Debt, Equity and Hybrid Funds
A scheme might have an investment objective to invest largely in equity shares and equity-related investments like convertible debentures. The investment objective of such funds is to seek capital appreciation through investment in this growth asset. Such schemes are called equity schemes.
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. These debt securities are discussed in Chapter8.
Hybrid funds have an investment charter that provides for investment in both debt and equity. Some of them invest in gold along with either debt or equity or both. This category of funds is discussed later in this Chapter.
Types of Debt Funds
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. AMCs tend to structure the scheme around pre-identified investments. Further, being close-ended schemes, they do not accept moneys
post-NFO. Thanks to these characteristics, the fund manager has little ongoing role in deciding on the investment options.
As will be seen in Chapter8, such a portfolio construction gives more clarity to investors on the likely returns if they stay invested in the scheme until its maturity (though there can be no guarantee or assurance of such returns). This helps them compare the returns with alternative investments like bank deposits.
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 other 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 short term debt securities. They can invest in debt securities of upto 91 days maturity. However, securities in the portfolio having maturity more than 60-days need to be valued at market prices *“marked to market” (MTM)+. Since MTM contributes to volatility of NAV, fund managers of liquid schemes prefer to keep most of their portfolio in debt securities of less than 60-day maturity. As will be seen later in this Work Book, this helps in positioning liquid schemes as the lowest in price risk among all kinds of mutual fund schemes. Therefore, these schemes are ideal for investors seeking high liquidity with safety of capital.
Types of Equity Funds
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 Linked Savings Schemes (ELSS), as seen earlier, offer tax benefits to investors. However, the investment is subject to lock-in for a period of 3 years.
Rajiv Gandhi Equity Savings Schemes (RGESS) too, as seen earlier, offer tax benefits to first-time investors. Investments are subject to a fixed lock-in period of 1 year, and flexible lock-in period of 2 years.
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 opposite positions in different markets / securities, such that the risk is neutralized, but a return is earned. For instance, by buying a share in BSE, and simultaneously selling the same share in the NSE at a higher price. Most arbitrage funds take contrary positions between the equity market and the futures and options market. (‘Futures’ and ‘Options’ are commonly referred to as derivatives. These are designed to help investors to take positions or protect their risk in some other security, such as an equity share. They are traded in exchanges like the NSE and the BSE. Chapter10 provides an example of futures contract that is linked to gold).
Although these schemes invest in equity markets, the expected returns are in line with liquid funds.
Gold Funds
These funds invest in gold and gold-related securities. They can be structured in either of the following formats:
Gold Exchange Traded Fund, which is like an index fund that invests in gold, gold-related securities or gold deposit schemes of banks. The structure of exchange traded funds is discussed later in this chapter. The NAV of such funds moves in line with gold prices in the market.
Gold Sector Fund i.e. the fund will invest in shares of companies engaged in gold mining and processing. Though gold prices influence these shares, the prices of these shares are more closely linked to the profitability and gold reserves of the companies. Therefore, NAV of these funds do not closely mirror gold prices.
(Gold Sector Fund is like any equity sector fund, which was discussed under ‘Types of Equity Funds’. It is discussed here to highlight the difference from a Gold ETF. It is important to understand that unlike Gold sector fund, Gold ETF does not invest in equity shares of companies involved in Gold related businesses including gold mining.)
Types of Hybrid Funds
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.
As will be discussed in Unit8, the term ‘Monthly Income’ is a bit of a misnomer and investor needs to study the scheme properly, before presuming that an income will be received every month.
Another very popular category among the hybrid funds is the Balanced Fund category. These schemes were historically launched for the purpose of giving an investor exposure to both equity and debt simultaneously in one portfolio. The objective of these schemes was to provide growth and stability (or regular income), where equity had the potential to meet the former objective and debt the latter. The balanced funds can have fixed or flexible allocation between equity and debt. One can get the information about the allocation and investment style from the Scheme Information Document.
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. (Zero coupon securities are securities that do not pay a regular interest, but accumulate the interest, and pay it along with the principal when the security matures).
As detailed in the following example, the investment is structured, such that the principal amount invested in the zero-coupon security, together with the interest that accumulates during the period of the scheme would grow to the amount that the investor invested at the start.
Suppose an investor invested Rs 10,000 in a capital protected scheme of 5 years. If 5-year government securities yield 7% at that time, then an amount of Rs 7,129.86 invested in 5-year zero-coupon government securities would mature to Rs 10,000 in 5 years. Thus, by investing Rs 7,129.86 in the 5-year zero-coupon government security, the scheme ensures that it will have Rs 10,000 to repay to the investor in 5 years.
After investing in the government security, Rs 2,870.14 is left over (Rs 10,000 invested by the investor, less Rs 7129.86 invested in government securities). This amount is invested in riskier securities like equities. Even if the risky investment becomes completely worthless (a rare possibility), the investor is assured of getting back the principal invested, out of the maturity moneys received on the government security.
Some of these schemes are structured with a minor difference – the investment is made in good quality debt securities issued by companies, rather than Central Government Securities. Since any borrower other than the government can default, it would be appropriate to view these alternate structures as Capital Protection Oriented Schemes rather than Capital Protected Schemes.
It may be noted that capital protection can also be offered through a guarantee from a guarantor, who has the financial strength to offer the guarantee. Such schemes are however not prevalent in the market.
Some of these funds are also launched as Asset Allocation Funds. These schemes are not different from those under the Hybrid category. One should go through the Scheme Information Document to understand the unique characteristics of the individual scheme.
A scheme might have an investment objective to invest largely in equity shares and equity-related investments like convertible debentures. The investment objective of such funds is to seek capital appreciation through investment in this growth asset. Such schemes are called equity schemes.
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. These debt securities are discussed in Chapter8.
Hybrid funds have an investment charter that provides for investment in both debt and equity. Some of them invest in gold along with either debt or equity or both. This category of funds is discussed later in this Chapter.
Types of Debt Funds
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. AMCs tend to structure the scheme around pre-identified investments. Further, being close-ended schemes, they do not accept moneys
post-NFO. Thanks to these characteristics, the fund manager has little ongoing role in deciding on the investment options.
As will be seen in Chapter8, such a portfolio construction gives more clarity to investors on the likely returns if they stay invested in the scheme until its maturity (though there can be no guarantee or assurance of such returns). This helps them compare the returns with alternative investments like bank deposits.
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 other 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 short term debt securities. They can invest in debt securities of upto 91 days maturity. However, securities in the portfolio having maturity more than 60-days need to be valued at market prices *“marked to market” (MTM)+. Since MTM contributes to volatility of NAV, fund managers of liquid schemes prefer to keep most of their portfolio in debt securities of less than 60-day maturity. As will be seen later in this Work Book, this helps in positioning liquid schemes as the lowest in price risk among all kinds of mutual fund schemes. Therefore, these schemes are ideal for investors seeking high liquidity with safety of capital.
Types of Equity Funds
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 Linked Savings Schemes (ELSS), as seen earlier, offer tax benefits to investors. However, the investment is subject to lock-in for a period of 3 years.
Rajiv Gandhi Equity Savings Schemes (RGESS) too, as seen earlier, offer tax benefits to first-time investors. Investments are subject to a fixed lock-in period of 1 year, and flexible lock-in period of 2 years.
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 opposite positions in different markets / securities, such that the risk is neutralized, but a return is earned. For instance, by buying a share in BSE, and simultaneously selling the same share in the NSE at a higher price. Most arbitrage funds take contrary positions between the equity market and the futures and options market. (‘Futures’ and ‘Options’ are commonly referred to as derivatives. These are designed to help investors to take positions or protect their risk in some other security, such as an equity share. They are traded in exchanges like the NSE and the BSE. Chapter10 provides an example of futures contract that is linked to gold).
Although these schemes invest in equity markets, the expected returns are in line with liquid funds.
Gold Funds
These funds invest in gold and gold-related securities. They can be structured in either of the following formats:
Gold Exchange Traded Fund, which is like an index fund that invests in gold, gold-related securities or gold deposit schemes of banks. The structure of exchange traded funds is discussed later in this chapter. The NAV of such funds moves in line with gold prices in the market.
Gold Sector Fund i.e. the fund will invest in shares of companies engaged in gold mining and processing. Though gold prices influence these shares, the prices of these shares are more closely linked to the profitability and gold reserves of the companies. Therefore, NAV of these funds do not closely mirror gold prices.
(Gold Sector Fund is like any equity sector fund, which was discussed under ‘Types of Equity Funds’. It is discussed here to highlight the difference from a Gold ETF. It is important to understand that unlike Gold sector fund, Gold ETF does not invest in equity shares of companies involved in Gold related businesses including gold mining.)
Types of Hybrid Funds
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.
As will be discussed in Unit8, the term ‘Monthly Income’ is a bit of a misnomer and investor needs to study the scheme properly, before presuming that an income will be received every month.
Another very popular category among the hybrid funds is the Balanced Fund category. These schemes were historically launched for the purpose of giving an investor exposure to both equity and debt simultaneously in one portfolio. The objective of these schemes was to provide growth and stability (or regular income), where equity had the potential to meet the former objective and debt the latter. The balanced funds can have fixed or flexible allocation between equity and debt. One can get the information about the allocation and investment style from the Scheme Information Document.
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. (Zero coupon securities are securities that do not pay a regular interest, but accumulate the interest, and pay it along with the principal when the security matures).
As detailed in the following example, the investment is structured, such that the principal amount invested in the zero-coupon security, together with the interest that accumulates during the period of the scheme would grow to the amount that the investor invested at the start.
Suppose an investor invested Rs 10,000 in a capital protected scheme of 5 years. If 5-year government securities yield 7% at that time, then an amount of Rs 7,129.86 invested in 5-year zero-coupon government securities would mature to Rs 10,000 in 5 years. Thus, by investing Rs 7,129.86 in the 5-year zero-coupon government security, the scheme ensures that it will have Rs 10,000 to repay to the investor in 5 years.
After investing in the government security, Rs 2,870.14 is left over (Rs 10,000 invested by the investor, less Rs 7129.86 invested in government securities). This amount is invested in riskier securities like equities. Even if the risky investment becomes completely worthless (a rare possibility), the investor is assured of getting back the principal invested, out of the maturity moneys received on the government security.
Some of these schemes are structured with a minor difference – the investment is made in good quality debt securities issued by companies, rather than Central Government Securities. Since any borrower other than the government can default, it would be appropriate to view these alternate structures as Capital Protection Oriented Schemes rather than Capital Protected Schemes.
It may be noted that capital protection can also be offered through a guarantee from a guarantor, who has the financial strength to offer the guarantee. Such schemes are however not prevalent in the market.
Some of these funds are also launched as Asset Allocation Funds. These schemes are not different from those under the Hybrid category. One should go through the Scheme Information Document to understand the unique characteristics of the individual scheme.
No comments:
Post a Comment