Chapter 6
Mutual Funds
Summary
Mutual fund have become hot favorite of millions of people all
over the world because of safety of principal guaranteed. One can own
a string of blue chips like ITC, TISCO and Reliance etc. through mutual
funds. In this way, mutual funds act as a gateway to enter in big
companies. Mutual funds works on the principle of ‘small drops of
water make big ocean’! It is formed by number of investors coming
together, who transfers their surplus funds to a professionally qualified
organization to manage it.
From all above discussion, it is very clear that, small investors to
earn added advantage of capital appreciation together with interest or
dividend creates that mutual fund.
The definition of Mutual Fund is given by Securities & Exchange
Board of India (Mutual Fund) regulation 1993 as, “a fund established
in the form of a trust by a sponsor, to raise monies by the trustees
through the sale of units to the public, under one or more schemes for
investing in securities in accordance with these regulations”. These
mutual funds are referred to as Unit Trusts in UK & open end
investment companies in USA. So in short mutual funds are
corporations, which pool funds by selling their own shares & reduce
risk by diversification.
Now, one may ask what is difference between shares & fund
unit. Let’s know it. The basic difference is investment on equity share
represents investment in a particular company alone, where as
investment on a unit of fund represents investment in the parts of
shares of a large number of companies. This itself gives an idea, how
safe the units are. The next one is mutual fund investment is for
genuine investors & share investment is for speculators.
The origin of the mutual funds is dates back to Egyptians &
Phoenicians. The real credit of introducing modern concept of mutual
funds goes to the Foreign & Colonial Government Trust of London
established in 1968. Therefore, a large number of close-ended mutual
funds were formed in USA. In India, it gain momentum only in 1980,
though it began in the year 1964 with the Unit Trust of India launching
its first Unit Scheme 1964.
In the investment market, there are varieties of investors with
different needs, so it is really very difficult to offer one fund to satisfy
the entire requirement of investors. So there are many types of
mutual funds available in the market for investors. Those can be
presented through chart as below.
MUTUAL FUNDS
On the basis of
execution and
operation
Closeended
On the basis of
yield and investment
pattern
Openended
Income
Fund
Growth
Fund
Balance
Fund
Specialised
Fund
Mutual Fund
Money Taxation
Market
Fund
Let’s now discuss some of the main types in brief.
1. Close-ended funds: Under this scheme, the corpus of the fund,
its duration & size is fixed. Once fund reaches its maximum
level, the entry of investor is closed. Then after expiry of fixed
period, the entire corpus is disinvested & proceed are disbursed
to unit holders.
2. Open-ended funds: As the name suggest, it is exactly opposite
of close ended fund. The investors are free to enter & exit at any
point of time. The best e.g. is Unit 1964 plan.
3. Income fund: This type of fund aims at generating regular
income. It sees that the average return is higher than that of
bank deposits.
4. Money Market Mutual Fund: These funds are open-ended
funds but they invest in highly liquid & safe securities like
commercial papers, certificates of deposit. They pay money
market rates of interest. In USA, these funds called as “money
funds”. In India, the entry to Money Market Mutual Funds is
restricted only to schedule commercial banks & their
subsidiaries. RBI also fixed minimum amount of investment is
Rs.1 lakh.
Beside of the chart there are other types. Some of them are:
¾ Leveraged Funds
¾ Dual Funds
¾ Index Funds
¾ Bond Funds
¾ Aggressive Funds
All this different types of funds are meant for individual to
institutional investors for gaining from their surplus. Since the every
individual is very keen & cautious about his investment, the mutual
fund is becoming more & more vital. Some of the importance of
mutual funds can be stated as below:
1. Canalising Savings for investment: Due to large number of small
investors, mutual funds plays important role in diverting those
small investment directly to capital investment.
2. Offering wide Portfolio investment: As stated earlier, the
investment in mutual fund is too much safe than that of in equity
investment. The small investors can enjoy the wide portfolio of
the investment held by mutual funds.
3. Providing better yields: Mutual funds pool the funds from large
number of customers, enables them to have large funds at its
disposal. So they can command market better than others & the
cost of transaction is also less. This entire enable them to
provide better return on investment. The most of mutual funds
so for given divided @ 12% to 17% p.a.
Although, we have seen till now, investment in mutual funds is
safe & secure but must know the fact that, the money collected from
small investors by mutual funds are invested in stock market on
shares which are volatile in nature & are not risk free. So market risk,
scheme risk, investment risk, business & last but not least is political
risk are inherent in their dealings.
The structure of mutual fund operation is three tiers namely:
1. A sponsor institution to promote the fund.
2. A team of trustees to oversee the operation.
3. An asset management company to actually deal with
funds.
There are number of facilities available to investors of mutual
funds like Repurchase facilities commonly known as buy back, reissue
facilities, Rollover facilities, & lateral shifting facilities. When
repurchase or buyback facilities are adopted by mutual funds, the
question comes in to the mind is, at what price it’s buying back? The
value is determined by Net Asset Value commonly known as NAV. This
price is derived by dividing market price of investment by scheme size
& multiplying it with value of each unit. For e.g. Positive Mutual Fund
has introduced a scheme called, Trustworthy scheme having scheme
size in 200 crores. The value of each unit is Rs.10/- & it has invest all
the funds in market & the market value of the investment comes to
400 crores. Now the NAV is calculated as below.
NAV =
400 x 10 = 20
200
So the value of each unit is 10/- but it’s worth Rs.20/-. The SEBI
Regulation 1993 contains specific provision regarding investor
servicing. The main points are i) Unit Certificate ii) Transfer of Unit iii)
Refund of application money iv) Audited Annual Report etc.
For proper functioning of mutual funds, the guidelines were
issued by government of India. Some of them are:
¾ RBI & others would regulate money market mutual funds
by SEBI.
¾ Mutual funds should be operated only by separately
established (AMCs).
The other guidelines are about business activities, schemes,
investment norms, income distribution, accounting norms etc.
Government of India & SEBI are always in close look of the activities of
mutual funds, since very large volume of individual contributing the
mutual funds & economy is also depends on progress of mutual funds.
So during April 1996, SEBI released an exhaustive study on the
mutual funds industry called “Mutual Fund 2000”. This study given,
nearly 10 to 11 suggestions,
The main points one should take into account, while selecting
mutual fund are a) Objective of fund b) Consistency of performance
c) Historical background d) Cost of operation e) Capacity of innovation
f) Investor servicing g) Market Trends & transparency of the mutual
fund management. These points are very vital while selecting mutual
fund to start investing.
In India, the Unit Trust of India has monopolized Mutual Fund
Industry since 1963. Now SBI, Canara Bank, Indian Bank has entered
into field. As on 30-9-95 there are nearly 25 mutual funds offering 80
different schemes & serving nearly 60 million investors. The private
sector entered in 1993, concentrating on primary market. The mutual
fund investment in India has been preferred as an avenue by
household savers from 1990. The sale of Unit which were Rs.890
crores in 1985-86 rose to Rs.4100/- crore in 1990-91 & Rs.9500 crore
in 1993-94. However the rate of growth is comparatively slow & not
much satisfactory.
Some of the main reasons behind slow growth of mutual funds
are:
• Disparity between NAV & Listed price
• No uniformity in the calculation of NAV
• Lack of transparency
• Poor investor servicing
• Too much dependence on outside agencies
• Investor’s psychology etc.
In spite of all these lacunas, the prospects for mutual fund in our
country are bright. The factors responsible for this are:
1. SEBI is lending its full support directly as well as indirectly.
2. Since disbanding of controller of capital issues office, small
investors easily subscribe to mutual funds at par with one’s little
investment.
3. In the recent time, the rate on bank deposit has been declining
& for this reason the household investors looking for alternative
source, which give them higher returns.
4. The trend of rising P.E. ratio, opening of the market to foreign
investors etc. would make stock market inaccessible to small
investors. Hence they have to necessarily go to the mutual fund
industry.
5. The mutual funds offering wider range of products to meet the
requirement.
6. The government also given tax concession & exemptions.
7. The union Budget 1999-2000 contains much measure to
encourage mutual fund industry. Like 3 years dividend tax
exemption, full income tax exemption for all income from U.T.I.
& other Mutual Fund Industries.
Considering above facts, the future of mutual fund in India is
looking bright & it is cost efficient tool for investment. They act as via
media between bank deposit & shares. Now this is the right time to
mutual funds companies to act not only as professional but also as
mutual friends by creating good rapport with investors.