT ON NAV
Open ended fund collects Rs,100crores
Entry load 2.25%
Initial issue expenses Rs,5 Corers
Impact on NAV
Initial NAV 10
As No. of Units allotted would be 9.775 corers
DISCLOSURE AND REPORTING REOLIREMENTS
AMC to prepare annual report and annual statement of account for each scheme
Annual statement of account to be audited by an auditor independent of the auditor of
AMC
37
Within 6 months of accounting year, fund shall
o Publish scheme wise abridged summary of reports in newspapers
o Mail summary of report to all unit holders
o Forward to SEBI annual audited accounts, half yearly unaudited accounts,
quarterly portfolio statement
o Display the scheme wise annual reports on their website & on AMFI website
o Mail annual reports to all unit holders
ACCOUNTING POLICIES
Investments to be marked to market
Unrealized appreciation can’t be distributed
Dividend / Bonus recognized on the date share is quoted ex-dividend / ex-bonus
Average cost considered for determining gain / loss on sale of shares
Purchase / sale of investments recognized
o on the trade date,
o not on settlement date
Debt investments to be taken as NPA
o if interest or principal amount remains unpaid for more than 3 months.
o e.g. if interest due 3 June 2000 remains unpaid on 1/10/2000 it becomes NPA
in 1/10/2000
PROVISIONING OF NPA - DEBT SECURITIES
38
If interest remain unpaid for 6 months 10% of Book Value
If interest remain unpaid for 9 months 20% of Book Value
If interest remain unpaid for 12 months Another 20% of Book Value
If interest remain unpaid for 15 months Another 25% of Book Value
If interest remain unpaid for 18 months Balance 25% of Book Value
VALUATION NORMS
FOR
MUTUAL FUNDS
39
VALUATION NORMS FOR MUTUAL FLNDS
Valuation norms prescribed by SEBI to protect investor’s interests
Valuation norms
o Based upon fair portfolio valuation
o Uniform across al funds
SEBI
o Prescribes detailed valuation methodologies in its fund regulations
o Mandates disclosure of valuation methods used for investors’ information
VALUATION NORMS FOR SHARES
40
Va1uation of traded shares
o done on the basis of traded price
o if not more than 30 days old
Valuation of thinly traded shares
o less than 50,000 shares or Rs.5 lacs or less amount and
o done as per SEBI approved norms
Valuation of not traded shares
o done as per SEBI approved valuation norms
If thinly traded & non traded equity securities exceed 5% of the total assets of the
scheme.
o independent valuer should be appointed for valuation
If illiquid securities exceed
o 15% of net assets for open ended finds
o 20% of net assets for close ended funds
o value is taken zero for securities in excess of 15% 20%
LIMIT ON ILLIOUID SHARES
Illiquid share (Non traded, thinly traded & Unlisted equity shares)
o not to exceed 15% for open ended find assets
o not to exceed 20% for close ended fund assets
41
VALUATION NORMS FOR THINLY-TRADED AND_NON-TRADE
SHARES
Equity Instruments
Calculate book value per share
Calculate earning value per share based upon average capitalization rate of industry
P/E and discount it by 75% (Latest audited EPS be taken for this purpose)
Calculate fair value per share taking 90% of average of book value and earning value
per share
If EPS is negative or not available for within previous nine months, it should be taken
as zero
CAPITALISATION OF EARNINGS—AN EXAMPLE
Assume net worth / share Rs.8
Audited EPS Rs.2
Industry PIE 12
Discounted P/E for comp (25% of 12)-3
Value of share (2*3) -6
Average value (8+6)/2 -7
Value to be taken discounted by 10%
90% of Average value (7) - Rs.6.30
VALUATION OF TRADED DEBT SECURITIES
42
A debt security. is treated as traded if traded any day during the last 15 days
Trading ca be on a stock exchange or between institutions
Publicly traded price or private placement price if private placement is within last 15
days is taken as valuation price
Market lot for trading in debt securities is 5 Crores
A debt security if not traded in last 15 days in called not traded or thinly traded debt
security
VALUATION OF THINLY - TRADED AND NON - TRADED DEBT
SECURITIES
Debt Instruments
Less than 182 days maturity
o Valued at cost plus accrued interest and
o Difference between redemption value and cost uniformly spread over
remaining life of instrument
More than 182 days maturity
o Government securities valued at prices released by CRISIL
o Investment grade debt securities valued on the basis of YTM derived
from CRISIL valuation matrix
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o Non investment grade
Performing asset valued at 25% discount to their face value
NPA valued as per valuation norms for NPA ’s
Calculating yields for pricing debt securities
o A risk free benchmark yields curve is built on GOl securities as the base.
o A matrix of spreads (based on the credit risk) are built for marking up the benchmark
yields
o Marked yields are adjusted for liquidity risk
o The yields so arrived are used to price debt portfolios
GROSS REDEMPTION YIELD (GRY)
Gross redemption yield (GRY) is also called Yield to Maturity (YTM)
YTM is the Internal Rate of Return on investment in Bond.
Internal rate of return is computed based on:
I. Coupon Rate
II. Purchase Price
III. Period to Maturity
If purchase price is the same as face value of bond,
44
o YTM will be the same as coupon rate.
If purchase price is more than the face value,
o YTM will be lower than the coupon rate.
If purchase price is less than the face value,
o YTM will be more than the coupon rate.
CALCULATING PRICE BOND WITH GIVEN YTM - AN EXAMPLE
Given data:
Face value : R& 1000
Coupon : 10%
Tenure : 5 Years
Interest payment : Yearly
Yield : 8. 72%
Calculate price of the bond
Cash flows under the bond and their present values are as under
100 + 100 + 100 + 100 +(100+1000)
(1+8.72%) (1+872%)2 (l+872%)3 (1+8.72%)4 (1+8.72%)5
Price of the bond = Rs.1050 (By solving the above equation)
45
TAXATION
OF
MUTUAL FUNDS
46
TAXATION_OF MF’S AND INVESTORS
Finance act 1999 radically changed taxation of dividends received by investors in
Mutual Funds
Mutual fund as an entity is not taxed since it is a Pass through entity. Section 10 (23d)
of the IT Act.
Finance Act 1999 made income (dividends) from UNITS totally EXEMPT from tax
u/s 10(33) in the hands of all investors
Income (dividends) distributed by a debt fund was made liable to dividend
distribution tax at applicable rate
Open ended funds with more than 50% invested in equity do not pay any DDT (since
changed to 65% in FY 06— 07)
47
Security transaction tax (STT) is charged as applicable (01% on Net Sales
Consideration
80 C benefit under ELSS up to Rs. I lac
Restriction on dividend stripping (Sec 94(7))
o Within 3 months prior to record date of dividend distribution and
o Within 9 months after record date for dividend distribution
IMPACT OF DIVIDEND TAX
Investor pays the tax indirectly. since NAV comes down to the extent of tax paid by
the fund.
DD tax bears no relationship to the investor’s tax bracket.
Dividend reinvested in also subject to dividend distribution tax.
In growth plans, dividend distribution tax not applied, since no dividend is distributed.
SHORT / LONG TERM CAPITAL GAINS TAX
Short term capital gain
If units held for less than 12 months
Long term capital gain
If units held for more than 12 months
Short term capital gains at normal tax rates as applicable to investor
48
Long term capital gains taxed at 20% with indexation or at 10% without indexation of
cost + Applicable surcharge & Educational cess
Under section 111(a) of IT Act
o No long term gains tax on equity oriented schemes if STT charged.
o Short term gains tax at Government specified rate if STT is charged for equity
oriented schemes currently the rate is 10%.
CAPITAL GAINS TAX
Option to pay 20% or 10% lies with investor for each and every security.
10% surcharge also payable
Indexation benefit on unlisted bonds not available
No capital gain tax payable if entire capital gain invested in capital gain bonds of
NABARD, NHAI, REC under sec 54 EC with a lock in of 3 years.
Long term capital gains exempt u/s 54 ED if invested within 6 months in shares of
companies formed and registered in India with a lock in of I year.
CALCULATE CAPITAL GAIN TAX - AN EXAMPLE
Mr. H Invests Rs.2 lacs in MF units during FY 97 — 98
After 2 years, he sells units and gets Rs.2.4 lacs
49
His tax liability will be: C 99-00:389, CU 97-98:331, Ratio: 389/331 = 1.18
Indexed cost (2,00,000 x 1.18) Rs.2,36,000
Capital gain — Rs.4,000
Long term capital gain tax of Mr. H: Rs.4,000* 20% = Rs.800 or 10% of Rs.40,000/-
i.e. Rs.4,000/-
Obviously he will select the option of paying Rs.800/-
WEALTH TAX
Ownership of units not included in ‘Net Wealth’
Hence no wealth tax payable on mutual ifind units
CHAPTER-VI
50
INVESTOR
SERVICES
INVESTOR SERVICES
Application procedure — as per offer document
o Wide distribution of application forms
o downloadable application forms
o Application through internet
The procedure for NRIs / OCB provided in the OD/ KIM
Bank details to be given in the application form
PAN no. to be given if investment is Rs. 50,000/- or more
Joint account can be operated jointly by all
APPLICATION PROCEDURE FOR PURCHASE OF MF UNITS
The application form is an important agreement on the part of the investor of having
read and understood the OD
51
The various modes of payment specified in the OD
NRI s can pay
o From FCNRINRE accounts by demand drafts or Cheques in case of
repatriation benefits.
o For non repatriation bel1efits payment can be made from NRO /
NRNR A/c.
FIls can remit directly from abroad or pay from their NRE A/c.
Offer documents contains procedure purchasing and redeeming of units
Introduction of Multi purpose application form
o dispenses with the need for existing investors to fill up full application form
o for making further investments
INVESTMENT PLANS AND SERVICES
Investment Plans
Systematic In plan (SIP)
o Regular investment of fixed amount periodically (Rupee cost averaging
advantage)
Automatic Reinvestment plan (ARP)
o Reinvestment of dividend at ex dividend NAY
Systematic Withdrawal plans (SWP)
o Regular withdrawals at periodical intervals
Systematic Transfer plans (STP)
52
o Selling units of one scheme & buying units of another scheme at regular
periodical intervals of the same AMC
OTHER SERVICES AVAILABLE L UNDER MUTUAL FUNDS
Phone Transactions
Internet / Email transactions
Cheque writing facility for Liquid Funds
Periodic statements of holdings
Periodic statements of Investment portfolio disclosures
Mutual Funds cannot give loan against units
Banks can give loan against MF units
Nomination facility allowed
Units of close end schemes can be transferred to another person
Transfer in open ended fund happens upon
o death of unit — holder or
o when units are pledged or
o by operation of law i.e. insolvency or
o winding up of the corporate investor
53
PART—VII
54
INVESTMENT POLICY AND
RESTRICTIONS
INVESTMENT POLICY OF A FUND
Investment policy of a fund scheme is stated in OD
For equity tuna
o See kind of Sectoral allocation & companies to invest
For debt find
o See types of instruments.
o Credit rating,
55
o Proposed average maturity,
o Minimum & maximum miii instruments percentage
For balanced fund
o See equity &debt proportions
For money market fund
o See types of instruments preferred & their rating profile
REGULATORY RESTRICTIONS ON INVESTMENTS BY FUNDS
Minimum no. Investors in scheme
o 20 &no single investors to hold over 25% of the corpus
Minimum portfolio diversification
o investment in equity of a single company — max 10% of the NAV (Except
index funds, sector finds)
o Al! non government debt to be mandatory rated by at least one rating company
o Investment in rated debt instrument of a company
Max 15% of net assets
Max 20% of net assets with approval of board of trustees
REGULATORY RESTRICTIONS ON IN VESTMENTS BY FUNDS
Investment in unrated/below investment grade securities
o Not exceeding 10% of net assets iii a single company
o Not exceeding 25% of net assets of the fluid in all the companies
Prior approval of Unrated mandatory for investments in unrated debt
Instruments.
REGULATORY RESTRICTIONS ON IN VESTMENTS BY FUNDS
56
Investment in unlisted shares of companies
o Close ended fund: not more than 10% of net assets
o Open ended fund: not more than 5% of net assets
Investments in equity shares under all schemes of a mf
o Not more than 10% of paid up capital of a company
Investment by a mutual fund in ADRs / GDRs allowed
Investment by a MR in equities of listed overseas companies having share holding of
at least 10%allowed
Overall limit of u.s $l billion for such overseas investment for entire MY. industry
Overall limit per M.F
o Not exceeding 10% of net assets subject to maximum 50 million
REGULATORY RESTRICTIONS ON INVESTMENTS BY FUNDS
A mutual fund can invest
o Maximum 5%of net assets under all its schemes
o Into different fund schemes of the same AMC or of any other AMC except
fund of funds schemes
The above limit doses not apply to fund of funds
Securities are to be bought or sold only on delivery basis no short selling allowed
57
Securities to be bought and sold for a relevant scheme
Purchases! sales cannot be aggregated and allocated later
MFs can lend securities under the SEBT approved stock lending scheme
A mutual fund can invest only iii marketable securities
A mutual fund cannot invest in unlisted securities of sponsor or sponsor group
companies
A mutual fund can invest in listed securities of the sponsor / sponsor group companies
up to 25% of net assets of the funds
A mutual fund can transfer securities from one scheme to another scheme at market
prices and on spot delivery basis
Inter-scheme transfers allowed if objectives of both the schemes are same
A mutual fund can park its money in deposits of scheduled commercial banks pending
deployment into regular investments
Borrowing by MFs restricted up to 20% of net assets for maximum 6 months for
paying dividends/ redeeming units
Record of investment decisions to be maintained.
A FOP cannot invest in other FOF scheme
A liquid fund can not have mark to market Components> 10%. Maximum re pricing
tenure 1 year
58
CHAPTER-VIII
59
MEASURING
&
EVALUATION
MUTUAL FUND
PERFORMANCE
MEASURING MF PERFORMANCE
Major sources of return to investors are dividends and capital.
Investor should track the value of his investments in terms of
o Returns on such investments
o Decide whether he needs to switch to another hind.
60
METHODS OF MEASURlNG/EVALUAT1NG MF PERFORMANCE
Absolute return method
Simple annual return method
Total return method
Total return method when dividend is reinvested
Compounded annual average rate method (CAGR)
Expense ratio method
Income ratio method
Portfolio turn over ratio method
Transaction cost method
Fund size
Cash holding percentage
ABSOLUTE RETURN METHOD
Absolute returns for a specific period
Absolute return are calculated for less than l year period
If NAV changes from 20 to22 in 6 months, absolute return is 2/20*100=1
61
SIMPLE ANNUAL RETURN METHOD
Simple annual return method computes returns as follows
Lets take the previous examples
o NAV changed from 20 to 22 in 6 months period
o Annual return is
( 22 - 20) x 12 x 100 = 20%
20 6
TOTAL RETURN METHOD
Formula for total return when dividend is received but not reinvested:
Dividend distributed -- changes in NAV X 100
NAV at the start
Total return when dividend is not received but reinvested
This method is used to calculate return on investments when dividends are declared
and reinvested at ex dividend NAV price
See example as given below for calculating total returns
TOTAL RETURN METHOD WHEN DIVIDEND NOT REINVESTED AT
NAV- AN EXAMPLE
Assume units are purchased when NAV is 20
Assume that dividend of Rs 4/- is distributed when NAV ex dividend is 21
62
Assume NAV at the end of the year is rs.22/-
Simple total returns for the year will be as under
(22-20)+4 x 100 = 30%
20
TOTAL RETURN or ROl or CAGR METHOD
Compounded average annual return method
Formula
A=P x (1 + R/100)N
P = Principal invested
A =Maturity value
N = Period of investment in years
R = Annualized compound interest in %
R =[(Nth Root of A/P) — 1] x 100
COMPOUNDED AVERAGE ANNUAL RETURN METHOD AN EXAMPLE
Begin NAV - 100
End NAV-200
Period of investment - 10 years
Average annual compounded return — is it 10% or lower
63
2O0=100 x (1+R /100 )10
Solving fort gives annualized compounded rate of 7.1773% or 7.2%
Apply thumb rule of 72
SEBI prescribes average annual compounded return method to be followed for
advertising returns for over 1 year period.
RETURNS EMPACTED BY LOADS
The above example assumes a no load fund
If there is an entry load, you will be allotted lesser number of units since you will pay
more than NAV
If there is exit load, you will get lesser amount per unit than NAV
EXPENSES RATIO! INCOME RATIO (METHOD OF EVALUATION)
Funds can be evaluated based on expenses ratio and income ratio
Expenses Ratio : it is the ratio of total expenses to average net assets of the funds.
o This ratio is important for evaluating bond fund
64
o Expenses do not include brokerage paid since it is capitalized and therefore
expenses may be understated
Income Ratio = Net Investment Income
Net Assets
o Income ratio is important for evaluating bond Rinds
PORTFOLIO TURN OVER RATE METHOD OF FUND EVALUATION
Another measure of fund evaluation is portfolio turn over rate
Portfolio turnover rate = Total Sales & Purchases Net Assets of the Fund
Higher turnover rate indicates
More churning of portfolio
More transaction costs
Portfolio turn over ratio relevant for actively managed funds
IMPORTANCE OF BENCH MARKING IN EVALUATING FUND
PERFORMANCE
Three methods of evaluating fund performance
o Evaluating fund performance against bench marks
o Evaluating fund performance against other peer group mutual fund schemes
65
o Evaluating fund performance against other financial products
FUND EVALUATION AGAINST BENCHMARKS
Funds performances can be evaluated against some performance indicators called
benchmarks
Mutual funds are required by regulations to state the benchmark in the OD against
which scheme performance will be compared
Investors expect fund performance better than the benchmark
BENCHMARKS FOR EQUITY FUNDS
BENCHMARKS FOR DEBT FUNDS & MONEY MARKET FUNDS
66
Bo
nd Funds with over 60% in Bonds to use Bond Market Index
Balanced Funds should use Tailor Made Index
BENCHMARKS FOR DEBTS FUNDS & MONEY MARKET FUNDS
There are various Indices for benchmarking of debt funds
Bex index of I-SEC is used for tracking govt. Security performances
Crisil has 8 debt indices for tracking performances of corporate bond market &
money rnarket
NSE has govt. Security index & treasury bill index -
BENCHMARKING AGAINST OTHER MUTUAL FUNDS
Peer group comparisons:
Performance of fund can be compared with similar schemes of other mutual funds.
Criteria for peer group comparison would be similarity in
o Investment objectives and rating profile of portfolios
o Average maturity of debt portfolios
67
o Size of fund big or small
Higher expenses ratio of a debt fund hurts long term debt investors
BENCHMARKINQ WITH OTHER FINAN PRODUCTS
Comparison with other comparable financial products
Risk return relationship to be considered
Liquidity factors to be considered
Average annualized compounded returns to e compared
FUND PERFORMANCE RANKING
68
Fund performance evaluation & ranking done by Crisil
Fund house rating done by Crisil
SOURCES FOR TRACKING MUTUAL FUND PERFORMANCE
Following sources of information can be used to track performances of mutual fund schemes
Mutual funds annual periodic reports
Mania! funds website
AMFI website
Daily financia] news papers
Fund tracking agencies - Credence, Value Research & Lipper India
Newsletters from brokers.
Offer document of the fund
Analytical articles
69
CHAPTER-IX
RECOMMENDING FINANCIAL
PLANNING STRATEGIES
TO
INVESTORS
70
INVESTMENT STRATEGIES FOR INVESTORS
Start planning & investing early and regularly. Use SIP
Invest for long term.
Have realistic expectation of returns on investments
Harness the power of compounding by choosing growth option.
Choose an-investment strategy to maximize returns on investments
o Buy and hold strategy
Can be adopted for good mutual fund schemes but not for individual
stocks
o Rupee cost averaging strategy for investment
o Value averaging strategy for investments
UPEE COST AVERAGING STRATEGY OF IN VESTMENT
Rupee cost averaging RCA involves the following
o A fixed amount is invested at regular intervals
o More units are bought when NAY is low
o Fewer units are bought when NAY is high
o Over a period, average purchase price per unit is lower than average NAY
o This strategy does not tell you when to sell am! switch
o Investor use SIP to implement RCA
71
VALUE AVERAGING STRATEGY OF INVESTMENT
Value Averaging Strategy involves the following
o A fixed amount is targeted as a desired value of the portfolio at regular
intervals
o If market values go up
Units are so to restore target value
o If market values go down -
More investments are made to maintain target value
o Over a period,
Average purchase price per units is lower than
If one tries to guess the highs and of market
VALUE AVERAGING STRATEGY
Value averaging strategy is superior to RCA
It enables you to book profits and rebalance portfolios
Investors can use SWP to implement value averaging strategy
Investors can use mm funds and equity finds to implement value averaging strategy
SET ALLOCATION PRINCIPLES
Asset allocation is basic tool to translate financial plans into action.
Asset allocation is determining the percentages of investments to
beheld in equities, bonds and money market instruments
Over 95% of returns on managed portfolio come from the right
Level of asset allocation amongst stock, bonds & cash.
72
Asset allocation differs for investors depending upon
o Their personal situation,
o Financial goals and
o Risk appetite
MODEL PORTFOLIO FOR INVESTORS BENJAMIN GRAHAM’S 5O5 BALANCE
STRATEGY FOR ASSET ALLOCATION
50/50 split between equities and bonds-
o A common sense approach
o Conservative investments approach
o When value of equity goes up ,balance restored by liquidity part of equity
portfolio or
o vice versa.
o Good to get half the returns of a rising market and avoid the fbll losses of a
falling market.
MODEL PORTFOLIO FOR IN\ SUGGEST BY BOGLE
Bogle suggests the following combinations:
1. A basis managed portfolio
o 50% in diversified equity & ‘value’ finds
o 25% in a Govt. Securities Funds
o 25% in High Grade Corporate Bond Funds.
2. A Basic Indexed Portfolio
o 50% in Total Stock Market Index Fund
o 50% in Total Bond Market Portfolio
73
3. A Simple Managed Portfolio
o 85% in a Balanced 60/40 Fund.
o 15% in Medium TenTi Bond Fund 4, A Complex ManaQed Portfolio
o 20% in Diversified Equity Fund
o 20% in Aggressive Growth Fund
o 10% in Specialty Funds
o 30% in Long Teim Bond Funds
o 20% in Short Term Bond Funds
5. A Readymade Portfolio
Single Index Fund with 60/40 Equity / Bond Holdings
Bogle’s Rule of Thumb for Asset Allocation
Debt Portion of an investor’s portfolio to be equal to his age.
30 year old investor — 70/30 (Equity I Debt Allocation)
BOGLE’S STRATEGIC ASSET ALLOCATION STRATEGY FOR INVESTORS
Bogle recommends the following factors to be considered in strategic asset allocation strategy
for investors:
o Age
o Financial Circumstances
o Objectives
Equity / Debt
Lounger Investors in Accumulation Phase 80 / 20
Older Investors in Accumulation Phase 70 / 30
Younger Investors in Distribution Phase 60 / 40
74
Older Investors in Distribution Phase 50 / 50
FIXED v/s FLEXIBLE ASSET ALLOCATION STRATEGY
Asset Allocation percentages can be on Fixed or Flexible Basis
Fixed Ratio of Asset Allocation:
o Balance maintained by liquidating a part of the position in the Asset class with
higher return and
o reinvesting in the other assets with lower returns
Flexible Ratio of Asset Allocation:
o Not doing any rebalancing and
o letting the profits run
Fixed ratio approach works better in bull markets
INVESTICAL ASSET ALLOCATION STRATEGY
Change in Asset Allocation percentages based on Fund Manager’s views on the future
movements in asset prices.
May invest more in shares of small companies than large companies.
May change the equity debt mix where they expect greater returns.
75
CHAPTER-X
SELECTING THE RIGHT
INVESTMENT PRODUCTS
FOR
INVESTORS
76
ASSET TYPES — PHYSICAL & FINANCIAL ASSETS
Physical Assets
o Real Estate
o Gold
Financial Assets
o Bank Deposits - Bond I Debentures
o Company Deposits - Commercial Papers
o NSC, KVP, PPF - Certificate of Deposits
o RBI Relief Bonds - Life Insurance Policies
o Equity / Preference Shares - Mutual Funds
GUARANTEED AND NON GUARANTEED INVESTMENTS
Guaranteed Investments: Capital protection and interest rates are guaranteed by the
borrower.
Bank Deposits
Government Savings Instruments
Non — Guaranteed Investments: Capital protection and interest rates are Not
guaranteed
Mutual Funds
Equity Investments
77
PHYSICAL ASSETS
Individuals can invest physical assets e.g. Gold & Real Estate
Govt. has permitted issue of Gold Bonds by Banks
Gold Bonds represent securitization of Gold Where they earn some returns and avoid
risks associated with storage of gold
Investors are likely to be allowed to invest in gold linked units schemes
Real Estate M.F. are also in the offing Which Will offer the investors the twin
benefits of
o Real Estate Investing &
o Mutual Fund Investing
FINANCIAL PRODUCTS & ISSUERS
ISSUER PRODUCT AVAILBLE TO
Banks Fixed Deposits Investors.MFs.
Corporates Shares Investors.MFs.
Bonds, Debentures Investors.MFs.
Fixed Deposits Investors.MFs.
Government Govt. Securities Investors.MFs.
PPF Investor
Bonds Investors.MFs.
Insurance Policies Investor
EVALUATING FINANCIAL PRODUCTS
PRODUCT SAFETY/ LIQUIDITY RETURNS VOLATILITY
78
CONVINENCE
Equity Low High/Low High-
mod
High
F1 Bonds High Moderate Mod.-
High
Moderate
Debentures Moderate Low Mod-Low Moderate
Corp. FD Low Low Moderate Low
Bank Dep. High High Low-High Low
PPF High Moderate Moderate Low
Life Ins. High Low Low-Mod. Low
Gold High Moderate Mod.-Low Modarate
Real Estate Moderate Low High-Low High
Mutual
Fund
High High High Modarate
WHY MF IS BEST OPTION?
MF combine the advantage of each of the investment product choices
It reduces the short comings of other options
Returns in mutual funds get adjusted for market changes/movements
INVESTING THROUGH MF’S Vs DIRECT EOUITY INVESTMENT
Identifi’ing stocks without detailed research is difficult in direct equity rnvestment
Diversification easily achieved in MF
Professional management employed in ME
79
Investment activities based on investment objective in MFs
MFs offers more liquidity
Transactions costs are Lower of MFs
More convenience in mutual funds
INVESTOR’S PERPECTI YES: MF’S V/s OTHER PRODUCTS
80
CHAPTER-XI
HELPING INVESTORS
UNDERSTAND RISKS
IN FUND INVESTORS
81
CLASSIFICATION OF INVESTORS
Risk Tolerance Levels of Investors
o Low Risk Tolerance
o Moderate Risk Tolerance
o High Risk Tolerance
CLASSIFICATION OF FUNDS BASED ON RISK LEVELS
LOW RISK FUNDS
Money Market Fund
Government Securities Fund
Moderate Risk Funds
Income Fund
Balance Fund
Growth & Income Fund
Growth Fund
Short Term Bond Fund
Intermediate Bond Fund
Index Fund
82
High Risk Funds:
Aggressive growth fund
International fund
Sector fund
Specialized fund
Precious Metal find
High Yield fund
Commodity fund
Index find
JACOBS RECOMMENDATIONS FOR PORTFOLIO ALLOCATION
WITHIN EACH CATEGORY
Low Risk (Conservative) Portfolio:
50% - Gilt Fund + 50% Money Market Fund Moderate Risk (Cautiously A Portfolio
40% - Growth and Income Funds
30% - Gilt Funds
20% - Growth Funds
10% - Index Funds
High Risk (Aggressive) Portfolio:
25% - Aggressive Growth Funds
25% - International Funds
25% - Sector Funds
83
15% - High Yield Funds
10% - Gold Funds
RISKS IN MUTUAL FUND INVESTING
Risk in a generic sense means the possibility of financial loss
In the investment world possibility of financial loss arises from variability of earnings
from time to time.
A fund with stable, positive earnings is less risky
Than a fund with fluctuating total return.
Risk is thus equated with volatility of earnings — a statistically measurable concept.
RISK IN EOUITY FUNDS
Volatility of earnings of an equity fund conies from
o Kinds of stocks
o Degree of diversification
o Fund manager’s success at market timings
Equity funds are exposed to equity price risks arising out of
o Company specific risk
o Sector specific risk
o Market level risk
Market level risk
o Not diversiflable, not controllable because of changes due to broad economic,
political and other factors.
o Can be controlled to some extent through equity index fund or futures and
options.
RISK MEASURES OF AN EQUITY FUND
84
Beta Co-efficient Measure of Risk
EX Marks or ‘R Squared’ Measure of Risk
Standard Deviation Measure of Risk
RISK MEASURES
Beta Coefficient Measure of Risk:
o Beta relates a fund’s return with a market index.
o Measures the sensitivity of the fund’s returns to changes in the Market Index.
o Beta of 1 — Fund moves with the Market i.e. Passive Fund
o Beta of less than 1 — Fund less volatile than the market i.e. Defensive Fund
o Beta of more than 1 — Higher Beta — greater returns in rising markets and
higher losses in falling markets i.e. Aggressive Fund.
Ex — Marks or ‘R-squared’ Measure of Risk
o Ex-Marks represents co relation with markets
o Higher the ex-Marks, Lower the risk of the fund
o A fund with higher ex-marks is better diversified than a fund with a lower ex-
mark.
Standard Deviation Measure of Risk
o A statistical concept, which measures volatility.
o Measures the fluctuations of Fund’s returns around a mean le
o Basically gives you an idea of how volatile your earnings are
o Broader concepts than Beta.
o Measures total risk and not just the market risk of the portfolio.
RISK ADJUSTED PERFORMANCE MEASURES
85
Risk and Returns have co-relation.
Risk adjusted return is measured by using Sharpe ratio or Treynor ratio
SHARPE RATIO = Risk Premium
Fund’s Standard Deviation
TREYNOR RATIO = Risk Premium
Fund’s Beta
Risk Premium
o Difference between the fund’s average return and risk free return on
Government securities or Treasury Bills over a given period
PRICE EARNING MULTIPLES:
o Higher the Fund’s P/F, Higher the probability of its fall in thud values in future.
RISK MEASUREMENT OF DEBT FUNDS
Beta or P/E ratio not relevant to Debt Funds.
Debt Funds exposed to Risk of loss through
o Default (Non Performing Assets) and
o Interest Rate Changes.
Look at the average maturity (duration) of a debt portfolio
o Greater the loss if interest rates go up.
86
CHAPTER-XII
RECOMMENDING MODEL
PORTFOLIOS
AND
SELECTING
THE RIGHR FUNS
87
JACOBS’ FOUR STEPS TO DEVELOP A MODEL PORTFOLIO FOR A CLIENT
1. Work with investor to develop long term goals.
2. Determine the asset allocation of the investment portfolio.
3. Deterrniiie the sector distribution.
4. Select the specific fund manager and their schemes.
MODEL PORTFOLIOS FOR CLIENT’S RECOMMENDED BY JACOBS
For Young Unmarried Professional -
o 50% in Aggressive equity funds
o 25% in High yield bond funds and growth & income funds.
o 25% in Conservative money market funds.
For Young Couple with 2 incomes & 2 children
o 10% in Money Market Funds
o 30% in Aggressive Equity Funds
o 25% in High Yield Bond Funds and Long Term Growth Funds.
o 35% in Municipal Bond Funds.
88
For Older Couple, Single Income
o 30% in Short Term Municipal Funds.
o 35% in Long Term Municipal Funds
o 25% in Moderately Aggressive equity funds.
o 10% in Emerging growth equity funds
For Recently Retired Couple
o 35% in Conservative equity funds for capital preservation.
o 25% in Moderately Aggressive equity for modest capital
growth
o 40% in Money market funds.
JACOB’S MODEL PORTFOLIO FOR INVESTORS
Investors in accumulation phase:
Asset Allocation %
Diversified Equity, Sector & Balanced Funds 65 to 80
Income & Gilt Funds 15 to 30
Liquid Funds & Bank Deposits 5
Investors in Transition Phase:
o Mid-forties when children are approaching the age of higher education or marriage.
o Start Converting
Some of your equity investment into income and cash funds
To prepare for these financial commitments.
Investors in Distribution or Reaping Phase: -
89
Assets Class Allocation %
Diversified Equity & Balance Funds 15 to 30
Income Funds 65 to 80
Cash Funds 5
MODEL PORTFOLIO OF INDIAN INVESTORS BASED ON MUTUAL FUNDS
AVAILABLE IN INDIA
Investors in Intergenerational Transfer Phase
Young Investor up to age 50 years
o Life Insurance Policy
o To take care of next generation in the event of death.
Older Investors
o For grown up children
Balanced Corithination of Income & Growth Funds
o For grand children
Growth funds
o For charitable institutions
Income funds to provide current income.
Investors in Sudden Wealth Stage
o Keep money in Liquid Funds.
o Take time to decide what to do with the money.
Affluent Investors
90
o Wealth Creating Individuals — 70% to 80% in Diversified Equity and
Sector Funds.
o Wealth Preserving Individuals — 70% to 80% in Income, Gilt & Liquid
Funds.
EQUITY FUND SELECTION FOR A CLIENT
Select Specified Fund I Schemes For Inclusion in The Model Portfolio.
Bogle Approach:
Selecting equity funds
o Classify the available equity schemes into growth, value, equity income,
broad based specialty etc.
o Either Select main stream growth or value fund providing broad
diversification.
o Select differentiated growth or value fund or specialty fund where risk and
return vary from market.
o Evaluate past returns records of avai funds
Review Salient Feature Of A Scheme
o Fund size
o Fund age
o Portfolio managers experience
o Cost of investing
91
o Portfolio characteristics cash position, portfolio concentration, market
capitalization
o Portfolio turnover
o Portfolio statistics
o Ex Marks, Beta, Gross Dividend Yield.
DEBT FUND SELECTION FOR A CLIENT
Selecting Debt Funds
Narrow down the choice
Know your investors’ objectives
o For young investors- long term bond funas
o For retired investors- monthly income funds
Determine the right selection criteria
o Fund age
o Fund size
o Relative yields
o Relative costs
o Portfolio characteristics
o Average maturity
o Tax implication
o Bonds vs bond fund
92
o Post returns and
o Expense performance
SELECTING MM / BALANCE FUNDS FOR A CLIENT
Selecting Money M Funds
o Costs, quality, yields.
Selecting Balance Funds
o Rarely- 50/50
o Equity oriented balanced funds or income oriented balanced funds.
o Selection criteria (Portfolio Balances, Debt Portfolio
o Characteristics , Costs, Portfolio Statistics, Returns)
Chapter-XIII
Business Ethics
For
Mutual Funds
93
WHAT IS MEANT BY BUSINESS ETHICS?
Business ethics means rules of acceptable & good conduct
Every person engaged in any business must comply with a set of mies of good
conduct
Rules may be set by those who own and manage business or by agencies regulating
such business
In addition to laws, rules of ethics are adopted by the business practitioners
themselves
Ethics go beyond the laws
Laws are enforced by regulators. Ethical codes are self enforced.
WHAT IS THE NEED FOR BUSLNESS ETHICS
The need for business ethics arises from the need to protect the consumer
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Ethical practices means practices in the interest of the consumer of a product or user
of a service
A consumer who feels cheated once will not buy the product again.
Mutual funds and their sales person are required to adopt ethical and good business
practices
Consumer of goods and services expect the goods and services meets the promises.
A sales persons is expected to know the product thoroughly
Not promising more than what the product gives is an ethical business practice.
AMFI’s code sets a common set of rules for all the funds.
OBJECTIVES OF BUSINESS ETHICS
One major objective of business ethics is being honest, open and transparent with
your potential clients.
another objectives of business ethics is to protect the consumer of goods &services
from being cheated or exploited
In mutual fund industry the product is described in detail in the
offer documents.
AMF sets rules of goods conduct by fund distributed
SOME KEY TERMS OF BUSINESS ETHICS
Fair business practice Ensure that business is cqnducted both hi the
interest of the seller and consumer! investors.
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Ethical standards are bench marks set for acceptable level of performance
Ethical norms or guidelines: these norms may be voluntary or compulsory
A code of conduct: it is voluntarily adopted set of good conduct,
acceptable to the business participants, the regulators & SRO’s
Ethical business practices: they ensure with compliance with rules &code of good
conduct.
Conflict of interest: in mutual fund business there are situations where the interest of
the investors runs counter to the interest of the agent
BUSINESS ETHICS & MUTUAL FUND REGULATIONS IN INDIA
The main role of SEW is to protect the interest of the investors.
SEBI encourages development of ethical standards among the mutual thnds
SEBI guidelines require mutual funds and AMFI to develop code of
conduct for
o Distributors
o Fund managers all employees
o Associate persons
SEBI also lays down its own rule of ethics for certain matters incorporated in the
Mutual Fund regulations
SEBI mandates that all activities are done in the best interest of the regulators mid it
monitors 3 areas
o Fund structure and governance
o Exercise of voting right’s by finds
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o Fund operations
The Mutual Fund structure in India is
o A 3 tier structure
o With sponsor, trustees & AMC as independent bodies
AMC’s are supervised by independent trustees
o Who have fiduciary responsibility towards the Investors.
There is a separation of functions,
o AMC charged with investment of funds and they don’t hold
asset of the fund.
o The Trust holds investment assets in fiduciary capacity since
beneficial owners are investors.
o Trustees actually don’t hold the trusts assets — investment assets
are held by the custodians.
By separating ownership, management & custody of assets
fraudulent use of assets is prevented.
Board of trustees have at least 2 I independent directors
o Thus ensuring independence of organization.
AMC board has at least 50% independent directors
Thus reducing the influence of the promoter.
The Mutual Funds have to exercise voting rights in the companies
o In the interest of fund investors and
o Not in the interest of fund managers or promoters or employees.
It is an Ethical but not a legal requirement
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SEBI expects day to day find operations to be free from unethical business practices.
o Insider trading regulations
o No preferential treatment to selected investors
o Control over personal trading by find managers and employees
o Uniform cut Off Time for accepting subscription application & for
determining applicability of uniform NAVs to all customers.
o Personal trades to be disclosed by the fund managers and the directors.
o All forms of advertisements to be as per SEBI regulations. To ensure that they
don’t mislead the investor
o Regulations require the trustees of the mutual fund to certify that the persons
of the AMC do not indulge in front running or self dealing.
o There are regulations on hind advertisements.
SEBI has made it mandatory for the AMC to appoint a compliance officer to ensure
implementation of laws and mutual find regulation & voluntary code of conduct.
SEBI requires all distributors to follow a code of conduct.
AMFI has put in place amore detailed code of conduct called AGNI
Mutual funds have to report any violation of all these regulations.
BUSINESS ETHICS & FUND REGULATIONS IN THE U.S.
The U.S Regulator (Security Exchanges Commission) Require at least 75% of the
funds board to be independent directors including the Chairman.
Independent directors are required meet separately every quarter and make self
assessment of their effectiveness
SEC requires registered investment advisors to adopt and enforce codes of ethics
applicable to their supervised persons, including personal trading
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Supervised persons have to acknowledge in writing receipt of copy of the code of
Ethics.
An advisor’s code will require the advisor’s supervised persons to comply with
applicable federal securities laws.
o There is requirement of reporting of personal securities holding &
transactions, including transactions in Mutual Funds advised
o by the advisor.
o The code requires access persons to pre clear any personal investments in
IPOs
o Prevention of disclosure of material non public information about the advisors
Buy and sell recommendations.
o Reporting of code violations to the compliance officer
The law requires intuitional investors to invest as a prudent man would invest.
The mutual fund managers have also to follow ‘Prudent Man’
Approach’ & ‘Responsible Investing Approach’ even though there is no law.
Responsible Investing means
o Ethical criteria may preclude investing in companies manufacturing cigarettes
or alcohol
o Voting in share holders meeting in the interest of the investors.
o Community investing to help the tinder privileged communities.
New Regulations & Fair Business Practices Require
o AMCs to avoid making special payments to distributors and brokcrs
o Uniform cut off time for all finds for NAV calculations
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OBSERVATION AND FINDINGS
If we analyze all the above findings from the survey, it gives a very clear picture regarding
the awareness investment avenues available in India and it gives an idea on the financial
planning done by people of Bhubaneswar to make their future more safe. The finding,
visualizes the perception of the population regarding Mutual funds.
From the analysis we can say, that People are more ever aware of investment avenues like
Bank FD, Postal FD, and Insurance, while more than 60% of people know there exists an
investment avenue called Mutual fund.
But unfortunately they have very little idea about the percentage of returns delivered by some
of the performing Mutual funds (where the average return was 26.3%). That is one of the
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vital points, why they never took an interest in Mutual h In we can also see that people who
have some idea are only aware of the Returns provided by mutual finds. they are hardly
aware other attributes like moderate risk and tax benefits etc.
We can conclude that if some strong steps are taken in creating an awareness of Mutual finds,
with its entire technicality, vyhich will certainly help in the growth of Mutual fund market in
Bhubaneshwar.
Due to unawareness and less knowledge regarding mutual hinds people still don’t believe
investing a chunk of their money into it. It has only been able to penetrate a small portion of
the population. People th Bhubaneshwar are still unaware of the benefits of SIP, which can
attract a larger part of the rural areas population to invest in Mutual funds. This is because
most of the populations belong to the middle class category and are now in the process of
growth in their economic standards.
Very few people have now chosen Mutual fund as an investment option and this is mostly
due to the past experience with UTI. So, now they are not interested in putting money into
mutual funds.
So there is a strong requirement of educating these people about the regulatory body that now
are actively working as watch dogs that are keeping track of this industry and ensuring it as a
safe investment avenue.
Bank & postal Fixed Deposits and Insurance were more preferred avenues five yeas back.
In the recent times, the Insurance has become a more preferred avenue in comparison to
others. And simultaneously mutual funds, equity market investments and real estate are
getting included th the investment portfolio.
One forth of the populations still don’t believe in new investment avenues, and these mostly
include the old people, who have witnessed the era before late nineties.
In Bhubaneswar people still don’t believe in taking professionals help for managing their
investment portfolio, which makes them unaware new in avenues in market and they miss the
opportunity.
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In India Mutual fund Industry has seen Dramatic improvements in Quality as well as quality
Qf products and services offering over the past decade, but the industmy has witnessed
growth in the last 10 years considerably below
Potential.
The Asset under Management have grown from about Rs. 470 billion in march 1993 to Rs.
1,540 billion in April 2004(CAGR of 11.4 percent) & now it grown to Rs. 1,679 billion till
June 2005. This has mainly achieved due to collection through mutual tund IPO’s that has
been increasing due to the investors feeling that it is cheaper in its IPO stage on account of its
Rs. 10 NAy.
There has been a strong appreciation in equities in comparison to the debt market which has
shown a downward trend last year. Aiid in turn Mid-cap and diversified funds have delivered
the highest in comparison to other funds. As the Indian economy is showing a growing trend
with GDP more than 6% and expected to show 8% and Indian household saving being 24%
of the entire GDP. There is a strong growth potential of Mutual fund.
CONCLUSION
Despite its crucial importance, the Mutual Funds are the least understood and most
misunderstood phenomenon, particularly by the retail investor. All economists, all over the
world, recognize him as the main artery supplying blood to the heart of the economy of the
nation. It is necessary to try and impart the much-needed insight into the system and clear his
cobwebs, in an Endeavour to help him understand this phenomenon. -
There has been a perceptible change In sweeping across the mutual fund landscape in India.
Factors such as changing investors’ needs and their appetite for risk, emergence of Internet as
a powerful servicing platform, and above all the growing commodization of mutual fund
products are acting as a major catalysts putting pressure on industry players to formulate
strategies to stay die course.
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In the changed scenario today, product innovation is increasingly becoming one of the key
determinants of success, Building and sustaining a powerful brand is also becoming an issue
of paramount importance. Increased deregulation of the financial markets in the country
coupled with the introduction of derivative products offers tremendous scope for the industry
to design the sell innovative schemes to suit individual customer needs.
Distribution has taken a whole new meaning with the introduction of automated trading,
clearing and settlement system. Factors such as cross- selling through modes like financial
institution, banks, post-offices and co branded credit cards are bound to play a decisive role
in the success of the industry players. Mutual funds still after 40 years of its presence doesn’t
have a strong foothold. The main reasons behind this are past experience faced by most of the
old people with lt. S 64 crisis, and the awareness level on all the benefits provided by this
Industry.
As we can see a steady growth in the economy of India where, the BSE sensex has crossed
the magic around 12000 points mark and the GDP which is growing at present percentage of
9 and above, along with the flow of FIIs which are playing vital role in the growth of the
economy. The market is showing strong increase in the midcap companies that are in
growing stage. Until now, any change in FII investment strategies would rock the market and
have a severe impact on valuations. But, if mutual fluids and domestic financial institutions
have a larger stake in the market, it is more likely to remain stable. So more initiatives needs
to taken for creating the awareness of mutual funds among the retail investors, which is the
larger section of the entire Indian population. So we can say that, Mutual funds in India, as an
investment vehicle, still have a miniscule penetration level compared to that in develop
countries. This certainly portends plenty of opportunity.
Orissa as a market was not that efficient few years back, but now with lot of multinational
companies and other reputed companies coming down, the Orissa market is slowly picking
up. For mutual funds it is one of the emerging markets that can be trapped form its
developing stage and though people of rural areas prefer Moderate risk they can easily accept
mutual funds. So, Mutual Fund industries can use these market conditions and the
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opportunities coming up for creating more awareness, It should try to capture the retail
investors along with the HNI’s those are going to put a substantial effect on the mutual fund
market. And help its customers to properly manage their disposable fluids and generate
returns from their investments. Which in turn will give a strong stability to the market if not
entirely, but certainly to a great extent. And in turn the Mutual fund industry will flourish in
Orissa / Bhubaneswar and India at large.
BIBLOGRAPHY
SBI :SBI Mutual Fund Handbook
Magazine :Business Today
: Business World
News Papers :Economics Times
: Financial Express
Website :www.sebigov.in
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: www.arnfiindia.com
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