As per Mutual Funds Regualtion1996 issued by Securities and Exchange Board of India (SEBI), Mutual Funds means “a fund established in the form of a trust to raise monies through the sale of units to the public or a section of public under one or more schemes for investing in securities including money market investments.”
A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI), before it can collect funds from the public. Mutual funds are governed by SEBI (Mutual funds) Regulations 1996 and amended from time to time. The regulations were amended in the year 2000 and 2006.
Unit Trust of India was the first Mutual fund, which was set up in year 1964 by an act of Parliament.
Setting a Mutual fund
A mutual fund is set up in the form of a trust. It is established by a sponsor or more than one sponsor who is like promoter of a company. The trustees of the mutual fund hold its property for the benefit of the unit holders. The trustees monitor the performance and ensure compliance of SEBI Regulations.
They are vested with the general power of superintendence and direction over Asset Management Company (AMC). Asset Management Company (AMC) registered with SEBI manages the fund by making investments in various types of securities.
Since, Mutual funds are setup as trusts, Indian Trust Act, 1882 applies on them. As they deal in securities, they are governed by the provisions of Securities Contract Regulation Act, 1956 and also by other tax laws.
Mutual Funds
An investor can invest in securities either in the primary market or secondary market. Investments in securities i.e. stocks, bonds, and other financial instruments requires expertise. It is not child’s game. Every investor is not an expert in the field. An investor needs to be in regular touch with the market for taking decision whether to hold the security or off load it or to buy or to reshuffle the portfolio. Mutual funds came into existence for helping the investors from all these botherations. Mutual funds are financial intermediary.
It is a mechanism for pooling the resources by issuing units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unit holders. The profits or losses are shared by the investors in proportion to their investments.
Mutual funds are a form of collective investment scheme where funds from investors, are pooled and invested in diversified securities mentioned in the offer document, such as stocks, bonds, debentures, shares, money market instruments etc. It provides indirect investment opportunities to investors in accessing the capital market.
The fund manager trades in securities, books capital gains or loss, collects dividends or interest and then passes on to the investors periodically or at the end of specified period. The services are not provided free. The fund manager charges Management fee.
Mutual funds investment portfolio are continually adjusted under the supervision of professional manager, who after studying market trends, economic development and economic conditions, government policies and guidelines decides investments appropriate for the fund and choose those which according to him will closely match funds investment objectives. The fund manager trades in securities, books capital gains or loss, collects dividends or interest and then passes on to the investors periodically or at the end of specified period.
Difference between investing in a Mutual Fund and in an Initial Public Offering (IPO)
IPOs of companies may open at lower or higher price than the issue price depending on market sentiment and perception of investors. However, in the case of mutual funds, the par value of the units may not rise or fall immediately after allotment. A mutual fund scheme takes some time to make investment in securities. NAV of the scheme depends on the value of securities in which the funds have been deployed.
What is portfolio?
Portfolio is group of physical and financial assets. However, the term is commonly used for financial assets i.e. securities like shares. Bonds, debentures etc. Since, there is an element of risk involved in financial assets it is said not to keep all eggs in one basket i.e. investments should be in diversified securities and in multiple institutions. This will reduce risk if not eliminate it. Investments done in the securities of various sectors and different institution are known as portfolio. People invest in more than one security for maximizing returns and reduce risk. Therefore, a portfolio manager does portfolio rebalancing. He lays more emphasis on sector, industry or theme rather than individual blue chips. The risk attached to an investment relates to uncertainty attached to investment returns and variability of the expected returns.
Classification of Mutual fund on the basis of scheme
A mutual fund scheme can be classified into open-ended scheme or close-ended scheme depending on its maturity period.
Open-Ended Fund / Scheme
An open-ended Mutual fund is one that is available for subscription and repurchase on a continuous basis. An investor can invest at any time and withdraw any time as per his wishes. After the close of initial public offer, the units of the fund are quoted at a price. These Funds do not have a fixed maturity period. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices, which are declared on a daily basis. The price is inclusive of Net Asset Value (NAV) and sales load if any. Sales load are the charges levied at the time of selling the units. Price paid while withdrawing the fund is equal to Net Asset Value less back –end load i.e. charges collected by the scheme at the time of buying back of the units from the unit holder. The key feature of open-end schemes is liquidity.
Close-Ended Fund / Scheme
A close-ended mutual fund can be purchased only at the time of launch of the scheme. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where the units are listed. It has a stipulated maturity period e.g. 5-7 years. On maturity, the fund is redeemed and the corpus value is distributed to the unit holders. In case an investor wants to sell the units before the maturity period, he can sell it in the secondary market. Some close-ended funds give an option of selling back the units to the mutual fund through periodic repurchase at NAV related prices. These mutual funds schemes disclose NAV generally on weekly basis.
SEBI Regulations stipulate that at least one of the two exit routes is provided to the investor i.e. either repurchase facility or through listing on stock exchanges.
Load Fund
A Load Fund is one that charges a percentage of NAV for entry or exit. That is, each time one buys or sells units in the fund, a charge will be payable. This charge is used by the mutual fund for marketing and distribution expenses.
Suppose the NAV per unit is Rs.10. If the entry as well as exit load charged is 1%, then the investors who buy would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund will get only Rs.9.90 per unit. Loads affect yields/returns. Efficient Mutual funds may give higher returns in spite of loads.
Mutual funds cannot increase the load beyond the level mentioned in the offer document. Any change in the load will be applicable only to prospective investments and not to the original investments.
No-Load Fund
A no-load fund is one that does not charge for entry or exit. It means the investors can enter the fund/scheme at NAV and no additional charges are payable on purchase or sale of units. Classification according to Investment Objective
Prospectus of Mutual funds contains the investment objectives. On the basis of objectives schemes can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes. Such schemes may be classified mainly as follows:
1. Growth Funds
2. Income funds
3. Balanced Funds
4. Industry Specific Fund
5. Tax Saving funds
6. Guilt Fund
7. Money Market or Liquid Fund
8. Index Funds
9. Multi Fund
10. Assured Return Scheme
11. International funds
Growth / Equity Oriented Scheme
The aim of growth funds is to provide capital appreciation over the medium to long- term. These funds normally invest a major part of their corpus in equities. For earning higher returns, the fund is kept invested for long duration in the stock market securities. The aim of growth funds is to provide capital appreciation over the medium to long- term.
Growth schemes are good for those investors who want to have appreciation over a long-term period of time. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. The investors have to indicate the option in the application form. The mutual funds also allow the investors to change the options at a later date. Such funds have comparatively high risks.
Income Funds / Debt Oriented Scheme
The aim of income funds is to provide regular and steady income to investors. These funds invest in high dividend yielding securities. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments. These funds are not affected because of fluctuations in equity markets. The NAVs of such funds are affected because of change in interest rates in the country. If the interest rates fall, NAVs of such funds are likely to increase in the short run and vice versa. However, long-term investors are not to bother about these fluctuations. The main objective is to generate current income. The risk in income fund is intermediate. Such funds are less risky compared to growth fund.
Balanced Fund
The aim of balanced funds is to provide both growth and regular income. These fund hold a portfolio of diversified stocks (shares), bonds for realizing both capital gains and dividend and interest income. They invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity / growth funds. The risk in balanced fund is lower.
Industry Specific (sector specific) funds/schemes
These are the funds/schemes, which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, Power etc.
The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds.
Tax Saving Schemes
These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 as the Government offers tax incentives for investment in specified avenues. e.g. Equity Linked Savings Schemes (ELSS). Pension schemes launched by the mutual funds also offer tax benefits. These schemes are growth oriented and invest pre-dominantly in equities. Their growth opportunities and risks associated are like any equity-oriented scheme.
Gilt Fund
These funds invest exclusively in government securities. Government securities have no default risk. NAVs of these schemes also fluctuate due to change in interest rates and other economic factor as is the case with income or debt oriented schemes.
Money Market or Liquid Fund
These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.
Index Funds
Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty), etc These schemes invest in the securities in the same weightage comprising of an index. NAVs of such schemes would rise or fall in accordance with the rise or fall in the index, though not exactly by the same percentage due to some factors known as "tracking error" in technical terms. Necessary disclosures in this regard are made in the offer document of the mutual fund scheme. There are also exchange traded index funds launched by the mutual funds, which are traded on the stock exchanges.
Multi Funds (Fund of Funds-FoF) scheme
These funds invest in the portfolio of other mutual funds. The scheme enables the investors to achieve greater diversification through one scheme. It spreads risks across a greater universe.
Assured Return scheme
Assured return schemes are those schemes that assure a specific return to the unit holders irrespective of performance of the scheme.
A scheme cannot promise returns unless such returns are fully guaranteed by the sponsor or AMC and this is required to be disclosed in the offer document.
International Funds
International funds invest in foreign securities.
Offer document
SEBI has prescribed minimum disclosures in the offer document. An abridged offer document gives useful information to the prospective investor. It contains features of the scheme, risk factors, initial issue expenses and recurring expenses to be charged to the scheme, entry or exit loads, sponsor’s track record, educational qualification and work experience of key personnel including fund managers, performance of other schemes launched by the mutual fund in the past, pending litigations and penalties imposed, etc.
Working
§ Mutual funds are required to despatch Unit certificates or statements of accounts within six weeks from the date of closure of the initial subscription of their schemes. In case of close-ended schemes, the investors would get either a demat account statement or unit certificates as these are traded in the stock exchanges.
§ In case of open-ended schemes, a statement of account is issued by the mutual fund within 30 days from the date of closure of initial public offer of the scheme. The procedure of repurchase is mentioned in the offer document.
§ Mutual funds are required to despatch to the unit holders the dividend warrants within 30 days of the declaration of the dividend and the redemption or repurchase proceeds within 10 working days from the date of redemption or repurchase request made by the unit holder.
§ In case of failures to despatch the redemption/repurchase proceeds within the stipulated time period, Asset Management Company is liable to pay interest as specified by SEBI from time to time (15% at present).
§ According to SEBI Regulations, transfer of units is required to be done within thirty days from the date of lodgment of certificates with the mutual fund.
Primary Market
Primary market is the market for raising money. When a company issues shares, debentures, bonds etc by public offer, and when investors apply for these securities and he is allotted the securities, it is said that the security has been purchased from primary market. Primary market is the place for new issues either in the form of Initial Public Offer (IPO) or through right offer to the existing shareholders.
Secondary Market
Secondary market is the place for trading securities purchased in primary market. When the initial buyer who had purchased the Shares, bonds, debentures etc., from the primary market sells these securities, he sells them in the secondary market. Secondary market is the stock exchange, where trading in securities is done.
Net Asset Value
Mutual funds invest the money collected from the investors in securities markets .Net Asset Value (NAV) denotes the performance of a particular scheme of a mutual fund. The value of share (Unit) of mutual fund is known as Net Asset value (NAV),which is calculated periodically. Net Asset Value is the market value of the securities held by the scheme. Since market value of securities changes every day NAV is calculated each day.
In case of open-ended schemes its net asset value is disclosed on daily basis and in case of close-ended schemes it is disclosed on weekly basis. The mutual funds are required to disclose full portfolios of all of their schemes on half-yearly basis, which are published in the newspapers. Some mutual funds send the portfolios to their unit holders.
Calculating Net Asset Value
Calculating mutual fund net asset values is easy. It is arrived after dividing total value of funds net assets by taking the closing market value of all securities held by the fund plus all other assets such as cash (minus any liabilities) by the number of shares outstanding. Suppose the net assets of a fund is Rs.60 lakh and there are one lakh shares of the fund, then the price per share (or NAV) is Rs.60.00. The value of share (Unit) of mutual fund can be at a premium or discount to NAV.
Investing in Mutual funds has both advantages and disadvantages mentioned below.
Advantages
i) Diversification Benefits
Diversified investment improves the risk return profile of the portfolio. Since, resources have limitations, an investor cannot invest in diversified securities. Since, mutual funds get funds from investors, it is able to create substantially big pool of funds, which enables it to hold a large number of securities in diversified and multiple securities.
Diversification provides them with a lower level of risk than investing in a single stock or bond.
ii) Availability of Various Schemes
Mutual Funds offer a number of schemes to suit the requirements of the investor. An investor can choose between regular income schemes and growth schemes as per his requirement.
iii) Professional Management
Mutual funds are managed by professionals who have in depth knowledge of market, economy and trends in global market. This helps in better management of portfolio and in getting better returns.
Disadvantages of Mutual Funds
§ Investor has to rely on the judgment and decision of the Fund manager. He cannot choose the security in which he is interested. If the fund manager does not perform well, the investor is exposed to risk.
§ Charging of management fee by the fund manager reduces the return
§ It is not easy to liquidate
Role of SEBI
§ SEBI is the foremost authority for regulating mutual funds in India. It formulates policies and regulations to protect the interest of investors in securities and to promote the development of the securities market.
§ Registration of mutual funds is done after taking into account their financial soundness as well as the track record of Sponsors.
§ The offer documents of schemes launched by mutual funds and scheme particulars are vetted by SEBI.
§ It inspects and monitors the mutual funds every year in order to ensure their compliance with the regulations and to ensure that the funds collected in a particular scheme are invested as per the investment objectives mentioned in the offer document of Mutual Fund
§ Mutual funds are permitted to take up underwriting of primary issues as a part of their investment activity in order to diversify their business.
§ SEBI has prepared a CODE OF CONDUCT for Mutual funds. As per the code of conduct, the mutual funds should not use any unethical means to sell, market or induce any investor to buy their schemes. Further, they shall maintain high standards of integrity and fairness in all their dealings, render at all times high standards of service and exercise due diligence.
§ SEBI has laid down a code of advertisement for mutual funds. It has advised that the advertisement for Mutual Funds must contain following statement “Mutual Fund investments are subject to market risks, read the offer document carefully before investing”. And the above statement shall be displayed in black letters of at least 8inches height or covering 10% of the display area, on white background. The compliance officers shall ensure that the statement appearing in such advertisements are in legible font.
§ SEBI has issued guidelines about keeping its short tem funds with banks. Mutual funds cannot invest more than 10 per cent of the total net assets of a scheme in the short-term deposits of a single bank. It has also defined 'short term' for funds' investment purposes as a period not exceeding 91 days.
RBI is the monetary authority and the regulator of the banking system. Bank sponsored mutual funds are under the dual control of RBI and SEBI. Presently RBI is only the regulator of the Sponsors of bank-sponsored mutual funds. Bank sponsored Mutual funds are affected by the RBI stipulations on structure, issuance, pricing and trading of Government Securities SEBI is the regulator of all mutual funds.
Conclusion
People save money for meeting their future needs and exigencies. Savings is in fact sacrificing present needs for meeting future requirements. Every one wants to earn from the funds saved or from the extra funds. No one wants to keep the funds idle. Investors look for different investment avenues. Investing money in Mutual Funds is one of the several methods of investment. Resource mobilization by Mutual funds is on rise. Net resources mobilized by mutual funds were Rs.1, 53,802 crore during 2007-08. Net assets managed by mutual funds also increased to Rs.5, 05,152 crore during 2007-08.
Before taking investment decision the investor must go through the offer documents and risk factors.
“Mutual funds have two goals: to make money for themselves and for you, usually in that order.” Entry loads, exit loads, switching charges, annual recurring expenses, management fees, and investor servicing costs…these all add up over time.
