MUTUAL FUNDS
Introduction
There are many investment avenues available in the financial market for an investor.
Investors can invest in bank deposits, corporate debentures and bonds, post office saving
schemes etc. where, there is low risk together with low return. They may invest in stock of
companies where the risk is high and sometimes the returns are also proportionately high.
Investors who want to invest in equities are either too frightened or do not have the time nor
inclination to do detailed research before investing. For Investors, who do not have the time
and expertise to analyze and invest in stock, Mutual Funds is a viable investment alternative.
This is because Mutual Funds provide the benefit of cheap access to expensive stocks.
A Mutual Fund is a collective investment vehicle formed with the specific objective of
raising money from a large number of individuals and investing it according to a pre-
specified objective, with the benefits accrued to be shared among the investors on a pro-rata
basis in proportion to their investment.
According to Securities and Exchange Board of India Regulations, 1996 a mutual fund
means “a fund established in the form of trust to raise money through the sale of units to the
public or a section of the public under one or more schemes for investing in securities,
including money market instruments”.
A mutual fund serves as a link between the investor and the securities market by mobilising
savings from the investors and investing them in the securities market to generate returns.
Thus, a mutual fund is similar to portfolio management services (PMS). Although, both are
conceptually same, they are different from each other. Portfolio management services are
offered to high net worth individuals; taking into account their risk profile, their investments
are managed separately.
In the case of mutual funds, savings of small investors are pooled under a scheme and the
returns are distributed in the same proportion in which the investments are made by the
investors/unit-holders.
Mutual fund is a collective savings scheme. Mutual funds play an important role in
mobilising the savings of small investors and channelising the same for productive ventures
in the Indian economy.
1. NAV
NAV is an abbreviation of Net asset value. NAV is the sum total of the market value of assets held in
portfolio (all the shares/Mutual funds/bonds/debentures/cash and etc.,) less liabilities if any divided
by total number of mutual fund units.
For example: If a mutual fund has 1000 reliance shares with market value ₹1300 and 1000 HDFC
shares with market value ₹1650 and some cash of ₹10,00,000. Let’s assume there is no liability and
there are totally 1, 00,000 units in the mutual fund.
NAV = (Assets – liability)/ No. of units
= (((1000*1300) + (1000*1650) +10,00,000) – 0)/1,00,000
= ₹39.5
2. AUM
AUM is an abbreviation of Asset under management. This value refers to total market value of
assets managed by a mutual fund.
For example: If a mutual fund has 1000 reliance shares with market value ₹1300 and 1000 HDFC
shares with market value ₹1650 and some cash of ₹10,00,000.
AUM = (1000*1300) + (1000*1650) +10,00,000
= ₹39, 50,000
3. Exit load
Exit load is a small fee usually denoted by percentage of the total value redeemed that is collected
by mutual fund house when the investor redeems/ switches his funds. This is often collected to
discourage investors to redeem in short span. In general liquid funds do not have an exit load and
equity mutual funds greater than 1 year - doesn’t have exit load. The exit load and waiver period for
other schemes vary as per fund houses.
4. Entry load
Entry load is a small fee that is collected by mutual fund house from the investor when the investor
joins a mutual fund scheme. From August 2009 SEBI has cancelled the practice of collecting entry
load.
5. Commission
Commission is fee paid to your mutual fund agent for the investments you made through him/her.
This amount will be subtracted from your investment amount and then the units will be allocated for
remaining amount. If you choose direct funds there won’t be any commissions to the mutual fund
agent.
6. AMC
AMC means Asset Management Company. These are companies that get license from SEBI to
manage assets of a mutual fund. They usually take the investment decisions. SBI, HDFC, ICICI
Prudential, DSP Blackrock, Reliance Nippon, Birla sun life and etc., are few leading asset
management companies in India.
7. NFO
NFO means new fund offer, this usually happens when a mutual fund company launches a new
open/closed ended mutual fund.
8. Expense Ratio
Expense ratio is a measure of what it costs to operate a fund, expressed as a percentage of its
assets. Management fee/advisory fee is the major chunk of expense ratio. It also includes marketing
and distribution expenses. However it doesn’t include brokerage paid by the AMC for purchase and
sale of securities as the buying and sale price are taken into account after considering the
brokerage.
Unit
A unit represents one divided share of a scheme.
Unitholder
A person who holds unit(s) in his/her name is known as the unitholder.
Close-Ended Schemes
Close-ended schemes are mutual fund schemes that have a defined maturity period. An
investor can invest in such schemes only during the first issue. An investor can exit the
invest by two-manner – either at maturity of the scheme or by selling the units if the
scheme is listed on a stock exchange.
Open-End Scheme
A mutual fund scheme where the purchase and sale of units are allowed continually.
Face Value
It is the original price of a unit of a scheme.
Lock-In Period
The period during which the fresh investments made by an investor cannot be
redeemed.
NFO Launch
In a New Fund Offer (NFO), investors get an opportunity to subscribe to a mutual
fund scheme and say invested in it right from its inception. However, they can subscribe
only for a limited time. Once the NFO closes, the investors will only be able to purchase
the units. Moreover, the fund’s strategy is disclosed at the time of the NFO launch. Once
the fund manager fixes the fund strategy, it cannot be changed. It is because investors
invest in the fund based on the strategy. NFO’s are cheaper than existing funds as it’s new
to the market. However, mutual funds investors need to consider the fund houses’
reputation, objectives of the fund, cost of investment, risk, minimum subscription amount,
and the investment tenure before investing in an NFO.
Money is Pooled
Mutual funds pool money from many small investors to invest in securities. Investors
invest small amounts of money from their savings. Mutual funds allow small investors to
invest money in large portfolios, which they otherwise cannot. It can be due to the lack of
money or lack of time to perform mutual fund research in detail. Thus, mutual funds are
the solution to such investors.
Invest Money in Securities
The pooled money is invested in securities like shares, bonds, and government securities.
The fund manager decides the portfolio of the fund based on the strategy of the fund. The
portfolio manager has the expertise and time to do a thorough research of the securities.
Also, they perform a company, industry, and economy level analysis. In order to find the
securities that best fit the fund’s strategy and maximize the return for the mutual funds
investors. And at any point in time, if the selected securities are underperforming, they
replace them with better-performing securities. They sometimes use multiple strategies to
choose the securities for a fund. And sometimes, they also use a combination of investing
and trading strategies to take advantage of the stock market situations. All these efforts put
by the fund managers give investors access to large portfolios.
Fund Returns
The portfolio manager continuously strives to earn returns from the investments they
make on behalf of the fund investors. Thus, all their efforts in mutual fund research,
monitoring, and rebalancing the portfolio increases the fund’s NAV. Once the fund makes
returns, they are either distributed or invested back into the fund. While, for dividend
funds, the returns are distributed in the form of dividends. For growth funds, the returns
are reinvested into the fund to enhance the wealth of the fund investors. It is the critical
step of mutual fund investing as this completes the cycle of investing. The returns, if
retained in the fund, are further invested in creating more wealth for investors.
Hence, mutual fund investing is a continuous process that channelizes small savings of
many investors in productive securities to maximize their wealth.
How mutual funds work?
For instance, let’s assume that Aditya Birla Mutual Fund launches a mutual fund scheme.
Let us say, ABSL Top 25 Fund. For the ease of understanding, let’s assume the scheme
collects INR 1 crore from 100 investors. Investment per investor being INR 1 lakh. The fund
house allots the units at a NAV of INR 10. Therefore, each investor gets 10,000 units. Thus,
the total number of units issued and allocated by the fund house is 10 lakh units.
ABSL Top 25 Fund’s objective is to invest across 25 stocks. To follow the fund’s objective,
the fund manager does his research and pick the top 25 stock. The fund manager believes
that buying stocks that fit the criteria will contribute significant returns to the portfolio.
Upon selecting the shares, the fund manager invests equal amounts across each stock.
Thus, the equity fund comprises of top 25 shares.
As the Assets Under Management (AUM) of the fund is INR 1 crore, investment in each
stock is approximately INR 4 lakh. Thus these stocks become part of the equity
fund portfolio. Also, in reality, the fund manager deals and invests in high proportions. All
the investments are backed by research. The fund manager believes in buying stocks that
give good returns. Additionally, the fund also maintains a cash balance. It is to deal with
redemption from investors.
How do mutual funds function in Demat and physical form?
The unit allotment is done either in demat form or physical form. It takes t 2 working days
for units to be allotted to investors. Though both the forms are electronic, they differ in
terms of account type, account statement, and expense ratio.
Physical form
In physical form, the units are dealt through AMC. The AMC directly sells the units to
investors and, at the time of redemption, repurchases it. Investing through physical form
means holding it in Statement of Account (SOA) form. The fund house issues the account
statements. The RTA maintains all records of investors and assists fund houses to track
investor’s data. Investors can get on-demand reports of their mutual fund holdings
through online portals of RTAs. Physical form is cheaper than a demat form. There are no
additional brokerage costs. Just the mutual fund fee.
Demat form
In demat form, mutual funds are purchased and sold on the exchange or through brokers.
The buying and selling is done through a demat account. This form is highly liquid. It is
because the buyer or the seller can either be the AMC or any other investor as the units
are freely available. The broker with whom the mutual funds are dealt with provides a
demat account statement on demand. An investor can hold mutual fund holdings and
shares in one single demat account. This way, the investor can have a consolidated view
of all the types of investments. Demat or brokerage account has brokerage charges
which are over and above the mutual fund fee. Loan against mutual funds is possible
under brokerage account. STP and SWP are not possible in demat form, which is possible
under the physical form.
History and Growth of Mutual Fund Industry Growth of Mutual Fund
The Mutual Fund industry in India started in 1963 with the formation of Unit Trust of India at the
initiative of the Government of India and Reserve Bank. The primary objective at that time was to
attract small investors and it was made possible through the collective efforts of the Government of
India and Reserve Bank of India.
THE MUTUAL FUND INDUSTRY IN INDIA:
The mutual fund industry in India started in 1963 with the formation of Unit Trust of
India (UTI) at the initiative of the Reserve Bank of India (RBI) and the Government
of India. The objective then was to attract small investors and introduce them to
market investments. Since then, the history of mutual funds in India can be broadly
divided into six distinct phases.
Phase I (1964-87): Growth Of UTI:
In 1963, UTI was established by an Act of Parliament. As it was the only entity
offering mutual funds in India, it had a monopoly. Operationally, UTI was set up by
the Reserve Bank of India (RBI), but was later delinked from the RBI. The first
scheme, and for long one of the largest launched by UTI, was Unit Scheme 1964.
Later in the 1970s and 80s, UTI started innovating and offering different schemes to
suit the needs of different classes of investors. Unit Linked Insurance Plan (ULIP) was
launched in 1971. The first Indian offshore fund, India Fund was launched in August
1986. In absolute terms, the investible funds corpus of UTI was about Rs 600 crores
in 1984. By 1987-88, the assets under management (AUM) of UTI had grown 10
times to Rs 6,700 crores.
Phase II (1987-93): Entry of Public Sector Funds:
The year 1987 marked the entry of other public sector mutual funds. With the opening
up of the economy, many public sector banks and institutions were allowed to
establish mutual funds. The State Bank of India established the first non-UTI Mutual
Fund, SBI Mutual Fund in November 1987. This was followed by Canbank Mutual
Fund,LIC Mutual Fund, Indian Bank Mutual Fund, Bank of India Mutual Fund, GIC
Mutual Fund and PNB Mutual Fund. From 1987-88 to 1992-93, the AUM increased
from Rs 6,700 crores to Rs 47,004 crores, nearly seven times. During this period,
investors showed a marked interest in mutual funds, allocating a larger part of their
savings to investments in the funds.
Phase III (1993-96): Emergence of Private Funds:
A new era in the mutual fund industry began in 1993 with the permission granted for
the entry of private sector funds. This gave the Indian investors a broader choice of
'fund families' and increasing competition to the existing public sector funds. Quite
significantly foreign fund management companies were also allowed to operate
mutual funds, most of them coming into India through their joint ventures with Indian
promoters.
The private funds have brought in with them latest product innovations, investment
management techniques and investor-servicing technologies. During the year 1993-
94, five private sector fund houses launched their schemes followed by six others in
1994-95.
Phase IV (1996-99): Growth And SEBI Regulation:
Since 1996, the mutual fund industry scaled newer heights in terms of mobilization of
funds and number of players. Deregulation and liberalization of the Indian economy
had introduced competition and provided impetus to the growth of the industry.
A comprehensive set of regulations for all mutual funds operating in India was
introduced with SEBI (Mutual Fund) Regulations, 1996. These regulations set
uniform standards for all funds. Erstwhile UTI voluntarily adopted SEBI guidelines
for its new schemes. Similarly, the budget of the Union government in 1999 took a
big step in exempting all mutual fund dividends from income tax in the hands of the
investors. During this phase, both SEBI and Association of Mutual Funds of India
(AMFI) launched Investor Awareness Programme aimed at educating the investors
about investing through MFs.
Phase V (1999-2004): Emergence of a Large and Uniform Industry:
The year 1999 marked the beginning of a new phase in the history of the mutual fund
industry in India, a phase of significant growth in terms of both amount mobilized
from investors and assets under management. In February 2003, the UTI Act was
repealed. UTI no longer has a special legal status as a trust established by an act of
Parliament. Instead it has adopted the same structure as any other fund in India - a
trust and an AMC.
UTI Mutual Fund is the present name of the erstwhile Unit Trust of India (UTI).
While UTI functioned under a separate law of the Indian Parliament earlier, UTI
Mutual Fund is now under the SEBI's (Mutual Funds) Regulations, 1996 like all other
mutual funds in India.
The emergence of a uniform industry with the same structure, operations and
regulations make it easier for distributors and investors to deal with any fund house.
Between 1999 and 2005 the size of the industry has doubled in terms of AUM which
have gone from above Rs 68,000 crores to over Rs 1,50,000 crores.
Phase VI (From 2004 Onwards): Consolidation and Growth:
The industry has lately witnessed a spate of mergers and acquisitions, most recent
ones being the acquisition of schemes of Allianz Mutual Fund by Birla Sun Life, PNB
Mutual Fund by Principal, among others. At the same time, more international players
continue to enter India including Fidelity, one of the largest funds in the world.
Since May 2014, the Industry has witnessed steady inflows and increase in the AUM as
well as the number of investor folios (accounts).
● The Industry’s AUM crossed the milestone of 10 Trillion for the
first time as on 31st May 2014 and in a short span of two years the AUM size has
crossed 15 lakh crore in July 2016.
●
The overall size of the Indian MF Industry has grown from 3.26 trillion as on 31st March 2007 to 15.63 trill
the highest AUM ever and a
five-fold increase in a span of less than 10 years !!
● In fact, the MF Industry has more
doubled its AUM in the last 4 years from 5.87 trillion as on 31st Ma
● The no. of investor folios has gone up from 3.95 crore folios as on 31-03-2014 to
4.98 crore as on 31-08-2016.
● On an average 3.38 lakh new folios are added every month in the last 2 years since
Jun 2014.
The growth in the size of the Industry has been possible due to the twin effects of the
regulatory measures taken by SEBI in re-energising the MF Industry in September 2012
and the support from mutual fund distributors in expanding the retail base.
MF Distributors have been providing the much needed last mile connect with investors,
particularly in smaller towns and this is not limited to just enabling investors to invest in
appropriate schemes, but also in helping investors stay on course through bouts of market
volatility and thus experience the benefit of investing in mutual funds.
Structure of Mutual Funds in India.
The structure of Mutual Funds in India is a three-tier one. There are three
distinct entities involved in the process – the sponsor (who creates a
Mutual Fund), trustees and the asset management company (which
oversees the fund management). The structure of Mutual Funds has come
into existence due to SEBI (Securities and Exchange Board of India)
Mutual Fund Regulations, 1996. Under these regulations, a Mutual Fund is
created as a Public Trust.
The Fund Sponsor The Fund Sponsor is the first layer in the three-tier
structure of Mutual Funds in India. SEBI regulations say that a fund
sponsor is any person or any entity that can set up a Mutual Fund to earn
money by fund management. This fund management is done through an
associate company which manages the investment of the fund. A sponsor
can be seen as the promoter of the associate company. A sponsor has to
approach SEBI to seek permission for a setting up a Mutual Fund. Once
SEBI agrees to the inception, a Public Trust is formed under the Indian
Trust Act, 1882 and is registered with SEBI. Trustees are appointed to
manage the trust and an asset management company is created
complying with the Companies Act, 1956.
There are eligibility criteria given by SEBI for the fund sponsor:
1. The sponsor must have experience in financial services for a
minimum of five years with a positive Net worth for all the previous
five years.
2. The net worth of the sponsor in the immediate last year has to be
greater than the capital contribution of the AMC.
3. The sponsor must show profits in at least three out of five years
which includes the last year as well.
4. The sponsor must have at least 40% share in the net worth of the
asset management company.
5. Any entity that fulfills the above criteria can be termed as a sponsor
of the Mutual Fund.
Money Market Mutual Funds
How do Money Market Funds work?
Money market funds are financial instruments having a short maturity period of up to 1 year.
These funds are debt securities offering a fixed rate of interest and hence, are used as tools
for raising capital by the issuer. However, money market funds are generally unsecured and
involve a theoretically high risk of non-repayment.
While there is also no collateral backing up of the security in these funds, they tend to offer
a high credit rating ensuring that issuers don’t default, which makes them a go-to avenue for
investors looking for options to park their money for short term and earn fixed returns on the
same.
Money market instruments, also known as long term borrowing instruments are grouped as
‘papers’ in contrast to ‘bonds’ and ‘shares’ and are traded on capital markets. One of the
core drivers of money markets is inter-bank lending. Inter-bank lending refers to banks
lending to and borrowing from other banks using money market instruments such as
repurchase agreements and commercial papers. In India, the RBI regulates the REPO rate
which is a benchmark rate to be used by domestic banks for the purpose of lending and
borrowing from one another.
When should you Invest in a Money Market
Fund?
Money Market funds are steady return products, with little risk of default. These funds tend
to offer the benefits of stability and liquidity to their investors. Money market funds generate
income from interest payments and capital gains. Also, the interest rates and the market
price of these funds go hand in hand. When the interest rate rises, the market price of these
funds increases, allowing the investor to earn through higher interest income. When the
interest rate falls, the market price of money market funds decreases. It must be noted that
higher the interest rate, higher will be the income generated by the investor. This can,
therefore, be considered as the ideal time for investing in money market funds.
Advantages of Money Market Mutual Funds
1. Professional Management
2. Diversification
3. Convenient Administration
4. Return Potential
5. Low Cost
6. Well Regulated
7. Transparency
8. Participation of Individual Investors
• Professional investment management : The money polled in the mutual funds is managed by
professionals who decide the investment strategies on behalf of the unit holders. On account of
large pool of investible funds, the mutual funds have all the resources to hire well qualified full
time investment managers.
• Diversification : Fund manager invest in safer short term instruments such as T Bills, certificate
of Deposit, commercial paper, government securities etc. the fund manager diversifies the
Mutual Fund portfolio by selectively and suitably investing in these instruments by creating an
appropriate mix.
• Return Potential : Over a medium to long term, Mutual Fund have the potential to provide a
higher return as they invest in a diversified basket of selected securities. Also since the fund
managers churn the portfolio at the appropriate time the extent of returns generated by the
Mutual Fund is higher.
• Low Cost : Since the fund managers have a large amount of funds at their disposal for the
purpose of investments, they enjoy the benefits of scale in brokerage, custodial and other fees
which translate into lower costs for investors. Thus Mutual Funds area relatively less expensive
way to invest.
• Well Regulated : All Mutual Funds are registered with SEBI and they function within the
provisions of strict regulations designed to protect the interest of investors. The operations of
MF are regularly monitored by SEBI. Hence it is said that MF sector is well regulated.
• Transparency : Regular information in the value of the MF investment in addition to disclosure
on the specific investments made by the scheme is mandatory as per SEBIs regulations. The
proportion of funds invested in each class of assets and the fund manager’s investment strategy
and outlook can be checked by the investors to confirm whether they have been as per the
disclosure norms or not.
• Convenient Administration : Investing in a MF reduces paperwork as apart from the one time
purchase formalities the investors are not required to make any other paperwork. Due to the
Dmat A/Cs facilities, many problems such as bad deliveries, delayed payments and unnecessary
follow up with brokers etc. which were a part and parcel of investment instruments are avoided.
MF thus save time and make investing easy and convenient.
• Participation by Individual Investor : the major participants of the Money Markets are banks
and Primary Dealers, but with MF schemes even individual investors can now expose their
investment portfolio to the money market which was otherwise not possible.
Disadvantages
Risks and Cost
Changing market conditions can create fluctuations in the value of a mutual fund investment. A the
RBI brings in changes in the monetary policy, its immediate effect is seen in the money market
instruments. Since the mutual funds will invest in these securities they have to bear such a risk. also
there are fees and expenses associated with investing in MF that do not usually occur when
purchasing individual securities.
2. Unassured and variable returns
As Money Market MF invests in debt which also depends on the monetary policy and the market
conditions, the returns of MF are always unassured….. Even the scheme related documents clearly
mentioned that they are subject to market risk and read all schemes carefully before investing in
it….thereby washing off their responsibilities towards the returns.
3. No Control:
Investor does not have control on investments, all the decisions are taken by the fund manager.
Investor can just leave or join.
