MUTUAL FUNDS: April 2007

A BRIEF INTRODUCTION TO MUTUAL FUNDS

"A Mutual Fund is an ideal investment vehicle where a number of investors come together to pool their money with common investment goal. Each Mutual Fund with different type of schemes is managed by respective Asset Management Company (AMC). An investor can invest his money in one or more schemes of Mutual Fund according to his choice and becomes the unit holder of the scheme. The invested money in a particular scheme of a Mutual Fund is then invested by fund manager in different types of suitable stock and securities, bonds and money market instruments. Each Mutual Fund is managed by qualified professional man, who use this money to create a portfolio which includes stock and shares, bonds, gilt, money-market instruments or combination of all. Thus Mutual Fund will diversify your portfolio over a variety of investment vehicles. Mutual Fund offers an investor to invest even a small amount of money.
"Mutual Funds schemes are managed by respective Asset Management Companies sponsored by financial institutions, banks, private companies or international firms. The biggest Indian AMC is UTI while Alliance, Franklin Templeton etc are international AMC's.
"Mutual Funds offers several benefits to an investor such as potential return, liquidity, transparency, income growth, good post tax return and reasonable safety. There are number of options available for an investor offered by a mutual fund.1
1Source: Website of "eastindiavyapaar.com"

Mutual Funds - Scope for Growth and Development in India
Mutual Fund Industry in its true spirit rooted in a free market and oriented towards competitive functioning with the dedicated goal of service to the investors can be said to have settled in India only in 1993. However the industry took its roots much earlier with the setting up of the Unit Trust In India (UTI) in 1964 by the Government of India. During the last 36 years, UTI has grown to be a dominant player in the industry with assets of over Rs.72,333.43 Crores as of March 31, 2000. The UTI is governed by a special legislation, the Unit Trust of India Act, 1963. In 1987 public sector banks and insurance companies were permitted to set up mutual funds and accordingly since 1987, 6 public sector banks have set up mutual funds. Also the two Insurance companies LIC and GIC established mutual funds. Securities Exchange Board of India (SEBI) formulated the Mutual Fund (Regulation) 1993, which for the first time established a comprehensive regulatory framework for the mutual fund industry. Since then several mutual funds have been set up by the private and joint sectors.
Growth of Mutual Fund Business in India
The Indian Mutual fund business has passed through three phases. The first phase was between 1964 and 1987, when the only player was the Unit Trust of India, which had a total asset of Rs. 6,700/- crores at the end of 1988. The second phase is between 1987 and 1993 during which period 8 funds were established (6 by banks and one each by LIC and GIC). The total assets under management had grown to Rs. 61,028/- crores at the end of 1994 and the number of schemes were 167. The third phase began with the entry of private and foreign sectors in the Mutual fund industry in 1993. Kothari Pioneer Mutual fund was the first fund to be established by the private sector in association with a foreign fund. The share of the private players has risen rapidly since then.
Within a short period of seven years after 1993 the growth statistics of the business of Mutual Funds in India is given in the table below:
Net Assets of Mutual Funds as at 3l.03.2000[Source: Website of SEBI]
The net assets of all domestic schemes of mutual funds were Rs.1,07,946.10 crores as on March 31, 2000 as against Rs. 68,193.08 crores as on March 31, 1999 . The details are given below :

Amount(Rs Crs)
Percentage(%)
UTI
72,333.43
67.00
Public Sector
10,444.78
9.68
Private Sector
25,167.89
23.32
Total
1,07,946.10
100.00
During the year 1999-2000, the share of UTI in the total assets of the mutual funds industry has declined to 67% from 77.9% in 1998-99. Net assets of other public sector mutual funds have also shown a decline from 12.09% in 1998-99 to 9.68% in 1999-2000. However, net assets of private sector mutual funds have increased from 9.97% in 1998-99 to 23.32% in the year 1999-2000.
There are 34 private Mutual Funds in the fray and they have seized about 25% of the market share in the brief period of 7 years, mobilising above Rs.25000 Crores from the public
Scope for Development of Mutual Fund Business in India
A 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 a relatively low cost. India has a burgeoning population of middle class now estimated around 300 million. A typical Indian middle class family can have liquid savings ranging from Rs.2 to Rs.10 Lacs today. Investments in Banks are liquid and safe, but with the falling rate of interest offered by Banks on Deposits, it is no longer attractive. At best a part can be saved in bank deposits, but what is the other sources of investment for the common man? Mutual Fund is the ready answer. Viewed in this sense globally India is one of the best markets for Mutual Fund Business, so also for Insurance business. This is the reason that foreign companies compete with one another in setting up insurance and mutual fund business units in India. The sheer magnitude of the population of educated white collar employees provides unlimited scope for development of Mutual Fund Business in India.
The alternative to mutual fund is direct investment by the investor in equities and bonds or corporate deposits. All investments whether in shares, debentures or deposits involve risk: share value may go down depending upon the performance of the company, the industry, state of capital markets and the economy; generally, however, longer the term, lesser the risk; companies may default in payment of interest/ principal on their debentures/bonds/deposits; the rate of interest on an investment may fall short of the rate of inflation reducing the purchasing power. While risk cannot be eliminated, skillful management can minimise risk. Mutual Funds help to reduce risk through diversification and professional management. The experience and expertise of Mutual Fund managers in selecting fundamentally sound securities and timing their purchases and sales, help them to build a diversified portfolio that minimises risk and maximises returns.
The Advantages of Investing in a Mutual Fund
The advantages of investing in a Mutual Fund are:
1. Professional ManagementThe investor avails of the services of experienced and skilled professionals who are backed by a dedicated investment research team which analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme.
2. DiversificationMutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own.
3. Convenient AdministrationInvesting in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and unnecessary follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.
4. Return PotentialOver a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities.
5. Low CostsMutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors.
6. LiquidityIn open-ended schemes, you can get your money back promptly at net asset value related prices from the Mutual Fund itself. With close-ended schemes, you can sell your units on a stock exchange at the prevailing market price or avail of the facility of direct repurchase at NAV related prices which some close-ended and interval schemes offer you periodically.
7. TransparencyYou get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook.
8. FlexibilityThrough features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans, you can systematically invest or withdraw funds according to your needs and convenience.
9. Choice of SchemesMutual Funds offer a family of schemes to suit your varying needs over a lifetime.
10. Well RegulatedAll Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI.
In the following chapters we propose to discuss all relevant information about Mutual Funds in India, the regulatory and legal structure governing them that a common investor ought to know. The literature is mostly drawn from the website of SEB, but suitably tabulated to provide ready information.
Mutual Funds - Origin in USA & Popularity
As with many other innovative financial products, Mutual Funds, as an attractive investment source started in the USA. MF is an investment company created under the Investment Company Act of 1940 that pools the resources of investors to buy a variety of securities, depending on the fund's stated objectives and management style. The investments typically are chosen by a professional manager. Mutual funds offered diversification and convenience even to small investors, and the thousands of mutual funds that came to be established cater to every conceivable investment need and taste.
Popularity of Mutual Funds in the USA
The popularity of the Mutual Fund has increased manifold. In developed financial markets, like the United States, Mutual Funds have almost overtaken bank deposits and total assets of insurance funds. As of date, in the US alone there are over 7,000 Mutual Funds with total assets of over US $ 3 trillion (Rs. 100 lakh crores). According to "The Investing Kit" (Dearborn Financial Publishing, Inc., Chicago), mutual funds offer "professional portfolio management, diversification, a wide variety of investment styles and objectives, easier access to foreign markets, dividend reinvestment, ease of buying and selling shares and exchange privileges."
"Mutual funds have become the investment of choice for millions of investors. The basic idea of a mutual fund is simple. It is an organization whose only business is the investment of its shareholders' (Unit-holders') money into cash equivalents (money markets), stocks, bonds or a combination of stocks and bonds, for the purpose of achieving specific investment goals. To do this, it attracts funds from many individual and institutional investors, and it attempts to invest and manage those funds more effectively than investors could do on their own. More and more investors are using mutual funds to achieve at least some of their investment goals. According to Stephen Littauer, author of "How to Buy Mutual Funds the Smart Way" (Dearborn Financial Publishing, Chicago, 1993), one of the most important reasons why investors choose mutual funds is the availability of past performance records. You can see a complete and unquestionable picture of what a fund has achieved in the past. However, past performance may not be an indicator of future performance. To help you achieve your investment objective, mutual funds can provide you with the three basics of prudent investing: (1) careful selection of securities, (2) diversification and (3) liquidity."1
"Mutual funds have a number of advantages over individual securities. A key advantage is that mutual funds are generally more diversified . A typical fund invests in dozens of securities. Thus, small investors can achieve a level of diversification greater than they could on their own or with less effort than they could on their own. The funds are professionally managed, which logically should add to your investment returns in the long run. Investing in a mutual fund will also save you lots of paperwork headaches because the monthly and annual statements will summarize short- and long-term gains, dividends and interest earned on your account. Most also offer telephone and online trading, which makes buying, selling or switching funds a snap. Idle cash can be automatically invested at competitive rates in a money market fund and many companies also offer unlimited checking privileges, debit cards and credit cards, much as a bank would. You can even designate a beneficiary so that, when you die, there will be none of the delays and expenses of probate".1
"Believe it or not, there are now more mutual funds than there are publicly traded stocks. As a result, you can find a fund that easily fits your own investment tastes. Some funds invests in stocks and bonds. Some invest only in U.S.-based companies, while others focus on overseas securities. Some even invest in other mutual funds! Some carry sales charges, called loads, and others do not. Choose carefully because less than one of three funds successfully beats the return on the S&P 500."1
Factors Responsible for the Huge Growth in Mutual Fund Assets in the USA
There are now approximately 7,000 actively managed mutual funds in the United States, with wide variations in size, age, purpose and policy. The oldest have been in existence for more than 65 years; many have been established in the last 5 years. Some have only several million dollars under management, while others measure their assets in the tens of billions. The greatest growth of mutual funds occurred after World War II and has continued since with only occasional pauses. In 1946 mutual fund companies managed just over $2 billion in assets. By 1956 this had grown to $10.5 billion, and to more than $39 billion in 1966. In the 1980s growth exploded, jumping from $64 billion in 1978 to more than $1 trillion by the end of 1991. Today, there are approximately $3 trillion dollars invested in all types of mutual funds. While a great deal of this growth has derived from the return on invested assets, most growth has come from new money going into the funds. For example, according to the 1996-97 Directory of Mutual Funds (Investment Company Institute, Washington, D.C.), the number of funds has grown from 1,528 in 1985 to about 7,000 today. The number of shareholder accounts has grown from 45.1 million in 1986 to about 150 million today".1
Risks the Investor may confront by Investing in a Mutual Fund
1. The companies in which the fund has invested will perform poorly, suffer mismanagement or otherwise meet with misfortune.
2. some economic, political or other development will cause the overall market to fall, dragging down with it the holdings of your particular fund.
3. Wrong Investment Decision, or speculative Decisions by MFs. The fund management, for instance, may be doing things you don't know about or wouldn't like if you did. What you think is a plain vanilla domestic equity-income fund might, in order to boost returns, invest in derivatives, invest overseas, or invest in growth companies that pay little or no dividend. In a downturn, you could be in for an unpleasant surprise. There is also the risk that the fund will under-perform a benchmark index, which means that management fees aren't buying any added value.1
1Source - MSN Money.
Mutual Fund Industry Comes to India
In India, the Mutual Fund industry started with the setting up of Unit Trust of India in 1964, as a single State Monopoly. Twenty-three years later Public Sector banks and financial institutions were permitted to establish Mutual Funds in 1987. The Industry was brought under the control of SEBI and opened for private sector participation in 1993.
The private sector and foreign Institutions began setting up Mutual Funds thereafter. The fast growing industry is regulated by the Securities and Exchange Board of India (SEBI). A Mutual fund in India is registered / incorporated as a public trust. As per Clause 14 of SEBI guidelines- A mutual fund shall be constituted in the form of a trust and the instrument of trust shall be in the form of a deed, duly registered under the provisions of the Indian Registration Act, 1908 (16 of 1908) executed by the sponsor in favour of the trustees named in such an instrument. If the Trust Deed so provides the trustees can appoint an Asset Management Company for the day to day administration of the MF and investment of its funds.
SEBI's Website (FAQ on Mutual Fund) defines MF as under: A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. Anybody with an investible surplus of as little as a few thousand rupees can invest in Mutual Funds. These investors buy units of a particular Mutual Fund scheme that has a defined investment objective and strategy The money thus collected is then invested by the fund manager in different types of securities. These could range from shares to debentures to money market instruments, depending upon the scheme's stated objectives. The income earned through these investments and the capital appreciation realised by the scheme are shared by its unit holders in proportion to the number of units owned by them. Thus a 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 a relatively low cost.
Organisation Structure of Mutual Fund
"The mutual funds can be organised in two ways. One, the Trust structure and the other, the Company structure. In both these structures, there is an entity which undertakes the designing and marketing of schemes, raises money from the public under the schemes and manages the money on behalf of its owners. This entity is the fund manager or an Asset Management Company (AMC) . To segregate the collected funds from this entity's own funds, the corpus is placed in a legal vehicle. It is the character of this legal vehicle that determines the character of the Fund itself. If this vehicle is a corporate entity then the fund acquires the name of an investment company as in the US and UK and if the entity is a Trust, the fund acquires the name of mutual fund as in UK and India, for example. Irrespective of the nature of the structure, what is more fundamental is that in view of the fiduciary role of the AMC or the fund manager towards the public, there is a need for supervision of the activities of the AMC or fund manager by a separate body. This supervisory role is fulfilled by the Board of Trustees and in a corporate structure by the Board of directors of the Investment company."2
Organisation Structure of Indian Mutual Funds
There are four constituents of a mutual fund in India,
1. the sponsor,
2. the board of Trustees or Trustee company,
3. the asset management company and
4. the custodian.
The sponsor is the Settlor of the Trust which holds Trust property on behalf of investors who are the beneficiaries of the Trust. The sponsor is also required to contribute at least 40% of the capital of the asset management company which is formed for managing the assets of the Trust. The assets of the Trust comprise of properties of the schemes which are floated by the asset management company with the approval of the Trustees. Schemes may have different characteristics - they may be open or closed ended or may have a particular investment focus or portfolio composition. Finally, the safe custody of assets of the Trust is entrusted to one or more custodians
Organisation Structure of the Unit Trust of India
"Unit Trust of India (UTI), which has a structure different from the three tiered structure of other mutual funds in India was established by the Government of India to encourage private savings and investment. It was formed under a special Act of Parliament, viz. The Unit Trust of India Act, 1963 as a corporate body. The promoter-sponsor of UTI is the Government of India through the Reserve Bank and Financial institutions. In the true sense however they were the only owners of the initial units of the UTI. The UTI Act provides that the general superintendence, direction and management of the affairs and business of the Trust shall vest in a Board of Trustees which may exercise all `powers and do all acts and things which may be exercised or done by the Trust". The Board of Trustees comprises nominees of the Central Government, RBI, IDBI, LIC SBI, participating financial institutions and an Executive Trustee to be appointed by IDBI. The UTI Act stipulates that there shall be an Executive Committee which shall consist of The Chairman of the Board, Executive Trustee and two other Trustees. Subject to such general or special directions as the Board may from time to time give, the Executive Committee shall be competent to deal with any matter within the competence of the Board of Trustees. The Executive Committee in effect, performs the asset management functions. Thus, the activities of the Executive Committee which itself comprises members of the Board of Trustees, are overseen by the Board of Trustees themselves. In matters involving public interest, the Central Government and the Reserve Bank of India have powers to give directions.
"The management structure of UTI is thus distinct from the remaining mutual funds in more than one way. First, unlike other mutual funds, it is a statutory body corporate and not a Trust under the Indian Trusts Act. Second, there is no separate asset management company with a separate Board of directors of AMC to manage the schemes. The functions of the Board of directors of AMC, and Trustees are combined in the Executive Committee and Board of UTI. The Sponsors exist in the form of Government and IDBI, though they do not hold any equity in the Trustee company or AMC for none exists. SEBI at present regulates UTI through a special regulatory dispensation effective from July 1, 1994 which inter alia requires UTI to file offer documents in accordance with the SEBI (Mutual Funds) Regulations and allows SEBI to inspect UTI. This arrangement in SEBI's view is only an intermediate step and according to SEBI, it would be desirable to amend or repeal the UTI Act to bring UTI and other mutual funds under a common regulatory framework. In the meanwhile UTI has set up three separate asset management Committees as directed by SEBI"2. Recent changes in UTI set-up are discussed in a subsequent article
Organisation Structure of Mutual Funds of Public Sector Banks
"When the public sector banks were allowed to set up mutual funds, the first mutual fund was set up by the State Bank of India in 1987 prior to the establishment of SEBI. State Bank of India preferred to adopt the Trust route and set up the mutual fund as a Trust under the Indian Trust Act 1882. Other mutual funds followed suit and thus Trusts set up under the Indian Trusts Act came to be the adopted legal form of mutual funds in India. The author or Settlor of the Trust came to be principal Trustee and also functioned as the fund manager.
"These mutual funds combined the role of Trustee, fund manager and custodian in the sponsoring bank. There was little demarcation in the role and responsibilities and the structure was open to conflict of interests.
"Other mutual funds that were set up later adopted the same pattern and thus, over time, Trusts set up under the Indian Trusts Act became the accepted legal form for establishment of Mutual Funds in India. The author or Settlor of the Trust became the principal Trustee and also functioned as the fund manager.
With the establishment of SEBI under the SEBI Act, 1992, mutual funds other than the UTI, were for the first time brought under the regulatory purview of SEBI. At that time, no special legislation similar to the UTI Act existed under which the mutual funds could be incorporated. Historically, SEBI found that mutual funds had been set up by public sector banks adopting the trust route because using the route of the Companies Act appeared to be more complex as it could have also led to multiple regulatory jurisdiction. Sufficient information is not available as to whether, at this stage, a rigorous examination of the advantages and disadvantages of the two alternative routes were undertaken or not. Nonetheless, the SEBI (Mutual Funds) Regulations provided for setting up of mutual funds as Trusts under the Indian Trusts Act of 1882. It may not be out of place to mention that the Indian Trusts Act of 1882 was enacted to govern private Trusts and envisaged a different manner of conduct and supervision of operations. Quite clearly, it did not at that time take into account the nature of activities that will be involved in the functioning of mutual funds.
"SEBI, while framing the Mutual Fund Regulations, gave a lot of consideration to two major factors, one, that mutual funds garner large moneys from the pubic for investment in a dynamic market place which require specialisation on the part of persons performing these functions. Secondly, there could arise potential conflicts of interest which were to be avoided by ensuring arm's length relationship between various functionaries. Such stipulation of arm's length relationship ensures that the person who performs a function is answerable to another and does not assess or judge his own performance. The Regulations stipulated a three tiered structure of entitites for carrying out different functions of a mutual fund, but placed the primary responsibility on the trustees. Internationally, irrespective of the route adopted, a three tiered structure exists and there is a segregation between the responsibility of fund management and the trustee or supervisory responsibility.
"Considering the inherent fiduciary nature of the functions, arm's length relationships were sought to be built into the various constituents of a mutual fund, primarily through separate entities and delineating the role and responsibility of the asset management companies and the Trustees and regulations on affiliate transactions. Arm's length relationships were also expected to be achieved by requiring a certain proportion of Trustees to be independent of the sponsor, requiring independent directors on the board of the AMC and requiring an independent custodian to be appointed."2
Mutual Funds - Frequently Asked Questions (FAQs)
Definition of Important Terms/Concepts in Mutual Fund Industry
Before proceeding to consider the salient provisions of SEBI regulations governing mutual funds, it is necessary to get familiar with the basic terms and phraseology used in Mutual Fund literature.
Net Asset Value ("NAV"): The performance of a particular scheme of a mutual fund is denoted by Net Asset Value (NAV). Mutual funds invest the money collected from the investors in securities markets. In simple words, Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day, NAV of a scheme also varies on day to day basis. The NAV per unit is the market value of securities of a scheme divided by the total number of units of the scheme on any particular date. For example, if the market value of securities of a mutual fund scheme is Rs 200 lakhs and the mutual fund has issued 10 lakhs units of Rs. 10 each to the investors, then the NAV per unit of the fund is Rs.20. NAV is required to be disclosed by the mutual funds on a regular basis - daily or weekly - depending on the type of scheme.
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 close-ended schemes redeem their units on maturity. Such prices are NAV related.
Sales Load: Is a charge collected by a scheme when it sells the units. Also called, 'Front-end' load. 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.
What are the different types of mutual fund schemes?
A. Schemes according to Maturity Period::
A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.
i. 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.
CRISIL's composite performance ranking (CPR) measures the performance for each of the open-ended scheme of Mutual Fund. There are four parameters considered to measure the performance of a mutual fund such as Risk-adjusted returns of the scheme's NAV, Diversification of Portfolio, Liquidity and Asset Size.
ii. 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. SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges. These mutual funds schemes disclose NAV generally on weekly basis.
B. Schemes according to Investment Objective: A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:
i. Growth / Equity Oriented Scheme: The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. 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. The investors must indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Growth schemes are good for investors having a long-term outlook seeking appreciation over a period of time.
ii. Income / Debt Oriented Scheme: The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long term investors may not bother about these fluctuations.
iii. Balanced Fund: The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.
iv. Money Market or Liquid Fund: These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. 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.
v. Gilt Fund: These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factors as is the case with income or debt oriented schemes.
vi. Index Funds: Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds which are traded on the stock exchanges.
What are sector specific funds/schemes? - 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. While these funds may give higher returns, they are more risky compared to diversified funds. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. They may also seek advice of an expert.
What are Tax Saving Schemes? - 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
What is a Load or no-load Fund? - A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells units in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution expenses. Suppose the NAV per unit is Rs.10. If the entry as well as exit load charged is 1%, then the investors who buy would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund will get only Rs.9.90 per unit. The investors should take the loads into consideration while making investment as these affect their yields/returns. However, the investors should also consider the performance track record and service standards of the mutual fund which are more important. Efficient funds may give higher returns in spite of loads.
A no-load fund is one that does not charge for entry or exit. It means the investors can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale of units.
Can a mutual fund impose fresh load or increase the load beyond the level mentioned in the offer documents?Mutual funds cannot increase the load beyond the level mentioned in the offer document. Any change in the load will be applicable only to prospective investments and not to the original investments. In case of imposition of fresh loads or increase in existing loads, the mutual funds are required to amend their offer documents so that the new investors are aware of loads at the time of investments.
What is a sales or repurchase/redemption price?The price or NAV a unitholder is charged while investing in an open-ended scheme is called sales price. It may include sales load, if applicable.
Repurchase or redemption price is the price or NAV at which an open-ended scheme purchases or redeems its units from the unitholders. It may include exit load, if applicable.
What is an assured return scheme?Assured return schemes are those schemes that assure a specific return to the unitholders irrespective of performance of the scheme. A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or AMC and this is required to be disclosed in the offer document.
Investors should carefully read the offer document whether return is assured for the entire period of the scheme or only for a certain period. Some schemes assure returns one year at a time and they review and change it at the beginning of the next year.
Can a mutual fund change the asset allocation while deploying funds of investors?Considering the market trends, any prudent fund managers can change the asset allocation i.e. he can invest higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer document. It can be done on a short term basis on defensive considerations i.e. to protect the NAV. Hence the fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the investors. In case the mutual fund wants to change the asset allocation on a permanent basis, they are required to inform the unitholders and giving them option to exit the scheme at prevailing NAV without any load.
How to invest in a scheme of a mutual fund?Mutual funds normally come out with an advertisement in newspapers publishing the date of launch of the new schemes. Investors can also contact the agents and distributors of mutual funds who are spread all over the country for necessary information and application forms. Forms can be deposited with mutual funds through the agents and distributors who provide such services. Now a days, the post offices and banks also distribute the units of mutual funds. However, the investors may please note that the mutual funds schemes being marketed by banks and post offices should not be taken as their own schemes and no assurance of returns is given by them. The only role of banks and post offices is to help in distribution of mutual funds schemes to the investors.
Investors should not be carried away by commission/gifts given by agents/distributors for investing in a particular scheme. On the other hand they must consider the track record of the mutual fund and should take objective decisions.
Can non-resident Indians (NRIs) invest in mutual funds?Yes, non-resident Indians can also invest in mutual funds. Necessary details in this respect are given in the offer documents of the schemes.
How much should one invest in debt or equity oriented schemes?An investor should take into account his risk taking capacity, age factor, financial position, etc. As already mentioned, the schemes invest in different type of securities as disclosed in the offer documents and offer different returns and risks. Investors may also consult financial experts before taking decisions. Agents and distributors may also help in this regard.
How to fill up the application form of a mutual fund scheme? An investor must mention clearly his name, address, number of units applied for and such other information as required in the application form. He must give his bank account number so as to avoid any fraudulent encashment of any cheque/draft issued by the mutual fund at a later date for the purpose of dividend or repurchase. Any changes in the address, bank account number, etc at a later date should be informed to the mutual fund immediately.
What should an investor look into an offer document?An abridged offer document, which contains very useful information, is required to be given to the prospective investor by the mutual fund. The application form for subscription to a scheme is an integral part of the offer document. SEBI has prescribed minimum disclosures in the offer document. An investor, before investing in a scheme, should carefully read the offer document. Due care must be given to portions relating to main features of the scheme, risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry or exit loads, sponsor's track record, educational qualification and work experience of key personnel including fund managers, performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.
When will the investor get certificate or statement of account after investing in a mutual fund?Mutual funds are required to despatch certificates or statements of accounts within six weeks from the date of closure of the initial subscription of the scheme. In case of close-ended schemes, the investors would get either a demat account statement or unit certificates as these are traded in the stock exchanges. In case of open-ended schemes, a statement of account is issued by the mutual fund within 30 days from the date of closure of initial public offer of the scheme. The procedure of repurchase is mentioned in the offer document.
How long will it take for transfer of units after purchase from stock markets in case of close-ended schemes?According to SEBI Regulations, transfer of units is required to be done within thirty days from the date of lodgment of certificates with the mutual fund.
As a unit-holder, how much time will it take to receive dividends/repurchase proceeds?A mutual fund is required to despatch to the unit-holders the dividend warrants within 30 days of the declaration of the dividend and the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase request made by the unitholder.
In case of failures to despatch the redemption/repurchase proceeds within the stipulated time period, Asset Management Company is liable to pay interest as specified by SEBI from time to time (15% at present).
Can a mutual fund change the nature of the scheme from the one specified in the offer document?Yes. However, no change in the nature or terms of the scheme, known as fundamental attributes of the scheme e.g. structure, investment pattern, etc. can be carried out unless a written communication is sent to each unit-holder and an advertisement is given in one English daily having nationwide circulation and in a newspaper published in the language of the region where the head office of the mutual fund is situated. The unit-holders have the right to exit the scheme at the prevailing NAV without any exit load if they do not want to continue with the scheme. The mutual funds are also required to follow similar procedure while converting the scheme form close-ended to open-ended scheme and in case of change in sponsor.
How will an investor come to know about the changes, if any, which may occur in the mutual fund?There may be changes from time to time in a mutual fund. The mutual funds are required to inform any material changes to their unit-holders. Apart from it, many mutual funds send quarterly newsletters to their investors.
At present, offer documents are required to be revised and updated at least once in two years. In the meantime, new investors are informed about the material changes by way of addendum to the offer document till the time offer document is revised and reprinted.
Mutual Funds - Frequently Asked Questions (FAQs)
What is an asset management company (AMC)?The trustee delegates the task of floating schemes and managing the collected money to a company of professionals, usually experts who are known for smart stock picks. This is an asset management company (AMC). AMC charges a fee for the services it renders to the MF trust. Thus the AMC acts as the investment manager of the trust under the broad supervision and direction of the trustees. The AMC must have a net worth of at least Rs10 crores at all times and it can not act as a trustee of any other mutual fund.
Who is a custodian?The custodian, an independent organisation, has the physical possession of all securities purchased by the mutual fund, and undertakes responsibility for its handling and safekeeping. For instance, the Stock Holding Corporation of India Ltd. (SCHIL) is the custodian for most fund houses in the country.
What is the difference between mutual funds and portfolio management services (PMS)?While the concept remains the same of collecting money from investors, pooling them and investing the funds, the target investors are different. In the case of portfolio management the target investors are high networth investors, while in the case of mutual funds the target investors include the retail investors. Further, in case of PMS the investments of each investor are managed separately, while in the case of MFs the funds collected under a scheme are pooled and the returns are distributed in the same proportion, in which the investments are made by the investors/ unit holders. Moreover, the investments of the PMS are managed taking the risk profile of individuals into account. In mutual fund, the risk is pooled depending on the objective of a scheme.
How to know the performance of a mutual fund scheme?The performance of a scheme is reflected in its net asset value (NAV) which is disclosed on daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes. The NAVs of mutual funds are required to be published in newspapers. The NAVs are also available on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of Association of Mutual Funds in India (AMFI) www.amfiindia.com and thus the investors can access NAVs of all mutual funds at one place.
The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns/yields over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception of schemes. Investors can also look into other details like percentage of expenses of total assets as these have an affect on the yield and other useful information in the same half-yearly format.
The mutual funds are also required to send annual report or abridged annual report to the unit-holders at the end of the year.
Various studies on mutual fund schemes including yields of different schemes are being published by the financial newspapers on a weekly basis. Apart from these, many research agencies also publish research reports on performance of mutual funds including the ranking of various schemes in terms of their performance. Investors should study these reports and keep themselves informed about the performance of various schemes of different mutual funds.
Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity oriented schemes with the benchmarks like BSE Sensitive Index, S&P CNX Nifty, etc.
On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme.
How to know where the mutual fund scheme has invested money mobilised from the investors?The mutual funds are required to disclose full portfolios of all of their schemes on half-yearly basis which are published in the newspapers. Some mutual funds send the portfolios to their unit-holders.
The scheme portfolio shows investment made in each security i.e. equity, debentures, money market instruments, government securities, etc. and their quantity, market value and % to NAV. These portfolio statements also required to disclose illiquid securities in the portfolio, investment made in rated and unrated debt securities, non-performing assets (NPAs), etc.
Some of the mutual funds send newsletters to the unitholders on quarterly basis which also contain portfolios of the schemes.
Is there any difference between investing in a mutual fund and in an initial public offering (IPO) of a company?Yes, there is a difference. IPOs of companies may open at lower or higher price than the issue price depending on market sentiment and perception of investors. However, in the case of mutual funds, the par value of the units may not rise or fall immediately after allotment. A mutual fund scheme takes some time to make investment in securities. NAV of the scheme depends on the value of securities in which the funds have been deployed.
If schemes in the same category of different mutual funds are available, should one choose a scheme with lower NAV?Some of the investors have the tendency to prefer a scheme that is available at lower NAV compared to the one available at higher NAV. Sometimes, they prefer a new scheme which is issuing units at Rs. 10 whereas the existing schemes in the same category are available at much higher NAVs. Investors may please note that in case of mutual funds schemes, lower or higher NAVs of similar type schemes of different mutual funds have no relevance. On the other hand, investors should choose a scheme based on its merit considering performance track record of the mutual fund, service standards, professional management, etc. This is explained in an example given below.
Suppose scheme A is available at a NAV of Rs.15 and another scheme B at Rs.90. Both schemes are diversified equity oriented schemes. Investor has put Rs. 9,000 in each of the two schemes. He would get 600 units (9000/15) in scheme A and 100 units (9000/90) in scheme B. Assuming that the markets go up by 10 per cent and both the schemes perform equally good and it is reflected in their NAVs. NAV of scheme A would go up to Rs. 16.50 and that of scheme B to Rs. 99. Thus, the market value of investments would be Rs. 9,900 (600* 16.50) in scheme A and it would be the same amount of Rs. 9900 in scheme B (100*99). The investor would get the same return of 10% on his investment in each of the schemes. Thus, lower or higher NAV of the schemes and allotment of higher or lower number of units within the amount an investor is willing to invest, should not be the factors for making investment decision. Likewise, if a new equity oriented scheme is being offered at Rs.10 and an existing scheme is available for Rs. 90, should not be a factor for decision making by the investor. Similar is the case with income or debt-oriented schemes.
On the other hand, it is likely that the better managed scheme with higher NAV may give higher returns compared to a scheme which is available at lower NAV but is not managed efficiently. Similar is the case of fall in NAVs. Efficiently managed scheme at higher NAV may not fall as much as inefficiently managed scheme with lower NAV. Therefore, the investor should give more weightage to the professional management of a scheme instead of lower NAV of any scheme. He may get much higher number of units at lower NAV, but the scheme may not give higher returns if it is not managed efficiently.
How to choose a scheme for investment from a number of schemes available?As already mentioned, the investors must read the offer document of the mutual fund scheme very carefully. They may also look into the past track record of performance of the scheme or other schemes of the same mutual fund. They may also compare the performance with other schemes having similar investment objectives. Though past performance of a scheme is not an indicator of its future performance and good performance in the past may or may not be sustained in the future, this is one of the important factors for making investment decision. In case of debt oriented schemes, apart from looking into past returns, the investors should also see the quality of debt instruments which is reflected in their rating. A scheme with lower rate of return but having investments in better rated instruments may be safer. Similarly, in equities schemes also, investors may look for quality of portfolio. They may also seek advice of experts. Are the companies having names like mutual benefit the same as mutual funds schemes?
Investors should not assume some companies having the name "mutual benefit" as mutual funds. These companies do not come under the purview of SEBI. On the other hand, mutual funds can mobilise funds from the investors by launching schemes only after getting registered with SEBI as mutual funds.
Is the higher net worth of the sponsor a guarantee for better returns?In the offer document of any mutual fund scheme, financial performance including the net worth of the sponsor for a period of three years is required to be given. The only purpose is that the investors should know the track record of the company which has sponsored the mutual fund. However, higher net worth of the sponsor does not mean that the scheme would give better returns or the sponsor would compensate in case the NAV falls.
Where can an investor look out for information on mutual funds?Almost all the mutual funds have their own web sites. Investors can also access the NAVs, half-yearly results and portfolios of all mutual funds at the web site of Association of mutual funds in India (AMFI) www.amfiindia.com. AMFI has also published useful literature for the investors.
Investors can log on to the web site of SEBI www.sebi.gov.in and go to "Mutual Funds" section for information on SEBI regulations and guidelines, data on mutual funds, draft offer documents filed by mutual funds, addresses of mutual funds, etc. Also, in the annual reports of SEBI available on the web site, a lot of information on mutual funds is given.
There are a number of other web sites which give a lot of information of various schemes of mutual funds including yields over a period of time. Many newspapers also publish useful information on mutual funds on daily and weekly basis. Investors may approach their agents and distributors to guide them in this regard.
If mutual fund scheme is wound up, what happens to money invested?In case of winding up of a scheme, the mutual funds pay a sum based on prevailing NAV after adjustment of expenses. Unit-holders are entitled to receive a report on winding up from the mutual funds which gives all necessary details.
How can the investors redress their complaints?Investors would find the name of contact person in the offer document of the mutual fund scheme whom they may approach in case of any query, complaints or grievances. Trustees of a mutual fund monitor the activities of the mutual fund. The names of the directors of asset management company and trustees are also given in the offer documents. Investors can also approach SEBI for redressal of their complaints. On receipt of complaints, SEBI takes up the matter with the concerned mutual fund and follows up with them till the matter is resolved. Investors may send their complaints to:
Securities and Exchange Board of IndiaMutual Funds DepartmentMittal Court 'B' wing, First Floor,224, Nariman Point,Mumbai - 400 021.Phone: 2850451-56, 2880962-70
What is the procedure for redressal of investor grievances? When investors send complaints to SEBI, SEBI takes up the matter with the concerned mutual funds and follows up with them till they are resolved.
In case of complaints, investors may write to :
Securites And Exchange Board of India,Mutual Fund Dept.,Mittal Court 'B' Wing,Nariman Point,Mumbai 400 021
Mutual Funds - Frequently Asked Questions (FAQs)
Your Rights as a Mutual Fund Unit-holder
As a unitholder in a Mutual Fund scheme coming under the SEBI (Mutual Funds) Regulations, you are entitled to:
1. Receive unit certificates or statements of accounts confirming your title within 6 weeks from the date of closure of the subscription or within 6 weeks from the date your request for a unit certificate is received by the Mutual Fund;
2. Receive information about the investment policies,investment objectives, financial position and general affairs of the scheme;
3. Receive dividend within 42 days of their declaration and receive the redemption or repurchase proceeds within 10 days from the date of redemption or repurchase;
4. Vote in accordance with the Regulations to:
a. either approve or disapprove any change in the fundamental investment policies of the scheme which are likely to modify the scheme or affect your interest in the Mutual Fund; (as a dissenting unitholder, you would have a right to redeem your investments);
b. change the asset management company;
c. wind up the schemes.
5. Inspect the documents of the Mutual Funds specified in the scheme's offer document.
In addition to your rights, you can expect the following from Mutual Funds:
i. To publish their NAV, in accordance with the regulations: daily, in case of most open ended schemes and periodically, in case of close-ended schemes;
ii. To disclose your schemes' portfolio holdings, expenses, policy on asset allocation, the Report of the Trustees on the operations of your schemes and their future outlook through periodic newsletters, half- yearly and annual accounts;
iii. To adhere to a Code of Ethics which require that investment decisions are taken in the best interests of the unitholders.
How to Invest in Mutual Funds
Step One - Identify your investment needs
Your financial goals will vary, based on your age, lifestyle, financial independence, family commitments, level of income and expenses among many other factors. Therefore, the first step is to assess your needs. Begin by asking yourself these questions:
1. What are my investment objectives and needs?Probable Answers: I need regular income or need to buy a home or finance a wedding or educate my children or a combination of all these needs.
2. How much risk am I willing to take? Probable Answers: I can only take a minimum amount of risk or I am willing to accept the fact that my investment value may fluctuate or that there may be a short-term loss in order to achieve a long-term potential gain.
3. What are my cash flow requirements? Probable Answers: I need a regular cash flow or I need a lump sum amount to meet a specific need after a certain period or I don't require a current cash flow but I want to build my assets for the future. By going through such an exercise, you will know what you want out of your investment and can set the foundation for a sound Mutual Fund investment strategy.
Step Two - Choose the right Mutual Fund.
Once you have a clear strategy in mind, you now have to choose which Mutual Fund and scheme you want to invest in. The offer document of the scheme tells you its objectives and provides supplementary details like the track record of other schemes managed by the same Fund Manager. Some factors to evaluate before choosing a particular Mutual Fund are: * the track record of performance over the last few years in relation to the appropriate yardstick and similar funds in the same category.
· how well the Mutual Fund is organised to provide efficient, prompt and personalised service.
· degree of transparency as reflected in frequency and quality of their communications.
Step Three - Select the ideal mix of Schemes.
Investing in just one Mutual Fund scheme may not meet all your investment needs. You may consider investing in a combination of schemes to achieve your specific goals. The charts could prove useful in selecting a combination of schemes that satisfy your needs.
Step Four - Invest regularly
For most of us, the approach that works best is to invest a fixed amount at specific intervals, say every month. By investing a fixed sum each month, you buy fewer units when the price is higher and more unitswhen the price is low, thus bringing down your average cost per unit. This is called rupee cost averaging and is a disciplined investment strategy followed by investors all over the world. With many open-ended schemes offering systematic investment plans, this regular investing habit is made easy for you.
Step Five - Keep your taxes in mind
If you are in a high tax bracket and have utilised fully the exemptions under Section 80L of the Income Tax Act, investing in growth funds that do not pay dividends might be more tax efficient and improve your post-tax return. If you are in a low tax bracket and have not utilised fully the exemption available under Section 80L, selecting funds paying regular income could be more tax efficient. Further, there are other benefits available for investment in Mutual Funds under the provisions of the prevailing tax laws. You may therefore consult your tax advisor or Chartered Accountant for specific advice.
Step Six - Start early
It is desirable to start investing early and stick to a regular investment plan. If you start now, you will make more than if you wait and invest later. The power of compounding lets you earn income on income and your money multiplies at a compounded rate of return.
Step Seven - The final step
All you need to do now is to get in touch with a Mutual Fund or your agent/broker and start investing. Reap the rewards in the years to come. Mutual Funds are suitable for every kind of investor-whether starting a career or retiring, conservative or risk taking, growth oriented or income seeking

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