Chapter 1
• Mutual fund is a vehicle to mobilize moneys from investors, to invest in
different markets and securities, in line with the investment objectives
agreed upon, between the mutual fund and the investors. In other words,
through investment in a mutual fund, a small investor can avail of
professional fund management services offered by an asset management
company.
• Mutual funds perform different roles for different constituencies.
• The mutual fund structure, through its various schemes, makes it possible
to tap a large corpus of money from diverse investors.
• It is possible for mutual funds to structure a scheme for any kind of
investment objective.
• The money that is raised from investors, ultimately benefits governments,
companies or other entities, directly or indirectly, to raise moneys to invest
in various projects or pay for various expenses.
• As a large investor, the mutual funds can keep a check on the operations of
the investee company, and their corporate governance and ethical
standards.
• The mutual fund industry itself, offers livelihood to a large number of
employees of mutual funds, distributors, registrars and various other
service providers.
• Mutual funds can also act as a market stabilizer, in countering large inflows
or outflows from foreign investors. Mutual funds are therefore viewed as a
key participant in the capital market of any economy.
• Under the law, every unit has a face value of Rs. 10. (However, older
schemes in the market may have a different face value). The face value is
relevant from an accounting perspective. The number of units multiplied by
its face value (Rs. 10) is the capital of the scheme – its Unit Capital.
Investments can be said to have been handled profitably, if the following
profitability metric is positive:
(A) +Interest income
(B) + Dividend income
(C) + Realized capital gains
(D) + Valuation gains
(E) – Realized capital losses
(F) – Valuation losses
(G) – Scheme expenses
• When the investment activity is profitable, the true worth of a unit goes
up; when there are losses, the true worth of a unit goes down. The true
worth of a unit of the scheme is otherwise called Net Asset Value (NAV) of
the scheme.
• The relative size of mutual fund companies is assessed by their assets
under management (AUM). When a scheme is first launched, assets under
management would be the amount mobilized from investors. Thereafter, if
the scheme has a positive profitability metric, its AUM goes up; a negative
profitability metric will pull it down.
• Advantages of Mutual Funds for Investors are:
a. Professional Management
b. Affordable Portfolio Diversification
c. Economies of Scale
d. Liquidity
e. Tax Deferral
f. Tax benefits
g. Convenient Options
h. Investment Comfort
i. Regulatory Comfort
j. Systematic Approach to Investments
• Limitations of a Mutual Fund
a. Lack of portfolio customization
b. Choice overload
c. No control over costs
• Open-ended funds are open for investors to enter or exit at any time, even
after the NFO.
• The on-going entry and exit of investors implies that the unit capital in an
open-ended fund would keep changing on a regular basis.
• Close-ended funds have a fixed maturity. Investors can buy units of a close-
ended scheme, from the fund, only during its NFO. The fund makes
arrangements for the units to be traded, post-NFO in a stock exchange. This
is done through a listing of the scheme in a stock exchange. Such listing is
compulsory for close-ended schemes.
• Since post-NFO, sale and purchase of close-ended funds units happen to or
from counter-party in the stock exchange – and not to or from the mutual
fund – the unit capital of the scheme remains stable or fixed.
• Depending on the demand-supply situation for the units of the close-ended
scheme on the stock exchange, the transaction price could be higher or
lower than the prevailing NAV.
• Interval funds combine features of both open-ended and close-ended
schemes. They are largely close-ended, but become open-ended at pre-
specified intervals. For instance, an interval scheme might become open-
ended between January 1 to 15, and July 1 to 15, each year. The benefit for
investors is that, unlike in a purely close-ended scheme, they are not
completely dependent on the stock exchange to be able to buy or sell units
of the interval fund. However, between these intervals, the Units have to
be compulsorily listed on stock exchanges to allow investors an exit route.
Minimum duration of an interval period in an interval scheme/plan is 15
days. No redemption/repurchase of units is allowed except during the
specified transaction period (the period during which both subscription and
redemption may be made to and from the scheme). The specified
transaction period will be of minimum 2 working days, as per revised SEBI
Regulations.
• Actively managed funds are funds where the fund manager has the
flexibility to choose the investment portfolio, within the broad parameters
of the investment objective of the scheme. Since this increases the role of
the fund manager, the expenses for running the fund turn out to be higher.
Investors expect actively managed funds to perform better than the
market.
• Passive funds invest on the basis of a specified index, whose performance
it seeks to track. Thus, a passive fund tracking the BSE Sensex would buy
only the shares that are part of the composition of the BSE Sensex. The
proportion of each share in the scheme’s portfolio would also be the same
as the weightage assigned to the share in the computation of the BSE
Sensex. Thus, the performance of these funds tends to mirror the
concerned index. They are not designed to perform better than the market.
Such schemes are also called index schemes. Since the portfolio is
determined by the index itself, the fund manager has no role in deciding on
investments. Therefore, these schemes have low running costs.
• Schemes with an investment objective that limits them to investments in
debt securities like Treasury Bills, Government Securities, Bonds and
Debentures are called debt funds.
• Hybrid funds have an investment charter that provides for investment in
both debt and equity.
• Gilt funds invest in only treasury bills and government securities, which do
not have a credit risk (i.e. the risk that the issuer of the security defaults).
• Diversified debt funds on the other hand, invest in a mix of government
and non-government debt securities such as corporate bonds, debentures
and commercial paper. These schemes are also known as Income Funds.
• Junk bond schemes or high yield bond schemes invest in companies that
are of poor credit quality. Such schemes operate on the premise that the
attractive returns offered by the investee companies makes up for the
losses arising out of a few companies defaulting.
• Fixed maturity plans are a kind of debt fund where the investment
portfolio is closely aligned to the maturity of the scheme. Further, being
close-ended schemes, they do not accept moneys post-NFO.
• Floating rate funds invest largely in floating rate debt securities i.e. debt
securities where the interest rate payable by the issuer changes in line with
the market. For example, a debt security where interest payable is
described as‘5-year Government Security yield plus 1%’, will pay interest
rate of 7%, when the 5-year Government Security yield is 6%; if 5-year
Government Security yield goes down to 3%, then only 4% interest will be
payable on that debt security. The NAVs of such schemes fluctuate lesser
than debt funds that invest more in debt securities offering a fixed rate of
interest.
• Liquid schemes or money market schemes are a variant of debt schemes
that invest only in debt securities where the moneys will be repaid within
60-days.
• Diversified equity fund is a category of funds that invest in a diverse mix of
securities that cut across sectors.
• Sector funds however invest in only a specific sector. For example, a
banking sector fund will invest in only shares of banking companies. Gold
sector fund will invest in only shares of gold-related companies.
• Thematic funds invest in line with an investment theme. For example, an
infrastructure thematic fund might invest in shares of companies that are
into infrastructure construction, infrastructure toll-collection, cement,
steel, telecom, power etc. The investment is thus more broad-based than a
sector fund; but narrower than a diversified equity fund
• Equity Income / Dividend Yield Schemes invest in securities whose shares
fluctuate less, and the dividend represents a larger proportion of the
returns on those shares. The NAV of such equity schemes are expected to
fluctuate lesser than other categories of equity schemes.
• Arbitrage Funds take contrary positions in different markets / securities,
such that the risk is neutralized, but a return is earned.
• Gold Exchange Traded Fund, which is like an index fund that invests in
gold, gold-related securities or gold deposit schemes of banks.
• Gold Sector Fund i.e. the fund will invest in shares of companies engaged in
gold mining and processing.
• Monthly Income Plan seeks to declare a dividend every month. It therefore
invests largely in debt securities. However, a small percentage is invested in
equity shares to improve the scheme’s yield. Another very popular
category among the hybrid funds is the Balanced Fund category. The
balanced funds can have fixed or flexible allocation between equity and
debt.
• Capital Protected Schemes are close-ended schemes, which are structured
to ensure that investors get their principal back, irrespective of what
happens to the market. This is ideally done by investing in Zero Coupon
Government Securities whose maturity is aligned to the scheme’s maturity.
• International Funds are funds that invest outside the country. For instance,
a mutual fund may offer a scheme to investors in India, with an investment
objective to invest abroad. An alternative route would be to tie up with a
foreign fund (called the host fund). If an Indian mutual fund sees potential
in China, it will tie up with a Chinese fund. In India, it will launch what is
called a feeder fund. Investors in India will invest in the feeder fund. The
moneys collected in the feeder fund would be invested in the Chinese host
fund. Thus, when the Chinese market does well, the Chinese host fund
would do well, and the feeder fund in India will follow suit.
• The feeder fund was an example of a fund that invests in another fund.
Similarly, funds can be structured to invest in various other funds, whether
in India or abroad. Such funds are called fund of funds.
• AUM of the industry, as of July 31, 2013 has touched Rs 760,833 crore from
1172 schemes offered by 44 mutual funds.
