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CONCEPT
♦A Mutual Fund is a trust that pools the savings of number of investors who share a
common financial goal.
♦The money collected is then invested in capital market instruments such as shares,
debentures and other securities.
♦ Mutual funds can thus be considered as financial intermediaries who collect
funds from the public and invest on behalf of the investors.
♦The income earned through these investments are shared by its unit holders in
proportion to the number of units owned by them.
♦A mutual fund is required to be registered with SEBI which regulates securities
market before it can collect funds from the public.
♦Mutual Fund is the most suitable investment for the common man as it offers an
opportunity to invest in a diversified, professionally managed basket of securities at
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a relatively low cost.
Mutual Fund Operation Flow Chart
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History of Mutual Funds in India and
role of SEBI in mutual funds industry
►In the year 1963 -Unit Trust of India was the first mutual fund set up in
India
► In early 1990 -Government allowed public sector banks and institutions to
set up mutual funds.
► In the year 1992- Securities and exchange Board of India (SEBI) Act was
passed. The objectives of SEBI are – to protect the interest of investors in
securities and to promote the development of and to regulate the securities
market.
► SEBI issues guidelines to the mutual funds from time to time to protect the
interests of investors
► All mutual funds whether promoted by public sector, private sector or by
foreign entities are governed by the same set of Regulations and all are subject
to monitoring and inspections by SEBI.
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Issuers of Mutual funds in India
►Unit Trust of India was the first mutual fund which began operations in 1964.
► Public sector banks
SBI, Canara Bank, Bank of India,
Institutions → IDBI, ICICI, GIC, LIC
► Foreign Institutions
Alliance, Morgan Stanley, Templeton, Principal, JM financial, Deutsche etc.
Private financial companies → Kothari Pioneer, DSP Merrill Lynch, JM
financial, Sundaram, Kotak Mahindra, Cholamandalam, Reliance, Birla, Tata,
ABN Amro, Sahara, Escorts, ING Vysya, HSBC, Standard Chartered etc.
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Set up of Mutual fund
A mutual fund is set up in the form of a trust, which has sponsor, trustees,
asset management company (AMC) and custodian.
● The trust is established by a sponsor or more than one sponsor who is like
promoter of a company.
● The trustees of the mutual fund hold its property for the benefit of the
unit-holders.
● Asset Management Company (AMC) approved by SEBI manages the funds
by making investments in various types of securities.
● Custodian, who is registered with SEBI, holds the securities of various
schemes of the fund in its custody.
The trustees are vested with the general power of superintendence and
direction over AMC. They monitor the performance and compliance of SEBI
Regulations by the mutual fund.
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Organization of a Mutual Fund
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● At least two thirds of the directors of trustee company or board of trustees
must be independent i.e. they should not be associated with the sponsors.
● 50% of the directors of AMC must be independent.
● All mutual funds are required to be registered with SEBI before they launch
any scheme.
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Advantages of Mutual Funds
♦ Professional Management
♦ Diversification
♦ Convenient Administration
♦ Return Potential
♦ Low Costs
♦ Liquidity
♦ Transparency
♦ Flexibility
♦ Choice of schemes
♦ Tax benefits
♦ Well regulated
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Types of mutual fund schemes
► On the basis of Objective
Growth / Equity Oriented Scheme
The aim of growth funds/schemes 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.
These schemes provide different options to the investors like dividend option,
capital appreciation, etc. and the investors may choose an option depending on
their preferences.
Growth schemes are good for investors having a long-term outlook seeking
appreciation over a period of time.
There are different types of equity funds such as Diversified funds, Sector
specific funds and Index based funds.
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Sector specific funds/scheme
These are the funds/schemes which invest in the securities of only those
sectors or industries as specified in the offer documents. e.g. Pharmaceuticals,
Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc.
The returns in these funds are dependent on the performance of the respective
sectors/industries.
Generally these funds give higher returns.
They are more risky compared to diversified funds.
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Index Funds/Scheme
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.
Diversified funds/scheme
These funds invest in companies spread across sectors. These funds are
generally meant for risk-taking investors who are not bullish about any
particular sector.
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Income / Debt funds
The aim of income funds/schemes 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.
These funds are not affected because of fluctuations in equity markets.
The NAVs of such funds are affected because of change in interest rates, if the
interest rates fall, NAVs of such funds are likely to increase in the short run
and vice versa.
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Tax Saving funds/scheme
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 pre-dominantly in equities.
Their growth opportunities and risks associated are like any equity-oriented
scheme.
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Gilt Fund/scheme
These funds invest in Central and State Government securities.
They give a secured return and also ensure safety of the principal amount.
They are best suited for the medium to long-term investors who are averse to
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.
Hedge Funds/scheme
These funds adopt highly speculative trading strategies. They hedge risks in
order to increase the value of the portfolio.
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Balanced Fund/scheme
The aim of balanced funds is to provide both growth and regular income to
investors.
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 and NAVs of such funds are likely to be less volatile compared
to pure equity funds.
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Money Market or Liquid Fund/scheme
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.
Returns on these schemes fluctuate much less compared to other funds.
These funds are appropriate for corporate and individual investors as a means
to park their surplus funds for short periods.
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► On the basis of Flexibility
Open-ended Fund/ Scheme
An open-ended fund or scheme is one that is available for subscription and
repurchase on a continuous basis.
These schemes do not have a fixed maturity period.
Investors can conveniently buy and sell units at Net Asset Value (NAV) related
prices which are declared on a daily basis.
The key feature of open-end schemes is liquidity.
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Close-ended Fund/ Scheme
A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years.
The fund is open for subscription only during a specified period at the time of
launch of the scheme.
Investors can invest in the scheme at the time of the initial public issue and
thereafter they can buy or sell the units of the scheme on the stock exchanges
where the units are listed.
In order to provide an exit route to the investors, some close-ended funds give
an option of selling back the units to the mutual fund through periodic
repurchase at NAV related prices.
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Interval funds/scheme
These funds combine the features of both open–ended and close-ended funds
wherein the fund is close-ended for the first couple of years and open-ended
thereafter. Some funds allow fresh subscriptions and redemption at fixed times
every year (say every six months) in order to reduce the administrative aspects
of daily entry or exit, yet providing reasonable liquidity.
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On the basis of geographic location
Domestic funds/scheme
These funds mobilize the savings of nationals within the country.
Offshore Funds/scheme
These funds facilitate cross border fund flow. They invest in securities of
foreign companies. They attract foreign capital for investment.
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Mutual Funds plans
Growth Plan and Dividend Plan
A growth plan is a plan under a scheme wherein the returns from investments
are reinvested and very few income distributions, if any, are made. The investor
thus only realises capital appreciation on the investment. This plan appeals to
investors in the high income bracket.
Under the dividend plan, income is distributed from time to time. This plan is
ideal to those investors requiring regular income.
Dividend Reinvestment Plan
Dividend plans of schemes carry an additional option for reinvestment of
income distribution. This is referred to as the dividend reinvestment plan.
Under this plan, dividends declared by a fund are reinvested on behalf of the
investor, thus increasing the number of units held by the investors.
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Automatic Investment Plan
Under the Automatic Investment Plan (AIP) also called Systematic Investment
Plan (SIP), the investor is given the option for investing in a specified
frequency of months in a specified scheme of the Mutual Fund for a constant
sum of investment.
AIP allows the investors to plan their savings through a structured regular
monthly savings program.
Automatic Withdrawal Plan
Under the Automatic Withdrawal Plan (AWP) also called Systematic
Withdrawal Plan (SWP), a facility is provided to the investor to withdraw a
pre-determined amount from his fund at a pre-determined interval.
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Factors that influence the performance of Mutual Funds
● Stock market→ Equity funds
● Performance of company → Sector funds
● Interest rate and Credit quality → Bond funds
As interest rates rise, bond prices fall, and vice versa.
Bond funds with higher credit ratings are less influenced by changes
in the economy.
● Economy
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Investment restrictions
● Mutual fund will be allowed to invest in transferable securities in the money
market or in the capital market including any privately place debentures or security
debt.
● MF are not allow to give term loan for any purpose
● No MF under all its schemes taken together should invest more than 10% of its
fund in share or debentures or other securities of a single company.
● No MF under all its schemes taken together should invest more than 15% of its
fund in share and debentures of any specific industry (cotton, textile, tea, tires etc.)
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● No scheme should invest in or lend to another scheme under the same AMC
● MF must take and give delivery of script when purchased and sold.
● Transfer of script from one scheme to another in the same MF shall be
allowed at the prevailing market price for quoted instrument and in case of
unquoted instrument transfer should be done with the approval of board of
trustee.
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Frequently Used Terms
Net Asset Value (NAV) of a scheme
The performance of a particular scheme of a mutual fund is denoted by Net Asset
Value (NAV).
Net Asset Value is the market value of the securities held by the scheme.
NAV per unit =
Market value of securities of a scheme
total number of units of the scheme on any particular date.
= Market value of the fund’s investments + Receivables +
Accrued Income - Liabilities - Accrued Expenses
Number of Outstanding units
Market value of securities changes every day, NAV of a scheme also varies on
day to day basis.
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Sale Price
Is the price you pay when you invest in a scheme. Also called Offer Price. It
may include a sales load.
Repurchase Price
Is the price at which a close-ended scheme repurchases its units and it may
include a back-end load. This is also called Bid Price.
Redemption Price
Is the price at which open-ended schemes repurchase their units and closeended schemes redeem their units on maturity. Such prices are NAV related.
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Sales Load or ‘Front-end’ load
Is a charge (commission) collected by a scheme when it sells the units(1 to 2% of
current NAV). Schemes that do not charge a load are called ‘No Load’ schemes.
Repurchase or ‘Back-end’ Load
Is a charge collected by a scheme when it buys back the units from the unit holders
units(0.5 to 2% of current NAV).
Asset Management Company
An Asset Management Company (AMC) is a highly regulated organization that
pools money from investors and invests the same in a portfolio. They charge a
small management fee, which is normally 1.5 per cent of the total funds managed.
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Switch
Some Mutual Funds provide the investor with an option to shift his investment
from one scheme to another within that fund. For this option the fund may levy
a switching fee.
Switching allows the Investor to alter the allocation of their investment among
the schemes in order to meet their changed investment needs, risk profiles or
changing circumstances during their lifetime.
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