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3.Mutual fund
1. What is a Mutual Fund? Outline the concept of Mutual Fund.
1. Mutual Fund is a “trust” that pools together the resources of Investors through issue of units, to
make investments in Capital Market Instruments like Shares, Debentures and Bonds, and Money –
Market Instruments such as Commercial Papers, Certificate of Deposits and Treasury Bonds.
2. A Mutual Fund is managed by a Professional Money Manager (i.e., Fund Manager), who invests
collected from different investors (called Unit Holders) in various investments, according to specific
investment objectives as established by the fund.
3. The Net income earned on the Funds, along with capital appreciation of the investment, is shared
amongst the Unit Holders in proportion to the units owned by them.
4. In return for administering the Fund and managing it’s Investment Portfolio, the Fund Manager
charges Fees based on the value of the Fund’s assets.
2. Write short notes on the classification of Mutual Funds.

Classification of Mutual Funds

A. Functional Classification B. Portfolio based Classification C. Ownership based Classification

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1. Open Ended Funds, 1. Equity Funds (or) Stock 1. Public Sector Mutual
2. Close Ended Funds, and Funds, Funds,
3. Interval Schemes. 2. Debt Funds, 2. Private Sector Mutual

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3. Special Funds. Funds, and
3. Foreign Mutual Funds.

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3. Explain the Functional Classification of Mutual Funds.
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Type Description
Open Ended  It is a Mutual Fund Scheme which offers units for sale, without specifying any
Funds duration for redemption
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 The Investor can take entry and exit at any time.

 The Capital of the Fund is unlimited
 Redemption Period is indefinite.
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Close Ended  It is a Mutual Fund Scheme for which the period of maturity is specified at the
Funds inception or opening of the Scheme itself.
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 The investor can buy the Scheme during Initial Offering or from the Stock
Market after the units have been listed.
 The Scheme has a limited life at the end of which the corpus is liquidated.
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 The Investor can make his exit from the scheme by selling in the Stock Market,
or at the expiry of the Scheme or during re-purchase period, at his option.
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Interval  Interval Schemes combine features of an open – ended and a close – ended
Scheme Structure.
 These Scheme are open for both purchase and redemption during pre –
specified intervals (viz. monthly, quarterly, annually, etc.) at prevailing NAV
based prices.
 Interval Funds are very similar to listed on Stock – ended funds, but differ on the
following points:
 They are not required to be listed on Stock Exchanges, as they have an ln –
built redemption window.
 They can make fresh issue of units during the specified interval period, at
the prevailing NAV based prices.
 Maturity period is not defined.

4. Explain the Portfolio – Based Classification of Mutual Funds.

Type Description
Equity Funds 1. Equity Funds invest primarily in stocks, i.e. a unit of ownership in a Company.
or Stock 2. If the investee Company is successful, its Shareholders can benefit in two ways
Funds – (a) Increase in Stock Value, i.e., Capital Appreciation, (b) Share of Distribution
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MUTUAL FUND 3.2 CMA CHANDER DUREJA

Profit, i.e., Dividends.

3. Equity Funds are further classified into – (a) Growth Funds, (b) Aggressive
Funds, (c) Income Funds and (d) Balanced Funds.
Debt Funds Debt Funds are of two types –
1. Bond Funds:- They invest in fixed income securities, e.g. Government Bonds,
Corporate Debentures, convertible Debentures, Money Market, etc. investors
seeking tax free income invest in Government Bonds while those looking for
safe, steady income buy Government Bonds or high grade Corporate Bonds.
Generally, Bond Funds tend to be less volatile than Stock Funds and often
produce regular income. Investors often use Bond Funds to diversify, provide a
stream of income, or invest for intermediate – term goals. Like Stock Funds,
Bond Funds also have their risks.
2. Gilt Funds: They are mainly invested in Government Securities (G – Secs).
Special Special Funds are further classifies into – (1) Index Funds. (2) International Funds, (3)
Funds Offshore Funds, (4) Sector Funds, (5) Money Funds, (6) Fund of Funds, (7) Capital
Protection Oriented Funds, and (8) Gold Funds.

5. Explain the different types of Equity Funds (i.e. under Portfolio based Classification of Mutual Funds.)

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Type Description Suitable for
1. Growth They seek to provide long – term capital Long – Term Investors.
Funds appreciation to the Investor, by investing
instruments which have long – term capital

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growth.
2. They look super – normal returns, for which Investors who are willing to take risks.
Aggressive
Funds
investment is made in start – ups, IPOs and
speculative shares, etc.
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3. Income They seek to maximize present income of Investors seeking current income,
Funds investors by in safe stocks paying high cash safety and regular flow of returns.
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dividends and in high yield money market

instruments.
4. Balanced They are a mix of Growth and Income Funds. Investors seeking balance between
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Funds They buy shares for growth and bonds for Growth and Income.
income generation.
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6. Explain the different types of Special Funds (i.e. under Portfolio Based Classification of Mutual Funds).

Type Objective
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1. Index Every Stock Market has a Stock index which measures the upward and downward
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Funds sentiment Stock Market. Index Funds are low cost funds and influence the Stock
Market. The Investor will receive whatever the market delivers.
2. It is Mutual Fund located in India to raise money in India for investing globally.
International
Funds
3. Offshore It is a Mutual located in India to raise money globally, for investing in India
Funds
4. Sector These Funds invest their entire fund in particular industry, e.g. Utility Funds for utility
Funds industry like power, gas, public works, Real Estate Mutual Funds for investing in Real
Estate Properties and in Shares / Debentures of companies engaged in Real Estate
Assets / Projects, etc.
5. Money MMMFs are predominantly debt – orientedschemes, whose main objective is
Market preservation of capital/ principal, easy liquidity and moderate income.
Mutual To achieve these objectives, liquid funds invest predominantly in safer short –
Funds
terminstruments like Commercial Papers, Certificate of Deposits, Treasury Bills, G –
(MMMF)
Secs, etc.
These schemes are used mainly by institutions and individuals to park their surplus
funds for short periods of time.
MMMFs are similar to a high—yield Bank Account, but is not entirely risk free.
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MUTUAL FUND 3.3 CMA CHANDER DUREJA

These funds are more or less insulated from changes in the interest rate in the
economy and capture the current yields prevailing in the market.
6 Fund of FoFs are schemes which invest in other Mutual Fund Schemes.
Funds (FoF) This concept is popular in markets where there are number of Mutual Fund offerings
and choosing a suitable scheme according to one's objective is comparatively difficult.
Just as a Mutual Fund Scheme invests in a portfolio of securities like Equity, Debt, etc.
the underlying investments for a FoF is the Units of other Mutual Fund Schemes, either
from the same Fund Family or from other Fund Houses.
7 Capital It is a Mutual Fund Scheme which endeavours to protect the capital invested therein,
Protection through suitable orientation of its portfolio structure.
Oriented Capital Protection is through the portfolio structure of the scheme, and not from any
Fund Bank Guarantee, Insurance Cover, etc.
SEBI Regulation require that these types of schemes to be close – ended in nature,
listed on the Stock Exchange and the intended portfolio structure be rated by a credit
rating agency.
A typical portfolio structure in such scheme could be to set aside major portion of the
assets for capital safety and be invested in highly rated debt instrument. The
remaining portion would be invested in equity or equity related instruments to
provide capital appreciation.

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Note: Capital Protection Oriented Schemes are different from ‘Capital Guaranteed’
schemes.

7. Write short notes on Money Market Mutual Funds (MMMFs).

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1. Creation: MMMFs can be set up by Banks and Public Financial Institutions (PFIs).
2. Raising Funds: Resources raised under MMMF Scheme should not exceed 2% of the Sponsoring
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Bank's fortnightly Average Aggregate Deposits. If the limit is less than ` 50 Crores for any Bank,
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it may join with some other Bank and jointly set up MMMF. In case of PF Is, the limit should not
exceed 2% of the Long – TermDomestic Borrowings as per West audited Balance Sheet.
3. Investors:
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a. MMMFs are primarily intended for Individual Investors, including NRIs who may invest on a
non – repatriablebasis. MMMFs would be free to determine the minimum size of the
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Investment by a single Investor. Generally, Minimum Investment - 1 Lakh.

b. Investment by individuals and other Bodies would be in the form of Negotiable and
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Transferable Instruments and Money Market Deposit Accounts (MMDAs).

4. Rate of Return:There is no guaranteed minimum rate of return.
5. Lock in period:The minimum lock – in period would be 46 days. Re – purchasewould be subject to a
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minimum lock – in – periodof 3 months.

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6. Use of Funds: Resources mobilised by MMMFs should be invested in various Money Market
Instruments. So, the FUT will not be subject to Reserve Requirements. Maximum of 20% of Funds
can be used for Cali Money Markets. The of guidelines include –
a. Treasury Bills and Dated Government Securities having an unexpired maturity upto 1 year:
Minimum 25%.
b. Call/Notice Money: Minimum 30%.
c. CP: Maximum 15%. [Exposure to CP issued by an Individual Company should not be more
than 3%.]
d. Commercial Bills accepted/co –acceptedby Banks: Maximum 20%.
e. Certificate of Deposits: No limit,

8. Outline the classification of Mutual Funds based on types of Schemes.

Based on the types of Schemes, Mutual Funds may be classified as under –

1. Balanced Funds 2. Sector Funds 3. Hedge Funds 4. Equity Diversified Funds 5. Thematic
Funds
6.Cash Funds 7 Equity Linked Tax Savings Scheme 8.Arbitrage Funds 9. Exchange Traded Funds
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MUTUAL FUND 3.4 CMA CHANDER DUREJA

7. Explain the different types of Mutual Funds based on types of Schemes.

Type Objective
Balanced Balanced Funds make strategic allocation to both Debt as well as Equities.
Funds or These Funds operate on the assumption that while the Debt Portfolio of the Scheme
Balanced provides the Equity Portfolio provides growth.
Schemes Balanced Funds are an ideal option for Investors who do not like total exposure to
equity, substantial exposure.
Balanced Funds provide moderate returns to the Investors, as the Investors are taking
a risk, i.e. neither too high risk nor too low a risk.
Note: A variant of Balanced Funds is the "Diversified Funds".
Equity SEE NEXT QUESTION
Diversified
Funds
Equity ELSS is one of the options for investors to save taxes u/s 80C of the Income Tax Act.
Linked Tax ELSS has the potential to give better returns than any traditional tax savings
Savings instrument.
Scheme ELSS offer the perfect way to participate in the growth of the capital market, having a
(ELSS) lock – in – period of3 years.

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By investing in an ELSS through a Systematic Investment Plan (SIP), the Investor can
avoid the problem of investing a lump sum towards the end of the year, and also take
advantage of “averaging”
Sector Funds These funds are highly focused on a particular industry. The basic objective is to enable

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investors to take advantage of industry cycles.
Sector Funds ride on market cycles, and have the potential to offer good returns if the
timing is perfect
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Sector Funds do not have the advantage of downside risk protection as available in
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Diversified Funds.
Thematic A Thematic Fund focuses on trends that are likely to result in the 'outperformance' by
Funds certain sectors or Companies. The key factors in this concept are those that can make
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a difference to business profitability and market values.

The disadvantage of Thematic Funds is that the market may take a longer time to
recognize views of the Fund House with regards to a particular theme, which forms the
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basis of launching a fund.

Arbitrage Arbitrage Funds promise safety of deposits, but better returns, tax benefits and greater
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Funds liquidity. This fund is ideal for an Investor who seeks the return of small savings
instruments, safety of bank deposits, tax benefits of RBI relief bonds and liquidity of a
mutual fund.
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The open – endedEquity Scheme aims to generate low volatility returns by investing in
a mix of Cash Equities, Equity Derivatives and Debt Markets. The Fund seeks to provide
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better returns than typical Debt Instruments and lower volatility in comparison to
Equity.
Arbitrage Fund seeks to capitalize on the price differentials between Spot and Futures
Market.
Some examples of Arbitrage Funds are Benchmark Derivative, JM Equity and
Derivatives, UTI Spread and Prudential ICICI Equity and Derivatives.
Hedge Funds A Hedge Fund is a lightly—regulated Investment Fund that escapes most regulations by
being a sort of a Private Investment Vehicle being offered to selected Clients.
The difference between a Hedge Fund and a Mutual Fund is that the former does not
reveal anything about its operations publicly and charges a Performance Fee. So, if it
out – performs a benchmark, the Fund takes a share of the profits. But, any losses are
borne by the Investors themselves.
Hedge Funds are aggressively managed portfolio of investments, which use advanced
investment strategies such as leveraged, long, short and derivative positions in both
domestic and international markets, with the goal of generating high returns (either
in an absolute sense or over a specified market benchmark).
Even though Hedging is actually the practice of attempting to reduce risk, the goal of
most Hedge Funds is to maximize return on investment.
Cash Fund Cash Fund is an open – ended liquid scheme that aims to generate returns with lower
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MUTUAL FUND 3.5 CMA CHANDER DUREJA

volatility and higher liquidity through a portfolio of Debt and Money Market Instrument.
Fund The Fund will have Retail Institutional Plan and Super Institutional Plan, with
different prescribed values of minimum initial investment. Each Plan will offer growth
and dividend options.
The Fund has no entry or exit loads.
Investors can invest even through Systematic Investment Planning (SIP) route, by
way of installments.
Exchange An ETF combines the - (a) valuation feature of a Mutual Fund or Unit Investment Trust,
Traded Fund which can be bought or sold at the end of each trading day for its NAV, and (b)
(ETF) tradability feature of a closed – endfund, which trades throughout the trading day at
prices that may be more or less than its NAV.
ETFs are listed on the Stock Exchanges and their prices are linked to the Underlying
Index. TheAuthorized Participants act as Market Makers for ETFs.
ETFs can be bought and sold like any other stock on an Exchange, any time during the
market hours, at prices that are expected to be closer to the day – end – NAV. So, an
Investor can invest at real – timeprices as against the end of the day prices as is the
case with open – endedschemes.
ETFs are attractive investments because of their instant diversification, low costs, tax
efficiency, flexibility and stock – like features.

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8. Write short notes on Equity Diversified Funds.

An Equity Diversified Fund is a Fund that contains a wide array of stocks. The Fund Manager of an Equity

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Diversified Fund ensures a high level of diversification in its holdings, thereby reducing the amount of risk
in the fund. Some types of Equity Diversified Funds are –
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1. Flexi – cap/ Multi – cap Fund: These are Diversified Funds where the Offer Document generally spells
out the limits for the minimum and maximum exposure to each of the market caps.
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2. Contra Fund: A Contra Fund invests in those out –of – favour Companies that have unrecognized
value. It is ideally suited for Investors who want to invest in a Fund that has the potential to perform
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in all types of market environments as it blends together both growth and value opportunities.
Contra Funds are suitable for risk – savvy investors.
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3. Index Fund: An Index Fund seeks to track the performance of a Benchmark Market Index, e.g. BSE
Sensex or S&P CNX Nifty. The Fund maintains the portfolio of all the securities in the same
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proportion as stated in the Benchmark Index and hence, earns the same return as earned by the
market.
4. Dividend Yield Fund:
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a. A Dividend Yield Fund invests in Shares / Stocks of Companies dividend yields higher than
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the dividend yield of a particular index, i.e. Sensex or Nifty.

Note: Dividend Yield = Dividend per Share
Market Price per Share

b. The prices of dividend yielding stocks are generally less volatile than growth stocks. They
also offer the potential appreciate. Among Diversified Equity Funds, Dividend Yield Funds are
considered to be a medium – risk proposition.
c. However, Dividend Yield Funds have not always proved resilient in short – term corrective
phases.
d. Dividend Yield Schemes are of two types –
i. Dividend Payout Option: Dividends are paid out to the Unit holders under this option.
However, the NAV of the units falls to the extent of the dividend paid out and
applicable statutory levies.
ii. Dividend Re-Investment Option: Dividend that accrues on units is re –
investedback into the scheme at ex – divided NAV. Hence, Investors receive
additional units on their investments in lieu of dividends.

9. List the different types of Exchange Traded Funds.

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MUTUAL FUND 3.6 CMA CHANDER DUREJA

Following types of ETF products are available in the market –

1. Index ETFs: Index ETFs hold securities and attempt to replicate the performance of a Stock
Market Index.
2. Commodity ETFs: Commodity ETFs invest in commodities, such as Precious Metals and Futures.
3. BondETFs: ETFs that invest in Bonds are known as Bond ETFs. They thrive during economic
recession, because Investors pull their money out of the Stock Market and into Bonds (e.g.
Government Treasury Bonds or those issued by Companies regarded as financially stable). Due to
this cause and effect relationship, the performance of Bond ETFs may be indicative of broader
economic conditions.
4. Currency ETFs: These ETFs are total return products where the Investor gets access to the Foreign
Exchange spot change, local institutional interest rates and a collateral yield.

10. Bring out a comparison chart amongst Open Ended Funds, Close Ended Funds, and ETFs.

Open Ended Funds vs Close Ended Funds vs ETFs

Aspect Open ended Fund Close Ended Fund Exchange Traded Fund

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Fund Size Flexible Fixed Flexible
NAV Daily Daily Real time
Liquidity Fund itself Stock Market Stock Market / Fund itself
Provider

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Sale Price At NAV plus Load, if Significant Premium / Very close to actual NAV
any Discount to NAV
Availability Fund itself ja
Through Exchange where
listed
Through Exchange where listed
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Portfolio Monthly Monthly Daily / Real Time
Disclosure
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Uses Equalizing cash Equalizing cash, Hedge, Arbitrage

Intra – Day Not – Possible Expensive Possible at low cost
trading
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11. List the parties considered as “Constituents" in the context of Mutual Funds.
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The five principal Constituents in the Mutual Fund are –

1. Sponsor: A Company established under the Companies Act, that forms a Mutual Fund, is called
sponsor.
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2. Asset Management Company (AMC):

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a. It is an Entity registered under the Companies Act, to manage the money invested in the
Mutual Fund, and to operate the schemes of the Mutual Fund as per Regulations.
b. AMC carries the responsibility of investing and managing the investors' money. Professional
Money Managers are appointed by the AMC to ensure that the Investor's Corpus is invested
in profitable securities based on the risk appetite of the investors and according to the
Mutual Fund Scheme.
c. Generally, AMC has 3 departments - (i) Fund Management, (ii) Sales & Marketing, (iii)
Operations & Accounting
d. The Minimum Net Worth of an AMC is ` 10 Crores, of which not less than 40% is to be
contributed by the Sponsor.
e. At least half of the Directors of the AMC most be independent, i.e. not associated with the
Sponsor
3. Trustee:
a. The Trustee holds the property of the Mutual Fund in trust for the benefit of Unit holders,
and looks into the legal requirement of operating and functioning of the Mutual Fund.
b. The Trustee may also form a Limited Company under the Companies Act in some
situations.
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MUTUAL FUND 3.7 CMA CHANDER DUREJA

c. The Trustee have the duty to monitor the actions of the AMC to ensure compliance with the
SEBI Regulations and that the decisions of the AMC are not against the interests of the
Unitholders.
d. The Trust is headed by Board of Trustees.
4. Unit Holder: A Person/Entity holding an undivided share in the assets of a Mutual Fund Scheme, i.e.
Investor.
5. Mutual Fund: A Mutual Fund established under the Indian Trust Act, and registered with
SEBI, to raise money through the sale of units to the public for investing in the capital
market. The Funds thus collected are passed on to the AMC for investment.

12. Who are the parties considered as "Intermediaries" in the context of Mutual Funds?

Market Intermediaries in the context of Mutual Funds are –

1. Custodian A Custodian is a person who has been granted a Certificate of Registration to
conduct the business of custodial services under SEBI (Custodian of
Securities) Regulations, 1996.

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Custodial Services include - (i) safeguarding Clients' Securities, (ii)
maintenance of accounts of Clients' securities, (iii) collection of benefits /
rights accruing to a Client, etc.
Mutual Funds require Custodians so that AMC can concentrate on areas such

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as investment and management of money.
2. Transfer Agents
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A Transfer Agent is a person who has been granted a Certificate of
Registration to conduct the business of Transfer Agent under SEBI
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(Registrars to an Issue and Share Transfer Agents)Regulations, 1993,
Transfer Agents' services include - (i) issue / redemption of Mutual Fund Units,
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(ii) preparation of transfer documents, (iii) maintenance of updated

investment records.
(c) They also record transfer of units between Investors, where depository
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does not function.

3. Depository Under the Depositories Act, 1996, a Depository is Body Corporate who carries
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out the transfer of units to the Unit holder in dematerialised form and
maintains records thereof.
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13. List out the advantages of Mutual Funds.

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Bring out the role of Mutual Fund in the Financial Market.

1. ProfessionalManagement: Mutual Funds are managed by skilled and professionally experienced
managers with a backup of a Research team.
2. Diversification: Mutual Funds offer diversification in portfolio which reduces the risk. A Mutual Fund
is the most suitable investment for the cautious Investor, as it offers an opportunity to invest in a
diversified professionally managed basket of securities at a relatively low cost. Mutual Funds are
the best avenue for the risk – averseInvestors.
3. Convenient Administration: There are no administrative risks of share transfer, as many of the
Mutual Funds offer services in a demat form which save Investor's time and delay.
4. Higher Returns: Over a medium to long – terminvestment, Investors always get higher returns in
Mutual Funds as compared to other avenues of investment.
5. Low Cost of Management: No Mutual Fund can increase the cost beyond prescribed limits of 2.5%
maximum and any extra cost of management is to be borne by the AMC.
6. Liquidity: In all Open Ended Funds, liquidity is provided by direct sales / re –purchaseby the Mutual
Fund, and in case of Close – EndedFunds, the liquidity is provided by listing the units on the Stock
Exchange.
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MUTUAL FUND 3.8 CMA CHANDER DUREJA

7. Transparency: SEBI Regulations require all Mutual Funds to disclose their portfolios on a half –
yearlybasis. However, many Mutual Funds disclose this on a quarterly or monthly basis to their
Investors. The NAVs are calculated on a daily basis in case of Open Ended Funds and are now
published through AMFI in the newspapers.
8. Highly Regulated: Mutual Funds all over the world are highly regulated. In India all Mutual Funds are
registered with SEBI and are strictly regulated as per the Mutual Fund Regulations which provide
excellent investor protection.
9. Economies of Scale: Mutual Funds have the advantage of economies of scale, by using "pooled"
money from a number of Investors, as it is cheaper compared to investing directly in the Capital
Markets which involves higher charges. This also allows Retail Investors access to high entry level
markets like Real Estate, etc.
10. Flexibility: There are a lot of features in a regular Mutual Fund Scheme, which imparts
flexibility to the scheme investor can opt for Systematic Investment Plan (SIP), Systematic
Withdrawal Plan, etc. to plan his cash flow requirements as per his convenience. The wide
range of schemes launched by different Mutual Funds provides flexibility to the Investor to
plan his portfolio. The Investors can also switch from one scheme to another without any load.
11. Easy Entry to Capital Market: The Investor becomes a part owner of the assets of the Mutual Fund.

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Any person with an investible surplus of as little as a few thousand rupees can invest in Mutual
Funds by buying units of a particular Mutual Fund Scheme that has a defined investment objective
and strategy.

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14. What are the disadvantages of Mutual Funds?

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1. No Guarantee of Return: There are three issues involved —
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a. Some Mutual Funds may earn less than the Benchmark Index, i.e. it may not even perform
well as a novice Investor who invests in the stocks constituting the index.
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b. In a Mutual Fund, there is a risk of inadequate returns as well as principal erosion, i.e. Mutual
Fund Investment may depreciate in value.
c. A Mutual Fund may perform better than the Stock Market but this does not necessarily lead
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to a gain for the Investor. The market may have risen and the Mutual Fund Scheme
increased in value but the Investor would have got the same increase had he invested in risk
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free investments than in Mutual Fund.

2. Low Returns due to Diversification: A Mutual Fund having a diversified portfolio, minimises
risk, but does not maximize returns. The returns that Mutual Funds offer are less than what an
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Investor can achieve. For example, if a single security held by a Mutual Fund doubles in value,
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the Mutual Fund itself would not double in value because that security is only one small part
of the fund's holdings.
3. Selection of Proper Fund: It may be easier to select the right share rather than the right Fund.
For Stock, an Investor can base his selection on the parameters of economic, industry a nd
company analysis. In case Mutual Funds, past performance is the only criterion to fall back
upon. It may not be a reliable criterion in all situations.
4. Cost Factor: Mutual Funds carry a price tag. While investing, the Investor has to pay for Entry
Load, and when leaving he has to pay for Exit Load. Such costs reduce the return from
Mutual Fund. The Fees paid to the Asset Management Company is in no way related to
performance.
5. Unethical Practices: There is a risk that Mutual Funds may not always play a fair game. Each
Scheme may sell some of the holdings to its sister concerns for substantive notional gains and
posting NAVs in a formalized manner.
6. Taxes: Fund Managers take decisions on holding or selling investments from Mutual Fund viewpoint,
and not Investor personal tax viewpoint. There may be difference in decisions to hold or sell,
depending upon tax effect thereof,
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MUTUAL FUND 3.9 CMA CHANDER DUREJA

7. Transfer Difficulties: Complications arise with Mutual Funds when a managed portfolio is switched
to a different Financial Firm. Sometimes the Mutual Fund positions have to be closed out before a
transfer can happen. This can be a major problem for Investors; Liquidating a Mutual Fund portfolio
may increase risk, increase fees and commission, and lead to Capital Gains taxes.

15. What are the factors that influence the selection of Mutual Funds?

1. Past Performance: NAV is the basic yardstick for evaluating a Mutual Fund. The higher the NAV,
the better it is Performance is based on the growth of NAV during the referral period after
taking into consideration Dividend paid
2. Timing: The timing when the Mutual Fund is raising money from the market is vital. In a bullish
market, investment Mutual Fund falls significantly in value whereas in a bearish market, it is the
other way round where it registers growth.
3. Size of Fund: Managing a small sized fund is different from managing a large sized fund. Purchase
through large sized fund may by itself push prices up while sale may push prices down. Medium
sized funds are generally preferred
4. Age of Fund: Longevity of the Fund in business should be determined and its performance in rising,

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falling and steady markets have to be checked.
5. Largest Holding: It is important to note where the largest holdings in mutual fund have been
invested, in order to identify diversion of funds to Group concerns.

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6. Fund Manager: If a person of repute is handling the Fund Management, it gives confidence to
the Investors

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7. Expense Ratio: SEBI has laid down the upper ceiling for Expense Ratio. A lower Expense Ratio will
give a higher return which is better for an Investor.
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8. PE Ratio: The ratio indicates the Weighted Average PE Ratio of the Stocks that constitute the Fund
Portfolio, with weights being given to the market value of holdings. It helps to identify the risk levels
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in which the Mutual Fund operates.

9. Portfolio turnover: The Fund Manager decides as to when he should enter or quit the market. A
very low portfolio turnover that he is neither entering nor quitting the market very frequently.
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A high ratio, on the other hand, may suggest that too frequent moves have lead the fund
manager to miss out on the next big wave of investments. A simple average of the Portfolio
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Turnover Ratio of peer group updated by mutualfund tracking agencies may serve as
abenchmark. The ratio is lower of annual purchase plus annual sale to average value of the
portfolio.
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16. What are the signals indicators that Investors use as Exit Criteria from the Mutual Fund Scheme?

1. Below Index: When the Mutual Fund consistently under-performs the broad based index, it is high
time that it should get out of the scheme. It would be better to invest in the Index itself either by
investing in the constituents of the index or by buying into an Index Fund.
2. Below Peers / Other MFs: When the Mutual Fund consistently under performs its Peer Group, it is
better to get out of the scheme and then invest in better schemes.
3. Change in MF's Goals: When the Mutual Fund changes its objectives, e.g. instead of providing a
regular income to the investor, the composition of the portfolio has changed to a growth fund mode
which is not in tune with the investor risk preferences, the Investor may exit the Mutual Fund /
Scheme.
4. Change in Investors' Goals: When the Investor changes his objective of investing in a Mutual Fund
which no longer is beneficial to him, he may exit that Mutual Fund / Scheme.
5. Change in Fund Manager: When the Fund Manager handling the Mutual Fund Schemes, has been
replaced by a new entrant whose reputation or image is not known, the Investor may exit the
Mutual Fund / Scheme.
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MUTUAL FUND 3.10 CMA CHANDER DUREJA

17. of Expenses (Costs) of a Mutual Fund.

Costs incurred by Mutual Fund comprise –
1. Initial Expenses attributable to establishing a Scheme under a Fund, and
2. Ongoing Recurring Expenses (Management Expense Ratio) which is made up of –
a. Cost of employing technically sound Investment Analysts,
b. Administrative Costs,
c. Advertisement Costs involving promotion and maintenance of Scheme Funds.
Management Expense Ratio (in %) = Total Management Expenses (or) Expenses per Unit
Average Value of Portfolio Average NAV per Unit
18. Explain the Sharpe Ratio in evaluating performance of a Mutual Fund.

1. Meaning: Sharpe Ratiomeasures the Return earned on a portfolio in excess of the Risk Free Rate, to
the Portfolio Total Risk as measured by the Standard Deviation in its Returns over the measurement
period.
2. Formula:Sharpe Ratio (S) = Return on Portfolio-Risk Free Return = R p - R E
Standard Deviation of Portfolio p
3. Uses:

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a. The highera Sharpe Ratio, the better a portfolio's returns have been; relative to the amount
of investment risk the Investor has taken.
b. Sharpe Ratio indicates the amount of return earned per unit of risk. Thus, it compares reward

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to risk
c. Producing healthy returns with low volatilityis generally preferred by most Investors,
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rather than high return with high volatility. So, Sharpe Ratio is a good tool to use to
determine a Fund that is suitable to such investors.
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d. It is often used to rank the risk-adjusted performance of various portfolios over the same
time.
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e. It uses the volatility of the Portfolio Return instead of measuring the volatility against a
benchmark (i.e. index).
Note: However, Sharpe Ratio is just a number, and it is meaningless it is compared with several other
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types of portfolios with similar objectives. Sharpe Ratio is an appropriate measure of performance for an
overall portfolio, particular when it is compared to another portfolio, or another index.
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19. Explain the Treynor Ratio in evaluating performance of a Mutual Fund.

a

1. Meaning:TreynorRatio (also called Reward to Volatility Ratio), is the ratio of a Fund's average
excess Return to the Fund’s Beta
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2. Formula: TreynorRatio (T) = Return on Portfolio-Risk Free Return = Rp -RF

Beta of Portfolio p
3. Uses:
a. This ratio is similar to Sharpe Ratio, except it uses Beta instead of Standard Deviation.
b. TreynorRatio evaluates the performance of a portfolio based on the systematic risk of a
Fund.
c. It measures the returns earned in excess of those that could have been earned on a riskless
investment per unit of market risk assumed,
d. The formula is typically used in ranking Mutual Funds with similar objectives.

20. Bring Out a comparison between Sharpe Ratio and Treynor Ratio.

Sharpe Ratio Treynor Ratio

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MUTUAL FUND 3.11 CMA CHANDER DUREJA

Here, Risk is determined as the Here, Risk is determined by the Betaof the Portfolio –
degree of volatility in returns – thedegree of "momentum" that has been built into
the variability in period – on – the portfolio by the Fund Manager in order to derive
period returns – expressed his excess returns. So, High Beta (> 1) implies that
through the Standard Deviation the portfolio will move faster (up as well as down)
of the stream of returns. than the market.

Since Standard Deviation is

considered as a measure of Risk
into account both Systematic This ratio captures only the systematic risk in its
Risk Systematic Risk and computation.
Unsystematic Risk

The Ratio assumes that both This Ratio assumes that unsystematic or specific risk
types ofRisk (systematic and can bediversified and hence, only incorporates the
unsystematicRisk) have to be Systematic Risk (Beta) to gauge the portfolio's
considered in evaluation. performance.

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It is more appropriate for acompletely diversified
It is appropriate for any general portfolio, where the element of unsystematic risk would
type of portfolio. be very negligible.

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More suitable for sector – specific More suitable for Equity Diversified Funds, since
Mutual Funds, since Unsystematic Unsystematic Risk would be made negligible by holding
Risk would also be present. ja
a diversified portfolio.
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21. Write short notes on Jenson's Alpha in evaluating performance of a Mutual Fund.
1. Meaning: Jenson's Alpha is the difference between a fund's Actual Return and those that could have
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been made on a benchmark Portfolio with the same risk, i.e. beta.
2. Formula: Jenson's Alpha = Actual Return less Expected (or Benchmark) Return
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For this purpose, Expected (or Benchmark) Return is computed using Capital Asset Pricing Model
(CAPM), i.e. by factoring the sensitivity of the Portfolio Return to the Market Portfolio.
nd

So, Expected Return = Risk Free Return + Beta of Portfolio (Market Return – RiskFree Return)
= R F + (RM – RF)
3. Uses:
a

a. Jenson's Alpha measures the ability of active management to increase returns above those
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that are purely a reward for bearing market risk.

b. It will only produce meaningful results if it is used to compare two portfolios which have
similar betas.
c. Jenson's Alpha requires minimum evaluation timeframe period of 1 year, 3 year time –
frameis better.

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