Mutual Funds

Introduction Definitions

Mutual Fund - A mutual fund brings together money from many people and invests it in stocks, bonds or other assets. The combined holdings of stocks, bonds or other assets the fund o ns are kno n as its portfolio. !ach investor in the fund o ns shares, hich represent a part of these holdings. It is important to note that there is market risk involved hen investing in mutual funds, including possible loss of principal. Mutual funds are investment companies that pool money from investors at large and offer to sell and buy back its shares on a continuous basis and use the capital thus raised to invest in securities of different companies

As you probably kno , mutual funds have become e"tremely popular over the last #$ years. %hat as once &ust another obscure financial instrument is no a part of our daily lives. More than '$ million people, or one half of the households in America, invest in mutual funds. That means that, in the (nited )tates alone, trillions of dollars are invested in mutual funds. In fact, too many people, investing means buying mutual funds. After all, it*s common kno ledge that investing in mutual funds is +or at least should be, better than simply letting your cash aste a ay in a savings account, but, for most people, that*s here the understanding of funds ends. It doesn*t help that mutual fund salespeople speak a strange language that is interspersed ith &argon that many investors don*t understand. -riginally, mutual funds ere heralded as a ay for the little guy to get a piece of the market. Instead of spending all your free time buried in the financial pages of the %all )treet .ournal, all you had to do as buy a mutual fund and you*d be set on your ay to financial freedom. As you might have guessed, it*s not that easy. Mutual funds are an e"cellent idea in theory, but, in reality, they haven*t al ays delivered. /ot all mutual funds are created e0ual, and investing in mutuals isn*t as easy as thro ing your money at the first salesperson ho solicits your business. +1earn about the pros and cons in Mutual Funds Are A esome - !"cept %hen they2re /ot.,

A 3rief 4istory -f The Mutual Fund

Mutual funds really captured the public*s attention in the 56'$s and *6$s hen mutual fund investment hit record highs and investors sa incredible returns. 4o ever, the idea of pooling assets for investment purposes has been around for a long time. 4ere e look at the evolution of this investment vehicle, from its beginnings in the /etherlands in the 5'th century to its present status as a gro ing, international industry ith fund holdings accounting for trillions of dollars in the (nited )tates alone. In the 3eginning 4istorians are uncertain of the origins of investment funds7 some cite the closed-end investment companies launched in the /etherlands in 5'## by 8ing %illiam I as the first mutual funds, hile others point to a Dutch merchant named Adriaan van 8et ich hose investment trust created in 599: may have given the king the idea. 8et ich probably theori;ed that diversification ould increase the appeal of investments to smaller investors ith minimal capital. The name of 8et ich*s fund, !endragt Maakt Magt, translates to <unity creates strength<. The ne"t ave of near-mutual funds included an investment trust launched in ) it;erland in 5':6, follo ed by similar vehicles created in )cotland in the 5''$s. The idea of pooling resources and spreading risk using closed-end investments soon took root in =reat 3ritain and France, making its ay to the (nited )tates in the 5'6$s. The 3oston >ersonal >roperty Trust, formed in 5'6?, as the first closed-end fund in the (.). The creation of the Ale"ander Fund in >hiladelphia in 56$9 as an important step in the evolution to ard hat e kno as the modern mutual fund. The Ale"ander Fund featured semi-annual issues and allo ed investors to make ithdra als on demand.

@egulation and !"pansion

3y 56#6, there ere 56 open-ended mutual funds competing ith nearly 9$$ closed-end funds. %ith the stock market crash of 56#6, the dynamic began to change as highlyleveraged closed-end funds ere iped out and small open-end funds managed to survive. =overnment regulators also began to take notice of the fledgling mutual fund industry. The creation of the )ecurities and !"change Aommission +)!A,, the passage of the )ecurities Act of 56?? and the enactment of the )ecurities !"change Act of 56?: put in place safeguards to protect investorsB mutual funds ere re0uired to register ith the )!A and to provide disclosure in the form of a prospectus. The Investment Aompany Act of 56:$ put in place additional regulations that re0uired more disclosures and sought to minimi;e conflicts of interest. +For further reading, see >olicing The )ecurities MarketB An -vervie -f The )!A., The mutual fund industry continued to e"pand. At the beginning of the 56C$s, the number of open-end funds topped 5$$. In 56C:, the financial markets overcame their 56#6 peak, and the mutual fund industry began to gro in earnest, adding some C$ ne funds over the course of the decade. The 56D$s sa the rise of aggressive gro th funds, ith more than 5$$ ne funds established and billions of dollars in ne asset inflo s. 4undreds of ne funds ere launched throughout the 56D$s until the bear market of 56D6 cooled the public appetite for mutual funds. Money flo ed out of mutual funds as 0uickly as investors could redeem their shares, but the industry*s gro th later resumed.
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A 3rief of 4o Mutual Funds %ork Mutual funds can be either or both of open ended and closed ended investment companies depending on their fund management pattern. An open-end fund offers to sell its shares +units, continuously to investors either in retail or in bulk ithout a limit on the number as opposed to a closed-end fund. Alosed end funds have limited number of shares. Mutual funds have diversified investments spread in calculated proportions amongst securities of various economic sectors. Mutual funds get their earnings in t o ays. First is the most organic ay, hich is the dividend they get on the securities they hold. )econd is by the redemption of their shares by investors ill be at a discount to the current /AEs +net asset values,. Are Mutual Funds @isk Free and hat are the AdvantagesF

-ne must not forget the fundamentals of investment that no investment is insulated from risk. Then it becomes interesting to ans er hy mutual funds are so popular. To begin ith, e can say mutual funds are relatively risk free in the ay they invest and manage the funds. The investment from the pool is ell diversified across securities and shares from various sectors. The fundamental understanding behind this is not all corporations and sectors fail to perform at a time. And in the event of a security of a corporation or a hole sector doing badly then the possible losses from that ould be balanced by the returns from other shares. Gou might try to reduce the risks by taking a for instance 5# month term deposit account. This logic has seen the mutual funds to be perceived as risk free investments in the market. Ges, this is not entirely untrue if one takes a look at performances of various mutual funds. This relative freedom from risk is in addition to a couple of advantages mutual funds carry ith them. )o, if you are a retail investor and planning an investment in securities, you ill certainly ant to consider the advantages of investing in mutual funds. 1o est per unit investment in almost all the cases. Gour investment ill be diversified. Gour investment ill be managed by professional money managers.

Advantages of Mutual Funds

)ince their creation, mutual funds have been a popular investment vehicle for investors. Their simplicity along ith other attributes provides great benefit to investors ith limited kno ledge, time or money. To help you decide hether mutual funds are best for you and your situation, e are going to look at some reasons hy you might ant to consider investing in mutual funds. 5. DiversificationB -ne rule of investing, for both large and small investors, is asset diversification. Diversification involves the mi"ing of investments ithin a portfolio and is used to manage risk. For e"ample, by choosing to buy stocks in the retail sector and offsetting them ith stocks in the industrial sector, you can reduce the impact of the performance of any one security on your entire portfolio. To achieve a truly diversified portfolio, you may have to buy stocks ith different capitali;ations from different industries and bonds ith varying maturities from different issuers. For the individual investor, this can be 0uite costly. 3y purchasing mutual funds, you are provided ith the immediate benefit of instant diversification and asset allocation ithout the large amounts of cash needed to create individual portfolios. -ne caveat, ho ever, is that simply purchasing one mutual fund might not give you ade0uate diversification - check to see if the fund is sector or industry specific. For e"ample, investing in an oil and energy mutual fund might spread your money over fifty companies, but if energy prices fall, your portfolio ill likely suffer. #. !conomies of )caleB

The easiest ay to understand economies of scale is by thinking about volume discounts7 in many stores, the more of one product you buy, the cheaper that product becomes. For e"ample, hen you buy a do;en donuts, the price per donut is usually cheaper than buying a single one. This also occurs in the purchase and sale of securities. If you buy only one security at a time, the transaction fees ill be relatively large. Mutual funds are able to take advantage of their buying and selling si;e and thereby reduce transaction costs for investors. %hen you buy a mutual fund, you are able to diversify ithout the numerous commission charges. Imagine if you had to buy the 5$-#$ stocks needed for diversification. The commission charges alone ould eat up a good chunk of your savings. Add to this the fact that you ould have to pay more transaction fees every time you anted to modify your portfolio - as you can see the costs begin to add up. %ith mutual funds, you can make transactions on a much larger scale for less money. ?. DivisibilityB Many investors don*t have the e"act sums of money to buy round lots of securities. -ne to t o hundred dollars is usually not enough to buy a round lot of a stock, especially after deducting commissions. Investors can purchase mutual funds in smaller denominations, ranging from H5$$ to H5,$$$ minimums. )maller denominations of mutual funds provide mutual fund investors the ability to make periodic investments through monthly purchase plans hile taking advantage of dollar-cost averaging. )o, rather than having to ait until you have enough money to buy higher-cost investments, you can get in right a ay ith mutual funds. This provides an additional advantage li0uidity. :. 1i0uidityB Another advantage of mutual funds is the ability to get in and out ith relative ease. In general, you are able to sell your mutual funds in a short period of time ithout there being much difference bet een the sale price and the most current market value. 4o ever, it is important to atch out for any fees associated ith selling, including back-end load fees. Also, unlike stocks and e"change-traded funds +!TFs,, hich trade any time during market hours, mutual funds transact only once per day after the fund*s net asset value +/AE, is calculated. C. >rofessional ManagementB %hen you buy a mutual fund, you are also choosing a professional money manager. This manager ill use the money that you invest to buy and sell stocks that he or she has carefully researched. Therefore, rather than having to thoroughly research every investment before you decide to buy or sell, you have a mutual fund*s money manager to handle it for you.

Disadvantages of mutual funds

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5. Fluctuating @eturnsB Mutual funds are like many other investments ithout a guaranteed returnB there is al ays the possibility that the value of your mutual fund ill depreciate. (nlike fi"edincome products, such as bonds and Treasury bills, mutual funds e"perience price fluctuations along ith the stocks that make up the fund. %hen deciding on a particular fund to buy, you need to research the risks involved - &ust because a professional manager is looking after the fund, that doesn*t mean the performance ill be stellar. Another important thing to kno is that mutual funds are not guaranteed by the (.). government, so in the case of dissolution, you on*t get anything back. This is especially important for investors in money market funds. (nlike a bank deposit, a mutual fund ill not be insured by the Federal Deposit Insurance Aorporation +FDIA,. #. Aash, Aash and More AashB As you kno already, mutual funds pool money from thousands of investors, so everyday investors are putting money into the fund as ell as ithdra ing investments. To maintain li0uidity and the capacity to accommodate ithdra als, funds typically have to keep a large portion of their portfolios as cash. 4aving ample cash is great for li0uidity, but money sitting around as cash is not orking for you and thus is not very advantageous. ?. AostsB Mutual funds provide investors ith professional management, but it comes at a cost. Funds ill typically have a range of different fees that reduce the overall payout. In mutual funds, the fees are classified into t o categoriesB shareholder fees and annual operating fees. The shareholder fees, in the forms of loads and redemption fees, are paid directly by shareholders purchasing or selling the funds. The annual fund operating fees are charged as an annual percentage - usually ranging from 5-?I. These fees are assessed to mutual fund investors regardless of the performance of the fund. As you can imagine, in years hen the fund doesn*t make money, these fees only magnify losses. :. Misleading AdvertisementsB The misleading advertisements of different funds can guide investors do n the rong path. )ome funds may be incorrectly labelled as gro th funds, hile others are classified as small cap or income funds. The )ecurities and !"change Aommission +)!A, re0uires that funds have at least '$I of assets in the particular type of investment implied in their names. 4o the remaining assets are invested is up to the fund manager.

4o ever, the different categories that 0ualify for the re0uired '$I of the assets may be vague and ide-ranging. A fund can therefore manipulate prospective investors by using names that are attractive and misleading. Instead of labelling itself a small cap, a fund may be sold as a <gro th fund<. -r, the <Aongo 4igh-Tech Fund< could be sold ith the title <International 4igh-Tech Fund<.

C. !valuating FundsB Another disadvantage of mutual funds is the difficulty they pose for investors interested in researching and evaluating the different funds. (nlike stocks, mutual funds do not offer investors the opportunity to compare the >J! ratio, sales gro th, earnings per share, etc. A mutual fund*s net asset value gives investors the total value of the fund*s portfolio less liabilities, but ho do you kno if one fund is better than anotherF Furthermore, advertisements, rankings and ratings issued by fund companies only describe past performance. Al ays note that mutual fund descriptionsJadvertisements al ays include the tagline <past results are not indicative of future returns<. 3e sure not to pick funds only because they have performed ell in the past - yesterday*s big inners may be today*s big losers.

TG>!) -F M(T(A1 F(/D)

Most funds have a particular strategy they focus on hen investing. For instance, some invest only in 3lue Ahip companies that are more established and are relatively lo risk. -n the other hand, some focus on high-risk start up companies that have the potential for double and triple digit gro th. Finding a mutual fund that fits your investment criteria and style is important.

Types of mutual funds areB Ealue stocks B )tocks from firms ith relative lo >rice to !arning +>J!, @atio, usually pay good dividends. The investor is looking for income rather than capital gains. Ealue funds are those mutual funds that tend to focus on safety rather than gro th, and often choose investments providing dividends as ell as capital appreciation. They invest in companies that the market has overlooked, and stocks that have fallen out of favour ith mainstream investors, either due to changing investor preferences, a poor 0uarterly earnings report, or hard times in a particular industry. Investing in value fund involves identifying fundamentally sound stocks that are trading at a discount to their fair value. The fund manager buys these stocks and holds them until the stock bounce backs to its fair value. The fund managers identify undervalued stocks in the market on the basis of fundamental analysis techni0ues. In this process stocks ith lo price to earnings ratios are tagged. These stocks are then closely revie ed to see hich ones have the greatest gro th potential and are paying high dividends. )uitability of Ealue FundsB Ealue style of investing orks particularly ell during a bear phase in the stock markets. During this time, the fund manager has more opportunities to invest in stocks trading at a discount to their fair value. 3y buying lo and selling high, value funds take on lo er risk than gro th funds, hich tend to buy high and sell higher. Thus value funds are particularly suitable for investors ith a moderate risk profile. As value funds react slo ly to market movements, they can be a good instrument of investment for those investors ho are due to retire shortly. =ro th stock B )tocks from firms ith higher lo >rice to !arning +>J!, @atio, usually pay small dividends. The investor is looking for capital gains rather than income. 3ased on company si;e, large, mid, and small cap )tocks from firms ith various asset levels such as over H# 3illion for large7 in bet een H# and H5 3illion for mid and belo H5 3illion for small. Income stock B The investor is looking for income hich usually comes from dividends or interest. These stocks are from firms hich pay relative high dividends. This fund may include bonds

hich pay high dividends. This fund is much like the value stock fund, but accepts a little more risk and is not limited to stocks. !nhanced inde" B This is an inde" fund hich has been modified by either adding value or reducing volatility through selective stock-picking. )tock market sector B The securities in this fund are chosen from a particular marked sector such as Aerospace, retail, utilities, etc. Defensive stock B The securities in this fund are chosen from a stock economic do n turns. hich usually is not impacted by

@eal estate B )tocks from firms involved in real estate such as builder, supplier, architects and engineers, financial lenders, etc. )ocially responsible B This fund ould invest according to non-economic guidelines. Funds may make investments based on such issues as environmental responsibility, human rights, or religious vie s. For e"ample, socially responsible funds may take a proactive stance by selectively investing in environmentally-friendly companies or firms ith good employee relations. Therefore the fund ould avoid securities from firms ho profit from alcohol, tobacco, gambling, pornography etc. Ta" efficient B Aims to minimi;e ta" bills, such as keeping turnover levels lo or shying a ay from companies that provide dividends, hich are regular payouts in cash or stock that, are ta"able in the year that they are received. These funds still shoot for solid returns7 they &ust ant less of them sho ing up on the ta" returns. Aonvertible B 3onds or >referred stock hich may be converted into common stock. .unk bond B 3onds hich pay higher that market interest but carry higher risk for failure and are rated belo AAA. Mutual funds of mutual funds B This funds that speciali;es in buying shares in other mutual funds rather than individual securities.

!"change traded funds +!TFs, B

3askets of securities +stocks or bonds, that track highly recogni;ed inde"es. )imilar to mutual funds, e"cept that they trade the same ay that a stock trades, on a stock e"change. !"change Traded Funds +!TFs, represent a basket of securities that is traded on an e"change, similar to a stock. 4ence, unlike conventional mutual funds, !TFs are listed on a recognised stock e"change and their units are directly traded on stock e"change during the trading hours. In !TFs, since the trading is largely done over stock e"change, there is minimal interaction bet een investors and the fund house. !TFs can be categorised into close-ended !TFs or open-ended !TFs. !TFs are either actively or passively managed. Actively managed !TFs try to outperform the benchmark inde", hereas passively-managed !TFs attempt to replicate the performance of a designated benchmark inde". Difference bet een !TF and Aonventional Mutual FundsB Mutual funds are traded through fund house here as in an !TF, transactions are done through a broker as buying and selling is done on the stock e"change. In conventional mutual funds units can be bought and redeemed only at the relevant /AE, hich is declared only once at the end of the day. !TFs can be bought and sold at any time during market hours like a stock. As a result, !TF investors have the benefit of real time pricing and they can take advantage of intra-day volatility. Annual e"penses charged to investors in an !TF are considerably less than the vast ma&ority of mutual funds. Most of the mutual funds have an entry or e"it load varying bet een #.$$I and #.#CI. !TFs do not have any such loads. Instead !TF investors have to pay a brokerage to the broker hile transacting. This in most cases is not more than $.CI. !TFs safeguard the interests of long-term investors. This is because !TFs are traded on e"change and fund managers do have to keep cash in hand in order to meet redemption pressures.

)tructure of the Indian Mutual Funds

In developed countries like the (8 and the (), the mutual funds industry is highly regulated ith a vie of imparting operational transparency and protecting investors2

interest. )ince there is a clear distinction bet een open ended schemes and close ended schemes, usually t o different types of structural and management approaches are follo ed. -pen-ended funds +unit-trusts, in the (8 follo close-ended schemes follo +investment trusts, follo the Ktrust approach2, hile

the Kcorporate approach2. The

management and operations of the t o types of funds, are, therefore, guided by separate regulatory mechanisms, and the rules are laid do n by separate controlling authorities.

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4o ever, no such distinctions e"ist in India and both approaches +Trust and Aorporate, have been integrated by )!3I. The formation and operations of mutual funds in India are guided solely by the )!3I regulations. The belo figure gives an idea of the structure of the Indian mutual funds.

A mutual fund consists of four separate entities L sponsor, mutual fund trust, AMA and custodian. These are, of course, assisted by other independent administrative entities, such as banks, registrars and transfer agents.
Establishes MF as a Tr st

Sponsor Company Mana"e& by a $oar& o* Tr stees 'ppointe& by $/T

'ppointe& by Tr stees

(ol&s nit hol&ers) * n& !e"isters MF #ith in MF

SE$%

M t al F n&

Ens res +omplian+e to SE$% Enters into a"reement Floats MF * n&s #ith 'MC Mana"es * n&s as per SE$% " i&elines an& 'MC a"reement

'sset Mana"ement Company

C sto&ian 'ppointe& by 'MC $an.ers 'ppointe& by 'MC !e"istrars an& Trans*er '"ents

,ro-i&es ne+essary + sto&ian ser-i+es

,ro-i&e $an.in" Ser-i+es

,ro-i&e re"istrar ser-i+es an& a+t as trans*er a"ents

STRUCTURE OF THE INDIAN MUTUAL FUNDS

The sponsor for a mutual fund can be any person

ho, acting alone or in combination ith

ith another corporate body, establishes the mutual fund and gets it registered )!3I. The sponsor is re0uired to contribute at least :$I of the minimum net
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orth +@s

5$ crore, of the AMA. 4e must have a sound track record and a reputation for fairness and integrity in all his business transactions.

As per the 566D regulations, KA mutual fund shall be constituted in the form of a trust and the instrument of trust shall be in the form of a deed, duly registered under the provisions of the Indian @egistration Act, 56$', e"ecuted by the sponsor in favour of trustees named in such an instrument. The mutual fund is managed by the board of trustees or Trustee Aompany, and the sponsor e"ecutes the trust deeds in favour of the trustees. The mutual fund raises money through the sale of units under one or more schemes for investment in securities, in accordance ith )!3I guidelines. The trustees ith

must see to it that the schemes floated and managed by the AMA are in accordance

the trust deeds and )!3I guidelines. It is also their responsibility to control the capital property of the mutual fund schemes. The trustees have the right to obtain relevant information from the AMA, as ell as a

0uarterly report on its activities. They can also dismiss the AMA under certain conditions, as per )!3I regulations. At least half the trustees have the right to obtain relevant information from the AMA or its employees cannot act as trustees. The trustee of a particular mutual fund cannot be appointed as a trustee of any other mutual fund unless he is an independent trustee and obtains prior permission from the mutual fund in hich he is a trustee. The trustees are re0uired to submit half-yearly reports to )!3I hose activities they

on the activities of the mutual fund. They appoint a custodian, supervise. A trustee can be removed only The trustees appoint the AMA,

ith the prior approval of )!3I

hich must act as per the )!3I guidelines, the trust

deeds, and the management agreement it has made ith the trustees.

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The AMA should be registered

ith )!3I. Its net

orth should be in the form of cash ants to carry out other fund

and all assets should be held in its name. In case it

management business, it should satisfy the capital ade0uacy re0uirement for each such business independently. The AMA cannot give or guarantee loans, and is prohibited from ac0uiring any assets +out of the scheme property, hich ould involve the

assumption of unlimited liability. It is re0uired to disclose the scheme particulars and the base calculation of the /AE. It must submit 0uarterly reports to the mutual fund. The director of the AMA should be a person of repute and high standing, five years e"perience in the relevant field. ith at least

The appointment of the AMA can be

terminated by a decision of 9CI of unit-holders or a ma&ority of trustees. The )!3I regulations provide for the appointment of a custodian by the trustees for Kcarrying on the activity of safekeeping of the securities or participating in the clearing system2 on behalf of the mutual fund. The custodian must have a sound track record and ade0uate relevant e"perience. associated At the time of appointment, he should not be

ith the AMA, or act as a sponsor or trustee to any mutual fund. The revised

regulations of 566D define a mutual fund as a fund established in the form of a trust to raise moneys through the sale of units to the public, or a section of the public, under one or more schemes for investment in securities, including money market instruments. Mutual funds are also allo ed to diversify their activities in the follo ing areas. >ortfolio management services Management of offshore funds >roviding advice to offshore funds Management of pension or provident funds

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Management of venture capital funds Management of money market funds Management of real estate funds

The regulations deal

ith various issues relating to launching, advertising and listing of

mutual funds schemes. All the schemes to be launched by an AMA need to be approved by the trustees. Aopies of the offer document of such schemes are to be filed ith )!3I,

and should contain ade0uate disclosures to enable investors to make informed decisions. Advertisements in respect of schemes should be in conformity advertisement code of )!3I. The listing of close-ended schemes is mandatory and they should be listed in a recogni;ed stock e"change ithin si" months of the closure of subscription. 4o ever, ith the prescribed

listing is not mandatory if the scheme provides for periodic repurchase facilities to all unit-holders, or provides for monthly income or caters to special classes of persons, or discloses details of repurchase in the offer document, or opens for repurchase ithin si" months of the closure of subscription

The units of a close-ended scheme can be repurchased or reissued by an AMA. They can also be converted into an open ended scheme or may be rolled over if the ma&ority of shareholders pass a resolution to that effect. /o scheme other than unit linked schemes can be opened for subscription for more than :C days. In the offer document, the AMA must specify the minimum subscription and the e"tent of over-subscription hich it

intends to retain. In the case of oversubscription, all those applying for up to C$$$ units must be given full allotment sub&ect to oversubscription. The AMA must refund the

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application money if the minimum subscription is not received, and also, the e"cess oversubscription ithin si" eeks of the closure of subscription. =uaranteed returns can be provided for in a scheme only if they are fully guaranteed by the AMA or sponsor. In such cases, there should be a statement indicating the name of the person and the manner in document. hich the guarantee to be made must be made in the offer

The regulations provide procedure for the manner in ound up. It should be be

hich close-ended scheme is to be

ould up on the redemption date, unless it is rolled over. It can inding it up, or if

ould up if 9CI of the unit-holders pass a resolution in favour of

the trustees so re0uire for ay reason, or if )!3I so directs in the interest of the investors.

The regulations of 566D and the subse0uent amendments attempted to enhance transparency and accountability, and improve the mechanism of investor protection. They contained several provisionsB They demanded the provision of stringent disclosure norms in the offer document to facilitate informed decision-making by the investors. )tandardisation of accounting policies, computation of /AE and valuation of assets. >rudential supervision replaced the 0uantitative investment restrictions and the AMA as given complete freedom to structure schemes. )tringent restrictions schemes. A code of ethics as introduced for AMAs ere imposed on the launching of guaranteed return

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Transfer agents

ere entrusted for higher responsibilities to ensure better

management of funds.

Aonsidering the various irregularities and sharp deterioration in the performance of many mutual funds, it as decided to fi" certain responsibilities for the trustees to

ensure that they remained vigilant and played a more active role. The )!3I appointed a committee under the chairmanship of >.8. 8aul to e"amine the issue of responsibilities of trustees. The committee2s report ere decided upon, among others. as accepted by )!3I and the follo ing measures

The manner in out.

hich the trustees are to fulfil their responsibilities has been spelt

They are re0uired to meet at least once in three months. Trustees can appoint independent auditors. ere taken to promote

)everal other measures, like revision of the codes of conduct, integrity, diligence, and fairness among the trustees as together

ell as the AMAs. All this,

ith the standardi;ation of several provisions relating to operations, has

increased the level of transparency and strengthened the mechanism of investor protection.

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Diagrammatic @epresentation of Fund )tructure and it2s Aonstituents

F u n d ) p o n sor

T ru stees

A sset M an ag em en t A o m p a n y +A M A ,

D ep o sito ry

A gen t

A u sto d ia n

C. Asset 4olding >attern and @esource Mobili;ation Mutual Funds in IndiaB Mutual Fund is an instrument of investing money. /o adays, bank rates have fallen do n and are generally belo the inflation rate. Therefore, keeping large amounts of money in bank is not a ise option, as in real terms the value of money decreases over a period of time. -ne of the options is to invest the money in stock market. 3ut a common investor is not informed and competent enough to understand the intricacies of stock market. This is here mutual funds come to the rescue. A mutual fund is a group of investors operating through a fund manager to purchase a diverse portfolio of stocks or bonds. Mutual funds are highly cost efficient and very easy to invest in. 3y pooling money together in a mutual fund, investors can purchase stocks or bonds ith much lo er trading costs than if they tried to do it on their o n. Also, one doesn*t have to figure out hich stocks or bonds to buy. 3ut the biggest advantage of mutual funds is diversification.

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Diversification means spreading out money across many different types of investments. %hen one investment is do n another might be up. Diversification of investment holdings reduces the risk tremendously.

A1A))IFIAATI-/ -F M(T(A1 F(/D)BMutual fund schemes also classified on the basis of its structure and its investment ob&ective. 3y )tructureB -pen-ended FundsJ)chemesB +Tenor based, An open-end fund is one that is available for subscription all through the year. These do not have a fi"ed maturity. Investors can conveniently buy and sell units at /et Asset Ealue +</AE<, related prices. The key feature of open-end schemes is li0uidity. -pen-ended Mutual Funds are those funds in hich the company can issue al ays more outstanding shares. It can help to add on the net assets of the company. These types of funds do not have a fi"ed maturity period. Investors can buy and sell units of these funds at /et Asset Ealue +/AE, related prices hich are published on a daily basis. -pen-end schemes are more li0uid in nature. -pen end funds are operated by a mutual fund house hich raises money from shareholders and invests in a group of assets, as per the stated ob&ectives of the fund. -pen-end funds raise money by selling shares of the fund to the public, in a manner similar to any other company, hich sell its stock to raise the capital. An open-end mutual fund does not have a set number of shares. It continues to sell shares to investors and ill buy back shares hen investors ish to sell. (nits are bought and sold at their current net asset value. Most of the open-end funds are actively managed and the fund manager picks the stocks as per the ob&ective of the fund. -pen-end funds keep some portion of their assets in short-term and money market securities to provide available funds for redemptions. A large portion of most open mutual funds is invested in highly li0uid securities, hich enables the fund to raise money by selling securities at prices very close to those used for valuations. )ome of the benefits of open-end funds include diversification, professional money management, li0uidity and convenience. 3ut open-end funds have one negative as compared to closed-end funds. )ince open-end funds are constantly under redemption pressure, they al ays have to keep a certain amount of money in cash, hich they other ise ould have invested. This lo ers the potential returns. Fees There may be a percentage charge levied on the purchase of shares or units. )ome of these fees are called an initial charge +(8, or *front-end load* +(),. )ome fees are charged by a fund on the sale of these units, called a *close-end load,* that may be aived after several years of o ning the fund. )ome of the fees cover the cost or distributing the fund by paying commission to the adviser or broker that arranged the purchase. These

18

fees are commonly referred to as 5#b-5 fees in (.). /ot all fund have initial charges7 if there are no such charges levied, the fund is <no-load< +(),. These charges may represent profit for the fund manager or go back into the fund.

Active management Most open-end funds are actively managed, meaning that a portfolio manager picks the securities to buy, although inde" funds are no gro ing in popularity. Inde" funds are open-end funds that attempt to replicate an inde", such as the )M> C$$, and therefore do not allo the manager to actively choose securities to buy. 3uying and )ellingB -pen funds sell and redeem shares at any time directly to shareholders. To make an investment, you purchase a number of shares through a representative, or if you have an account ith the investment firm, you can buy online, or send a check. The price you pay per share ill be based on the fund2s net asset value as determined by the mutual fund company. -pen funds have no time duration, and can be purchased or redeemed at any time, but not on the stock market. An open fund issues and redeems shares on demand, henever investors put money into the fund or take it out. )ince this happens routinely every day, total assets of the fund gro and shrink as money flo s in and out daily. The more investors buy a fund, the more shares there ill be. There*s no limit to the number of shares the fund can issue. /or is the value of each individual share affected by the number outstanding, because net asset value is determined solely by the change in prices of the stocks or bonds the fund o ns, not the si;e of the fund itself. )ome open-ended funds charge an entry load +i.e., a sales charge,, usually a percentage of the net asset value, hich is deducted from the amount invested.

AdvantagesB
-pen funds are much more fle"ible and provide instant li0uidity as funds sell shares daily. Gou ill generally get a redemption re0uest processed promptly, and receive your proceeds by check in ?-: days. A ma&ority of open mutual funds also allo transferring among various funds of the same NfamilyO ithout charging any fees. -pen funds range in risk depending on their investment strategies and ob&ectives, but still provide fle"ibility and the benefit of diversified investments, allo ing your assets to be allocated among many different types of holdings. Diversifying your investment is key because your assets are not impacted by the fluctuation price of only one stock. If a stock in the fund drops in value, it may not impact your total investment as another holding in the fund may be up. 3ut, if you have all of your assets in that one stock, and it takes a dive, you2re likely to feel a more considerable loss. Alosed-ended FundsJschemesB +Tenor based,

19

A closed-end fund has a stipulated maturity period hich generally ranging from ? to 5C years. The fund is open for subscription only during a specified period. 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 e"changes here they are listed. In order to provide an e"it route to the investors, some close-ended funds give an option of selling back the units to the Mutual Fund through periodic repurchase at /AE related prices. )!3I @egulations stipulate that at least one of the t o e"it routes is provided to the investor. This fund has a fi"ed number of shares. The value of the shares fluctuates ith the market, but fund manager has less influence because the price of the underlining o ned securities has greater influence. Alose !nded mutual fund or generally termed as traded mutual fund is the one that can be brought and sold like a normal share. In it, the number of shares al ays stays fi"ed. These funds also have commission hich brokers get since the shares of these funds are traded over the counter, like the shares are traded. Alose-ended funds have a stipulated maturity period like C-9 years. It is open for subscription only during the time of launch. Investors can invest in the close ended mutual funds at the time of the initial public issue and thereafter can be brought or sold units of the scheme on the e"changes here the units are listed. Alose-ended funds give an option for the investor of selling back the units to the mutual fund through periodic repurchase at /AE related prices. 3ut the commissions ill incur for this selling and buying. Distinct Features of Alosed-end FundsB These funds are closed to ne capital after they begin operating Alosed-end funds trade on stock e"changes rather than being redeemed directly by the fund (nlike open-end funds, the closed-end funds can be traded during the market day at any time. -pen-end funds are generally traded at the closing price at the end of the market day. Alosed-end funds are usually traded at a premium or discount hereas open-end funds are traded at /AE.

Advantages of Alosed-end FundsB Alosed-end funds don*t have to orry about the redemption of shares, hence they tend to keep less cash in their portfolios and cam invest more capital in the market. Therefore, they have the potential to generate greater returns as compared to open-end funds. In case of market panic and mass-selling by investors, open-end funds need to raise money for redemptions. To cope ith the li0uidity concerns, the manager of an open-ended fund may be forced to sell stocks he ould rather keep, and keep stocks he ould rather sell. In such as scenario the 0uality of the portfolio may be affected .AdvantagesB The prospect of buying closed funds at a discount makes them appealing to e"perienced investors. The discount is the difference bet een the market price of the closed-end fund and its total net asset value. As the stocks in the fund increase in value, the discount usually decreases and becomes a premium instead. )avvy investors search for closed-end funds ith solid returns that are trading at large discounts and then bet that the gap bet een the discount
20

and the underlying asset value ill close. )o one advantage to closed-end funds is that you can still en&oy the benefits of professional investment management and a diversified portfolio of high 0uality stocks, ith the ability to buy at a discount.

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Availability
Alosed end funds are typically traded on the ma&or global stock e"changes. In the (.). the /e Gork )tock !"change is dominant although the /A)DAP is in competition7 in the (8 the 1ondon )tock !"change*s main market is home to the mainstream funds although AIM supports many small funds especially the Eenture Aapital Trusts7 in Aanada, the Toronto )tock !"change lists many closed-end funds. 1ike their better-kno n open-ended cousins, closed-end funds are usually sponsored by a funds management company hich ill control ho the money is invested. They begin by soliciting money from investors in an initial offering, hich may be public or limited. The investors are given shares corresponding to their initial investment. The fund managers pool the money and purchase securities. %hat e"actly the fund manager can invest depends on the fund*s charter. )ome funds invest in stocks, others in bonds, and some in very specific things. 3uying and )ellingB (nlike standard mutual funds, you cannot simply mail a check and buy closed fund shares at the calculated net asset value price. )hares are purchased in the open market similar to stocks. Information regarding prices and net asset values are listed on stock e"changes7 ho ever, li0uidity is very poor. The time to buy closed funds is immediately after they are issued. -ften the share price drops belo the net asset value, thus selling at a discount. A minimum investment of as much as HC$$$ may apply, and unlike the more common open funds discussed belo , there is typically a five-year commitment. Distinguishing features )ome characteristics that distinguish a closed-end fund from an ordinary openend mutual fund are thatB It is closed to ne capital after it begins operating, and Its shares trade on stock e"changes rather than being redeemed directly by the fund. Its shares can therefore be traded during the market day at any time. An openend fund can usually be traded only at the closing price at the end of the market day. A A!F usually has a premium or discount. An open-end fund sells at its /AE. A closed-end company can o n unlisted securities. Another distinguishing feature of a closed-end fund is the common use of leverage or gearing to enhance returns. A!Fs can raise additional investment capital by issuing auction rate securities, preferred stock, long-term debt, andJor reverserepurchase agreements. In doing so, the fund hopes to earn a higher return ith this e"cess invested capital.

22

%hen a fund leverages through the issuance of preferred stock, t o types of shareholders are createdB preferred stock shareholders and common stock shareholders. >referred stock shareholders benefit from e"penses based on the total managed assets of the fund. Total managed assets include both the assets attributable to the purchase of stock by common shareholders and those attributable to the purchase of stock by preferred shareholders. The e"penses charged to the common shareholder are based on the common assets of the fund, rather than the total managed assets of the fund. The common shareholder*s returns are reduced more significantly than those of the preferred shareholders due to the e"penses being spread among a smaller asset base. For the most part, closed-end fund companies report e"penses ratios based on the fund*s common assets only. 4o ever, the contractual management fees charged to the closed-end funds may be based on the common asset base or the total managed asset base. The entry into long-term debt arrangements and reverse-repurchase agreements are t o additional ays to raise additional capital for the fund. Funds may use a combination of leveraging tactics or each individually. 4o ever, it is more common that the fund ill use only one leveraging techni0ue. )ince closed-end funds are traded like stock, a customer trading them ill pay a brokerage commission similar to one paid hen trading stock +as opposed to commissions on open-ended mutual funds here the commission ill vary based on the share class chosen and the method of purchasing the fund,. In other ords, closed-end funds typically do not have sales-based share classes here the commission and annual fees vary bet een them. The main e"ception is loanparticipation funds. !"change-traded Alosed-end fund shares trade continually at hatever price the market ill support. They also 0ualify for advanced types of orders such as limit orders and stop orders. This is in contrast to some open-end funds hich are only available for buying and selling at the close of business each day, at the calculated /AE, and for hich orders must be placed in advance, before the /AE is kno n, and by simple buy or sell orders. )ome funds re0uire that orders be placed hours or days in advance. Alosed-end funds trade on e"changes and in that respect they are like e"changetraded funds +!TFs,, but there are important differences bet een these t o kinds of security. The price of a closed-end fund is completely determined by the valuation of the market, and this price often diverges substantially from the /AE of the fund assets. In contrast, the market price of an !TF trades in a narro range very close to its net asset value, because the structure of !TFs allo s ma&or market participants to redeem shares of an !TF for a <basket< of the fund*s underlying assets.Q5R This feature could lead to potential arbitrage profits if the market price of the !TF ere to diverge substantially from its /AE. The market prices of closed-end funds are often ten to t enty percent higher or lo er than their /AEs, hile the market price of an !TF is typically ithin one percent of

23

its /AE. )ince the market do nturn of late #$$' a number of fi"ed income !TF*s have traded at premiums of roughly t o or three percent to their /AE*s. Aomparison ith open-ended funds %ith open-ended funds, the value is precisely e0ual to the /AE. )o investing H5$$$ into the fund means buying shares that lay claim to H5$$$ orth of underlying assets +apart from sales charges,. 3ut buying a closed-end fund trading at a premium might mean buying H6$$ orth of assets for H5$$$. )ome advantages of closed-end funds over their open-ended cousins are financial. A!Fs don*t have to deal ith the e"pense of creating and redeeming shares, they tend to keep less cash in their portfolio, and they need not orry about market fluctuations to maintain their <performance record<. )o if a stock drops irrationally, the closed-end fund may snap up a bargain, hile open-ended funds might sell too early. Also, if there is a market panic, investors may sell en masse. Faced ith a ave of sell orders and needing to raise money for redemptions, the manager of an openended fund may be forced to sell stocks he*d rather keep, and keep stocks he*d rather sell, due to li0uidity concerns +selling too much of any one stock causes the price to drop disproportionately,. Thus it may become over eight in the shares of lo er-0uality or underperforming companies for hich there is little demand. 3ut an investor pulling out of a closed-end fund must sell it on the market to another buyer, so the manager need not sell any of the underlying stock. The A!F*s price ill likely drop more than the market does +severely punishing those ho sell during the panic,, but it is more likely to make a recovery hen the intrinsically sound stocks rebound. 3ecause a closed-end fund is on the market, it must obey certain rules, such as filing reports ith the listing authority and holding annual stockholder meetings. Thus stockholders can more easily find out about their fund and engage in shareholder activism, such as protest against poor management. !"amples Among the biggest, long-running A!Fs areB Adams !"press Aompany Foreign M Aolonial Investment Trust plc %itan Investment Trust plc Tri-Aontinental Aorporation =abelli !0uity Trust =eneral American Investors Aompany, Inc.

/e er A!Fs includeB Alpine Total Dynamic Dividend Fund Morgan )tanley Ahina A-)hare Fund .ohn 4ancock >AT@I-T Fund Teucrium /atural =as Fund
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Interval FundsJschemesB

Interval funds combine the features of open-ended and close-ended schemes. They are open for sale or redemption during pre-determined intervals at /AE related prices. 3y Investment -b&ectiveB =ro th FundsJschemesB +Asset class based, The aim of gro th funds is to provide capital appreciation over the medium to longterm. )uch schemes normally invest a ma&ority of their corpus in e0uities. It has been proven that returns from stocks, have outperformed most other kind of investments held over the long term. =ro th schemes are ideal for investors having a long-term outlook seeking gro th over a period of time. These type funds are those hich invest in the stocks of ell-established, blue chip companies. Dividends and steady income are not only goal of these types of funds. 3ut, they are focussed on increasing in capital gains. =ro th funds are those mutual funds that aim to achieve capital appreciation by investing in gro th stocks. They focus on those companies, hich are e"periencing significant earnings or revenue gro th, rather than companies that pay out dividends. =ro th funds tend to look for the fastest-gro ing companies in the market. =ro th managers are illing to take more risk and pay a premium for their stocks in an effort to build a portfolio of companies ith above-average earnings momentum or price appreciation. In India, gro th funds became popular after the tremendous gro th of the Indian companies during the post economic reforms period. The rapid gro th of Indian industry attracted investors2 money to sectors of high gro th and as a result gro th funds came into being. -b&ective of =ro th FundsB The ob&ective of gro th funds is to achieve capital appreciation by in stocks of those companies, hich are registering significant earnings or revenue gro th. =ro th funds offer tremendous opportunities for gro th, hen the financial market is bullish. In general, gro th funds are more volatile than other types of funds, rising more than other funds in bull markets and falling more in bear markets. -nly aggressive investors, or those ith enough time to make up for short-term market losses, should buy these funds =ro th and Income fundsJschemes +Asset class based, B

These types of mutual funds are focussed on increased capital gains and steady income. 1ess volatile than Aggressive =ro th funds. Aggressive =ro th Funds Jschemes+Asset class based, B

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These are stock funds that primarily have one ob&ective of ma"imum capital gains. Aapital gains are the increase in the value of investment. This type of mutual fund invest in many different kind of shares hich includes risk industry stocks, small company stocks and uses certain investment techni0ues like short selling of stocks, futures M options. These type of mutual funds are most volatile also. 3ond JIncome FundsJschemesB The aim of income funds is to provide regular and steady income to investors. )uch schemes generally invest in fi"ed income securities such as bonds, corporate debentures and =overnment securities. Income Funds are ideal for capital stability and regular income. Income funds are named appropriatelyB their purpose is to provide current income on a steady basis. %hen referring to mutual funds, the terms <fi"ed-income,< <bond,< and <income< are synonymous. These terms denote funds that invest primarily in government and corporate debt. %hile fund holdings may appreciate in value, the primary ob&ective of these funds is to provide a steady cash flo to investors. As such, the audience for these funds consists of conservative investors and retirees. 3ond funds are likely to pay higher returns than certificates of deposit and money market investments, but bond funds aren*t ithout risk. 3ecause there are many different types of bonds, bond funds can vary dramatically depending on here they invest. For e"ample, a fund speciali;ing in high-yield &unk bonds is much more risky than a fund that invests in government securities. Furthermore, nearly all bond funds are sub&ect to interest rate risk, hich means that if rates go up the value of the fund goes do n. 3alanced FundsJschemesB

The aim of balanced funds is to provide both gro th and regular income. )uch schemes periodically distribute a part of their earning and invest both in e0uities and fi"ed income securities in the proportion indicated in their offer documents. In a rising stock market, the /AE of these schemes may not normally keep pace, or fall e0ually hen the market falls. These are ideal for investors looking for a combination of income and moderate gro th. The ob&ective of these funds is to provide a balanced mi"ture of safety, income and capital appreciation. The strategy of balanced funds is to invest in a combination of fi"ed income and e0uities. A typical balanced fund might have a eighting of D$I e0uity and :$I fi"ed income. The eighting might also be restricted to a specified ma"imum or minimum for each asset class. A similar type of fund is kno n as an asset allocation fund. -b&ectives are similar to those of a balanced fund, but these kinds of funds typically do not have to hold a specified percentage of any asset class. The portfolio manager is therefore given freedom to s itch the ratio of asset classes as the economy moves through the business cycle. The investor may ish to balance his risk bet een various sectors such as asset si;e, income or gro th. Therefore the fund is a balance bet een various attributes desired. 3alanced mutual funds have a portfolio mi" of bonds, preferred stocks and common stocks. 3alanced mutual funds aim to conserve investors2 initial investment, to pay an income and to aid in the long-term gro th of both the principle and the income. 3alanced fund is also kno n as hybrid fund. It is a type of mutual fund that buys a combination of common stock, preferred stock, bonds, and short-term bonds, to provide both income and capital appreciation hile avoiding e"cessive risk.

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3alanced funds provide investor ith an option of single mutual fund that combines both gro th and income ob&ectives, by investing in both stocks +for gro th, and bonds +for income,. )uch diversified holdings ensure that these funds ill manage do nturns in the stock market ithout too much of a loss. 3ut on the flip side, balanced funds ill usually increase less than an all-stock fund during a bull market.

Advantages of 3alanced FundB

=enerally, balanced funds maintain a D$B:$ e0uity debt ratio. This means that D$I of their total investment is in e0uity and the balance :$I in debt and cash e0uivalents. 3alance funds combine the po er of e0uities +shares, and the stability of debt market instruments +fi"ed return investments like bonds, and provide both income and capital appreciation hile avoiding e"cessive risk. 3alanced funds continuously rebalance their portfolios to ensure that the broad asset allocation is not disturbed. Therefore, the profits earned from the stock markets are encashed and invested in lo risk instruments. This helps the investor in maintaining the appropriate asset mi", ithout getting into the hassles of rebalancing the portfolio on their o n.

Money Market FundsJschemesB+Asset Alass 3ased,

The aim of money market funds is to provide easy li0uidity, preservation of capital and moderate income. These schemes generally invest in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money. @eturns on these schemes may fluctuate depending upon the interest rates prevailing in the market. These are ideal for Aorporate and individual investors as a means to park their surplus funds for short periods. The money market consists of short-term debt instruments, mostly Treasury bills. This is a safe place to park your money. Gou on*t get great returns, but you on*t have to orry about losing your principal. A typical return is t ice the amount you ould earn in a regular checkingJsavings account and a little less than the average certificate of deposit +AD,. These are generally the safest and most secure of mutual fund investments. They invest in the largest, most stable securities, including Treasury bills. The chances of your capital being eroded are very minimal. Money-market funds are risk-free. If you invest a thousand rupees, you ill get that money back. It is simply a matter of hen you get it back. %hen investing in a money-market fund, you should pay attention to the interest rate that is being offered, along ith the rules regarding check- riting. Money-markets have allo ed investors to reap high yields on their deposits, and have made the entire investment process more accessible to people. The interest rates on money-market funds are changing nearly day to day. In times of inflation, these funds have had high yields. A money market fund is a mutual fund that invests solely in money market instruments. Money market instruments are forms of debt that mature in less than one year and are very li0uid. Treasury bills make up the bulk of the money market instruments. )ecurities in the money market are relatively risk-free. Money market funds are generally the safest and most secure of mutual fund investments. The goal of a money-market fund is to preserve principal hile yielding a modest return. Money-market mutual fund is akin to a high-yield bank account but is

27

not entirely risk free. %hen investing in a money-market fund, attention should be paid to the interest rate that is being offered.

Types of Money Market Mutual Funds

Money market funds are of t o typesB 5. Institutional Money Market Mutual FundsJschemesB These funds are held by governments, institutional investors and businesses etc. 4uge sum of money is parked in institutional money funds. #. @etail Money Market Mutual FundsJschemesB @etail money market funds are used for parking money temporarily. The investment portfolio of money market funds comprises of treasury bills, short term debts, ta" free bonds etc.

)pecial Features of Money Market Mutual FundsB

Money market mutual funds are one of the safest instruments of investment for the retail lo income investor. The assets in a money market fund are invested in safe and stable instruments of investment issued by governments, banks and corporations etc. =enerally, money market instruments re0uire huge amount of investments and it is beyond the capacity of an ordinary retail investor to invest such large sums. Money market funds allo retail investors the opportunity of investing in money market instrument and benefit from the price advantage. 1oad FundsJschemesB

A 1oad Fund is one that charges a commission for entry or e"it. That is, each time you buy or sell units in the fund, a commission ill be payable. Typically entry and e"it loads range from 5I to #I. It could be orth paying the load, if the fund has a good performance history. /o-1oad FundsJschemesB

Mutual funds can be classified into t o types - 1oad mutual funds and /o-1oad mutual funds. 1oad funds are those funds that charge commission at the time of purchase or redemption. They can be further subdivided into +5, Front-end load funds and +#, 3ackend load funds. Front-end loads are fees or e"penses recovered by mutual funds against compensation paid to brokers, their distribution and marketing costs. These e"penses are generally called as sales loads. Front-end load funds charge commission at the time of purchase. )imilar to front end loads there are back end loads. 3ack-end load funds charge commission at the time of redemption. /o-load funds are those funds that can be purchased ithout commission. /o load funds have several advantages over load funds. Firstly, funds ith loads, on average, consistently underperform no-load funds hen the load is taken into consideration in
28

performance calculations. )econdly, loads understate the real commission charged because they reduce the total amount being invested. Finally, hen a load fund is held over a long time period, the effect of the load, if paid up front, is not diminished because if the money paid for the load had been invested, as in a no-load fund, it ould have been compounding over the hole time period. A /o-1oad Fund is one that does not charge a commission for entry or e"it. That is, no commission is payable on purchase or sale of units in the fund. The advantage of a no load fund is that the entire corpus is put to ork.

!0uity FundsJschemes B+Asset class based,

Funds that invest in stocks represent the largest category of mutual funds. =enerally, the investment ob&ective of this class of funds is long-term capital gro th ith some income. There are, ho ever, many different types of e0uity funds because there are many different types of e0uities. A great ay to understand the universe of e0uity funds is to use a style bo", an e"ample of hich is belo . The idea is to classify funds based on both the si;e of the companies invested in and the investment style of the manager. The term value refers to a style of investing that looks for high 0uality companies that are out of favour ith the market. These companies are characteri;ed by lo >J! and price-to-book ratios and high dividend yields. The opposite of value is gro th, hich refers to companies that have had +and are e"pected to continue to have, strong gro th in earnings, sales and cash flo . A compromise bet een value and gro th is blend, hich simply refers to companies that are neither value nor gro th stocks and are classified as being some here in the middle. For e"ample, a mutual fund that invests in large-cap companies that are in strong financial shape but have recently seen their share prices fall ould be placed in the upper left 0uadrant of the style bo" +large and value,. The opposite of this ould be a fund that invests in start-up technology companies ith e"cellent gro th prospects. )uch a mutual fund ould reside in the bottom right 0uadrant +small and gro th,. These funds allo an investor to o n a portion of the company that they have invested in, it2s like having shares of a certain company. )tocks that have proven historically to bethe best investment. Also hich have already outperformed all other types of investments in long term, but the risk is high. These funds produce a greater level of current income by investing in e0uity securities of companies ith solid reputation and have a good record of paying dividends. !0uity mutual funds are also kno n as stock mutual funds. !0uity mutual funds invest pooled amounts of money in the stocks of public companies. )tocks represent part o nership, or e0uity, in companies, and the aim of stock o nership is to see the value of the companies increase over time. )tocks are often categori;ed by their market capitali;ation +or caps,, and can be classified in three basic si;esB small, medium, and large.

)!1!ATI-/ -F M(T(A1 F(/D)B4o to )elect an !0uity FundF Aompare a fund ith its peersB -ne of the basic fundamental of benchmarking is to evaluate funds ith in the same category. For e"ample, if you are evaluating the performance of a thematic fund, say IT

29

based fund, then you should compare its performance ith another similar IT based fund. Aomparing it ith banking sector fund for e"ample ill not give the correct picture. Aomparing a fund over stock market cycle +boom and bust, ill give investors a good idea about ho the fund has fared. Aompare returns against those of the benchmark inde"B !very fund mentions a benchmark inde" in the -ffer Document. It can be 3)! 5$$, 3)! #$$, /ifty or any other inde". The benchmark inde" serves as a guidepost for both the fund manager and the investor. Aompare ho the fund has fared against the benchmark inde" over a period of ?-C years. The funds that have outperformed their benchmark indices during stock market volatility must be given a close look. Aompare against the fund*s o n performanceB Apart from comparing a fund ith its peers and benchmark inde", investors should evaluate its historical performance. 3y evaluating a fund against its o n historical performance, you can get an idea about consistent performers. =lobalJInternational FundsJschemes B An international fund +or foreign fund, invests only outside your home country. =lobal funds invest any here around the orld, including your home country. It*s tough to classify these funds as either riskier or safer than domestic investments. They do tend to be more volatile and have uni0ue country andJor political risks. 3ut, on the flip side, they can, as part of a ell-balanced portfolio, actually reduce risk by increasing diversification. Although the orld*s economies are becoming more interrelated, it is likely that another economy some here is outperforming the economy of your home country. International mutual funds are those funds that invest in non-domestic securities markets throughout the orld. Investing in international markets provides greater portfolio diversification and let you capitali;e on some of the orld*s best opportunities. If investments are chosen carefully, international mutual fund may be profitable hen some markets are rising and others are declining. 4o ever, fund managers need to keep close atch on foreign currencies and orld markets as profitable investments in a rising market can lose money if the foreign currency rises against the dollar. In recent years international mutual funds have gained popularity. This can be attributed to removal of trade barriers and e"pansion of economies, hich has sparked off gro th in various regions of the orld.

Things to Aonsider 3efore Investing in International Mutual FundsB

International Investing FormulaB

According to a survey, the best policy for investment is to have a 9$I domestic investment and a ?$I international diversified funds investment. The survey reveals that this investment strategy is better than having a 5$$I domestic investment portfolio or a 5$$I international e"posure in terms of risk e"posure and return on the capital.

30

DiversificationB /ot all the markets of the orld move in one pack, so a do ns ing in a country*s market can be ell taken care off by gains in the others. )o, it is essential to have diversification in different markets across the orld. Aurrency !"change @iskB Gou should also factor in foreign e"change currency fluctuations in your investment returns. For e"ample you invested I/@ 6$$$ in an international mutual fund. At that time let say one dollar as orth @s :C.$$. This means in effect you invested H#$$. After a year your investment appreciated to @s 5$,$$$ but at the same time dollar appreciated to @s. C$. )o due to fluctuation in dollar-rupee rate, your investment is still orth H#$$ )pecialty FundsJschemes B This classification of mutual funds is more of an all-encompassing category that consists of funds that have proved to be popular but don*t necessarily belong to the categories e*ve described so far. This type of mutual fund forgoes broad diversification to concentrate on a certain segment of the economy. )ector funds are targeted at specific sectors of the economy such as financial, technology, health, etc. )ector funds are e"tremely volatile. There is a greater possibility of big gains, but you have to accept that your sector may tank. @egional funds make it easier to focus on a specific area of the orld. This may mean focusing on a region +say 1atin America, or an individual country +for e"ample, only 3ra;il,. An advantage of these funds is that they make it easier to buy stock in foreign countries, hich is other ise difficult and e"pensive. .ust like for sector funds, you have to accept the high risk of loss, hich occurs if the region goes into a bad recession. )ocially-responsible funds +or ethical funds, invest only in companies that meet the criteria of certain guidelines or beliefs. Most socially responsible funds don*t invest in industries such as tobacco, alcoholic beverages, eapons or nuclear po er. The idea is to get a competitive performance hile still maintaining a healthy conscience. Inde" FundsJschemes B+>osition >hilosophy 3ased, The last but certainly not the least important are inde" funds. This type of mutual fund replicates the performance of a broad market inde" such as the )M> C$$ or Do .ones Industrial Average +D.IA,. An investor in an inde" fund figures that most managers can*t beat the market. An inde" fund merely replicates the market return and benefits investors in the form of lo fees. The securities in this fund are the same as in an Inde" fund such as the Do .ones Average or )tandard and >oor*s. The number and ratios or securities are maintained by the fund manager to mimic the Inde" fund it is follo ing. They invest in the portfolio of an inde" such as 3)! )ensitive inde" +)!/)!S, , )M> /)! C$ inde" +/ifty,, etc. The investment is done in the securities in the same eightage comprising of an inde". Gou can see that the /AEs of such schemes ould rise or fall in

31

accordance ith the rise or fall in the inde". It may not be e"actly by the same percentage due to Ntracking errorsO. An inde" fund is a mutual fund or e"change-traded fund, that aims to replicate the movements of an inde" of a specific financial market. An Inde" fund follo s a passive investing strategy called inde"ing. It involves tracking an inde" say for e"ample, the )ense" or the /ifty and builds a portfolio ith the same stocks in the same proportions as the inde". The fund makes no effort to beat the inde" and in fact it merely tries to earn the same return. -rigin of Inde" Funds Inde" funds first came into being in the () in the 569$s. In the () the research established the efficient markets concept hich says that stocks are mostly priced accurately and that it is not possible to beat the market in a systematic ay. Though a fe actively managed mutual funds may beat the market for a hile, it is very rare for active funds to beat the market in the long run.

Advantages of Inde" Funds

As per efficient markets concept inde" funds provide optimum returns in the long run. An inde" fund doesn*t have to pay for e"pensive analysts and fre0uent trading. Inde" funds track a broad inde" hich is less volatile than specific stocks or sectors, thereby lessening the risk for investors.

Inde" Funds in the conte"t of India In the Indian market scenario inde" funds may not be the best option. The basic principle of inde"ing is - the more the number of stocks comprising an inde" the better is the diversification and price discovery. Indian indices like the )ense" +?$, and the /ifty +C$, cover a relatively small number of stocks and ignore many opportunities in the mid-cap sector. Also, unlike the capital markets in developed countries, Indian markets haven*t been thoroughly researched and there is enormous scope to beat the market by sound research. Fi"ed-Income Funds +Asset class based,B Fi"ed-income mutual funds are safer than e0uity funds, but as al ays, do not yield as high returns as the latter do. These types of mutual funds are geared to ards the investor ho is approaching old age and doesn2t have many earning years left. Many investors hope to dra a steady income from these types of mutual funds. 3ond funds fall into the category of fi"ed-income funds. @egional Mutual Fund JschemesB

@egional mutual fund is a mutual fund that confines itself to investments in securities from a specified geographical area, usually, the fund*s local region. A regional mutual fund generally looks to o n a diversified portfolio of companies based in and operating out of its specified geographical area. The ob&ective is to take advantage of regional gro th potential before the national investment community does. They may be some regional funds hose ob&ective is to invest in a specific segment of the region*s economy, such as banking, energy etc.

32

For the investor, the primary benefit of a regional fund is that heJshe increases hisJher diversification by being e"posed to a specific foreign geographical area. For the average investor, these funds are beneficial as most investors don*t have enough capital to ade0uately diversify themselves across many investments in the region. @egional funds select securities that pass geographical criteria. @egional funds differ from the international mutual funds in the sense that international mutual funds have a diversified portfolio ith investment spanning all across the orld, here as regional funds invest in companies in one specific region or nation. @egional funds carry more risk as compared to international mutual funds because their investments are less diversified geographically. Fund of Funds B

A fund of funds +FoF, is an investment fund that holds a portfolio of other investment funds rather than investing directly in shares, bonds or other securities. This type of investment is also kno n as multi-manager investment. Fund of funds can be classified intoB Mutual fund FoF and 4edge fund FoF. Mutual fund FoFB A Mutual fund FoF invests in other mutual funds. .ust as a mutual fund invests in a number of different securities, a fund of funds holds shares of many different mutual funds. 4edge fund FoFB A 4edge fund FoF invests in a portfolio of different hedge funds to provide broad e"posure to the hedge fund industry and to diversify the risks associated ith a single investment fund. >ros M Aons of Fund of funds B Fund of funds are designed to achieve greater diversification than traditional mutual funds. 3ut on the flipside, e"pense fees on fund of funds are typically higher than those on regular funds because they include part of the e"pense fees charged by the underlying funds. Also, since a fund of funds buys many different funds hich themselves invest in many different stocks, it is possible for the fund of funds to o n the same stock through several different funds and it can be difficult to keep track of the overall holdings. )ector Mutual FundsJschemes B

)ector mutual funds are those mutual funds that restrict their investments to a particular segment or sector of the economy. Also kno n as thematic funds, these funds concentrate on one industry such as infrastructure, banking, technology, energy, real estate, po er heath care, FMA=, pharmaceuticals etc. The idea is to allo investors to place bets on specific industries or sectors, hich have strong gro th potential. These funds tend to be more volatile than funds holding a diversified portfolio of securities in many industries. )uch concentrated portfolios can produce tremendous gains or losses, depending on hether the chosen sector is in or out of favour.

33

)ectoral mutual funds come in the high risk high re ard category and are not suitable for investors having lo risk appetite. =enerally, mutual fund houses avoid launching sectoral funds as they are seasonal in nature and do ell only in cycles. )ince these funds focus on &ust one sector of the economy, they limit diversification and the fund manager2s ability to capitalise on other sectors, if the specific sectors aren2t doing ell. (nless a particular sector is doing very ell and its long term gro th prospects look bright, it advisable not to trade in sector funds. -ther )chemes B Ta" )aving )chemes B )pecial )chemes B

1arge cap fundsJschemesB

1arge cap funds are those mutual funds, hich seek capital appreciation by investing primarily in stocks of large blue chip companies ith above-average prospects for earnings gro th. Different mutual funds have different criteria for classifying companies as large cap. =enerally, companies ith a market capitalisation in e"cess of @s 5$$$ crore are kno n large cap companies. Investing in large caps is a lo er risk-lo er return proposition +vis-T-vis mid cap stocks,, because such companies are usually idely researched and information is idely available. 1arge cap funds invest in those companies that have more potential of earning gro th and higher profit. -ne of the ma&or advantages of large cap funds is that they are less volatile than mid cap and small cap funds and the near term prospects of large cap funds can be more accurately predicted. -n the flip side, the large cap funds offer lo er returns than mid cap or small cap funds. 3ut hen compared in totality, large cap funds outperform all other funds. These funds come under lo risk lo return category. In volatile times it is advisable to invest in large cap funds.

Top 1arge cap Funds in IndiaB

4DFA Top #$$ (TI 1arge Aap Fund Franklin India 3lue Ahip 8otak ?$ D)>M1 Top 5$$ !0uity >rincipal 1arge Aap Fund @eliance =ro th Fund Mid Aap FundsJschemes B

34

Mid cap funds are those mutual funds, hich invest in small J medium si;ed companies. As there is no standard definition classifying companies as small or medium, each mutual fund has its o n classification for small and medium si;ed companies. =enerally, companies ith a market capitali;ation of up to @s C$$ crore are classified as small. Those companies that have a market capitali;ation bet een @s C$$ crore and @s 5,$$$ crore are classified as medium si;ed. 3ig investors like mutual funds and Foreign Institutional Investors are increasingly investing in mid caps no adays because the price of large caps has increased substantially. )mall J mid si;ed companies tend to be under researched thus they present an opportunity to invest in a company that is yet to be identified by the market. )uch companies offer higher gro th potential going for ard and therefore an opportunity to benefit from higher than average valuations. Mid cap companies are looked upon as ealth creators and have the potential to &oin the league of large cap companies. )uch companies are nimble, fle"ible and can adapt to the changes faster. -ne of the challenges that fund managers of mid cap funds face is to identifying such companies. 3ut mid cap funds are very volatile and tend to fall like a pack of cards in bad times. )o, caution should be e"ercised hile investing in mid cap mutual funds. Mid cap funds are a good option in case the investor ants to add some diversity to his portfolio.

Top mid Aap Funds in IndiaB

)undaram 3/> >aribas )elect Midcap Franklin India >rima Fund 4DFA Aapital 3uilder 8otak Indian Mid Aap Fund 4)3A Midcap !0uity Fund.

35

36

Mutual funds are an e"cellent ay to invest in the stock market. Investment funds and investors* money to a fund of money used to buy different types of actions, based on characteristics or investment purposes. There are many different houses to invest in a fund like T. @o e, loyalty and the price of art

37

4o to Invest in Mutual Funds )chemeF Mutual funds normally come out ith an advertisement in ne spapers publishing the date of launch of the ne schemes. Investors can also contact the agents and distributors of mutual funds ho are spread all over the country for necessary information and application forms. Forms can be deposited ith mutual funds through the agents and distributors ho provide such services. /o adays, the post offices and banks also distribute the units of mutual funds. 4o ever, the investors may please note that the mutual funds schemes being marketed by banks and post offices should not be taken as their o n schemes and no assurance of returns is given by them. The only role of banks and post offices is to help in distribution of mutual funds schemes to the investors. Investors should not be carried a ay by commissionJgifts given by agentsJdistributors for investing in a particular scheme. -n the other hand they must consider the track record of the mutual fund and should take ob&ective decisions. /on-@esident Indians +/@I, can also invest in mutual funds. /ormally, necessary details in this respect are given in the offer documents of the schemes.

I/E!)T-@ >@-T!ATI-/ A/D M(T(A1 F(/D) @!=(1ATI-/

/eed for regulation The prevalence of risk associated ith investment activity necessitates regulation of the

financial market in general, and the activities of investment management firms in particular. @egulatory measures, hatever their form and structure, are designed to

attain the t in ob&ectives of correcting market failures and protecting investors from potential loss. The principles of regulating are based on the follo ing premisesB To correct identified market imperfections and failures in order to improve the market and enhance competition 7 To increase the benefit to investors from economies of scale and To improve the confidence of investors in the market by introducing minimum standard of 0uality.

38

@egulatory measures can be broadly classified into five categoriesB

Imposing capital re0uirements for investment management firms 7 Monitoring and auditing the operations of investment management firms7 Disclosure, and rating of management firms 7 >roviding insurance 7 and )etting up minimum standards for investment management firms. ould be one hich is broadened by legislature action orkable and

A suitable regulatory structure

and supported by industry practitioners. In order to formulate a acceptable regulatory structure, the follo ing points must be noted.

A close inter linkage must be established bet een the industry and the regulatory body.

Though the basis of such a structure may be legislative, it should be fle"ible, adaptive and less bureaucratic.

The regulators should possess a high degree of perception and market e"perience The regulatory should have enough authority to enforce the regulatory measures. The regulators should not indiscriminately change their vie s as this may create instability in the market and loss of public confidence.

The structure of regulation should create enough space for investors, for

hom the

regulatory system has been developed. The regulators should treat the investors as facilitators in the smooth functioning of the system. !ffective regulation should take into account both the cost of regulation and value addition. T o types of costs are usually associated ith any regulatory measure7 direct hile the

and indirect. The direct cost is the cost of administration and implementation indirect cost is the loss of

elfare due to restriction on competition. It is essential that

39

any regulation is formulated only after taking into account the total cost and implicit benefits. This is more so in a developing country and emerging market like India, here regulatory e"penditure is an additional burden on the public e"che0uer and e"penses are incurred at the cost of development e"penditure. Moreover, in an emerging and semi-efficient market like India, investors are e"posed to greater volatility and risks. Therefore, in order to be effective, regulation should be able to protect the investors2 interests, and the direct benefits must be more than the indirect benefits and costs of regulation.

@egulation and Investor >rotection in India

)ecurities market regulation in India is in the process of evolution and cannot be identified ith the (8 or the () type of regulation. In India, under the present

frame ork, the regulation of all participants in the securities market + ith the e"ception of issuers of capital, is the responsibility of )!3I. As prime regulator of capital market activities in India, )!3I2s basic ob&ective is to protect the interests of investors. This ob&ective has been stated in the preamble of the )ecurities and !"change 3oard of India Act, 5665 thus KU.to protect the interests of investors in securities and to promote the development of, and to regulate, the securities market and the matters connected there ith or incidental thereto. Accordingly, all

capital market activities, including those of mutual funds are covered under the ob&ective so far as investor protection is concerned. The )!3I @egulations of 566? ere the first attempt to bring mutual funds under a

regulatory frame ork and to give direction to their functioning. 4o ever, as noted

40

earlier, ne

regulations

ere passed in 566D, and these have many similarities

ith the

Investment Aompany Act, 56:$, of the () as far as mutual funds regulation and investor protections are concerned. The regulatory and supervisory po ers of )!3I also stand strengthened by the )ecurities 1a +Amendment, -rdinance, 566C, hich empo ers

)!3I to impose penalties for violation of its regulations. (nder this amendment, )!3I is also allo ed to file complaints in court ithout prior approval of the Aentral

=overnment. )!3I has thus emerged as an autonomous and po erful regulator of mutual funds in India. The 566D regulations lay do n many measures to protect mutual funds investors. )ome of measures are as underB )!3I has incorporated several provisions to screen mutual funds at entry level, similar to provision for a Kfit and proper2 test in the (8. !very mutual fund shall be registered ith )!3I and the registration ill be granted on the fulfilment of certain conditions

laid do n in the regulations for Kefficient and orderly conduct of the affairs of a mutual fund2. The regulations further stipulate that the sponsor must have a sound track record and e"perience in the relevant field of financial services for a minimum period of five years, professional competence, financial soundness, and a general reputation for fairness and integrity in all business transactions. )!3I has laid do n conditions for the appointment of trustees and has specified their obligations, as ell as detailed guidelines on the trust deed. The AMA is to be approved

by )!3I. )!3I has also laid do n the terms and conditions for the approval of the AMA. The directors of the AMA are to be persons having ade0uate professional

e"perience in finance and financial services-related fields. The key personnel of the AMA should not have been orking for any AMA or mutual fund or any intermediary

hose registration has been suspended or cancelled at any time by the board.

41

Mutual funds must have a custodian

ho is to be approved by )!3I, and one of the

preconditions for approval is a Ksound track-record, general reputation and fairness in transaction2 /o ne scheme can be launched by any mutual fund unless the same is approved by the ith the board. )!3I has also

trustees and a copy of the document has been filed

stipulated that the AMA should stipulate the minimum amount it seeks to raise under the scheme and the e"tent of oversubscription to be retained. There are clear regulatory provisions regarding the listing of close-ended schemes, refunds, transfer and sending of unit certificates to investors. In addition, it has been stipulated that the names of the trustees of mutual fund and the director of the AMA should be disclosed in the prospectus of the fund. The investment ob&ective and strategy, as ell as the

appro"imate percentage share of investment to be made in various instruments are also disclosed. /o guarantee of returns can be given unless they are fully guaranteed by the sponsors or AMA, and a statement indicating the manner of guarantee and the name of the person ho ill guarantee the returns is to be made in the offer document. )!3I has outlined the advertisement code to be follo ed by mutual funds in making any publicity regarding a scheme and its performance. )!3I can inspect the books of accounts, records and documents of a mutual fund, the trustees, AMA and custodian. compliance. )!3I can impose a monetary penalty also for non-

The Indian regulatory mechanism is centered on statutory provisions of )!3I. There is strong emphasis on e"-post investigation and disciplining of mutual funds through financial penalties. The implicit tone of regulation is correction through control. There are enough provisions for disclosure. Thus, the regulatory mechanism and supervisory

42

control are strong enough for protecting the interests of investors. 4o ever, the level of protection can be enhanced by including a fe protection fund and credit rating. more elements, like )@-s, investors2

A-@>-@AT! =-E!@/A/A! I/ M(T(A1 F(/D)

Financial institutions play a vital role in promoting and sustaining the gro th and development of the economy. The stakeholders of financial institutions are larger in number than those of manufacturing companies. Financial institutions, in addition to enhancing the shareholders2 value, have to increase ho are the core of their business activities. institutions have ealth of the depositorsJinvestors,

Moreover, the activities of financial

ider spread and a failure of any one kind of institution may induce a

collapse in the entire economy. Therefore, corporate governance is more important for such institutions, not only in the interest of shareholders, investorsJdepositors and other stakeholders, but also in the greater interest of the national economy. The Indian mutual funds industry has come a long ay since the establishment of (TI in 56D?. 3y no , the industry has taken root in our financial system and is actively involved in strengthening the capital market-led system of economic gro th through the process of disintermediation. )ome of the features of the )!3I regulations that are intrinsically tied up governanceB Aomposition and @esponsibilities of Trustees and AMAB As per the )!3I guidelines, there should be a minimum of four trustees in the 3oard of trustees, and at least t o or three of them must be independent trustees. There is no prescribed minimum limit for number of directors on the board of the AMA, but at least C$I of them must be independent directors.
43

ith corporate

)!3I has prescribed a

ide range of responsibilities for the trustees in order to

strengthen the compliance mechanism. It has stipulated that all the information and documents relating to the compliance process shall be authenticated Jadopted by the board of directors of the AMA. )imilarly, the trustees are re0uired to revie all

information and documents received from the AMA.

All AMAs Kshall adopt a

management information system for reporting to the Trustees2. )!3I has also suggested that the AMA provide infrastructure and administrative support to the trustees. As per the )ecurities and !"change 3oard of India +Mutual Funds, +Amendment, @egulations, 5666, each trustee shall file the details of his transactions in respect of dealing in securities ith the mutual fund on a 0uarterly basis.

Model Aompliance Ahecklist

The compliance certificate to be submitted by the AMA to the trustees on a half-yearly basis should contain specific comments on the follo ingB If the AMA is carrying on other activities, hether these are conducted as per

regulations, and hether it continues to meet the capital ade0uacy re0uirement of each of the activities. The net orth of the AMA Any change in the directors on the AMA2s board of directors If the investments have been made in accordance and investment ob&ectives of the scheme. If the utili;ation of the services of the sponsor or any of the AMA2s associates, employees or their relatives for any securities transaction is in accordance the offer document and the brokerage and commission paid to such affiliates. ith ith the regulations, trust deed

44

Details of any changes in the interests of the directors on the AMA2s board of directors

The borro ings of the mutual fund, specifying the details of the date, nature of instrument, source, amount borro ed, purpose of borro ing, interest rate, security offered for the borro ing, percentage of borro ing to the net assets on the date of borro ing, date of repayment or proposed manner of li0uidation of the debt7 if the borro ing is from any associate of the sponsor of the AMA, the reasons for borro ing from such an entity and the competitiveness of the terms.

InvestmentsJ@edemption by the AMA, sponsor or any associate of the sponsor in any of schemes and inter scheme investments, giving details of the names of the schemes, date, price, value and charges levied.

Transactions in securities by the key personnel of the AMA,

hether in their o n

name or on behalf of the AMA, giving details of the names of the personnel, name of the security, and purchaseJsale details like the 0uantity, rate, value and name of the broker7 hether the transaction is on personal account or conducted by

immediate family or fiduciary. The valuation and pricing of units The maintenance of proper books of accounts, records and documents for each scheme. The identification and appropriation of e"penses to individual schemes and hether the e"penses are in conformity ith the limits laid do n by )!3I.

The ability to honour guarantees commitments in the case of schemes guaranteeing returns.

45

DeficiencyJ%arning letters, if any, received from )!3I and the corrective action taken.

3road coverage report of Trustees to )!3I

The trustees shall submit bi-annual reports at the end of )eptember and March. The reports should reach )!3I ithin t o months of the end of the half-year, and should

give specific comments on the follo ingB The performance of the schemes The activities of the AMA concentration of business ith specific reference to transactions ith affiliate brokers, compliance ith affiliates, ith investment

restrictions, inter-scheme transfers and the net orth of the AMA.

The ability of the AMAJsponsor to honour guaranteed returns in the case of any scheme guaranteeing returns.

%hether the deployment of the funds of the schemes is in accordance

ith the

investment ob&ectives and not intended for any option trading, short-selling or carryfor ard transactions. %hether the valuation and pricing of units is in accordance ith the regulations. The publication of an annual report, as ell as furnishing of bi-annual and annual

accounts statements to the unit-holders and )!3I. 1isting of schemes on the stock e"change as per the terms of the offer document, effecting of transfer and despatch of units to unit-holders ithin ?$ days, and timely

despatch of repurchaseJredemption proceeds and dividend arrants. Any action taken on deficiency and arning letters by )!3I.

46

%hether before the launch of a scheme, the AMA had systems in place for the back office, etc., if it had appointed all key personnel, auditors and compliance officers, prepared manuals, specified norms, and so on.

If the AMA has appointed a registrar and share transfer agents

ho are registered

ith )!3I, hether it has ensured that the rates charged are competitive, if the ork is done in-house, and the reasons for charging higher rates henever higher rates are charged. If the AMA has been diligent in empanelling brokers for monitoring securities transactions, and hether it has avoided undue concentration ith any broker. An assurance that the AMA has not given undue and unfair advantage to any associate. In case the company has invested more than CI of the /AE of a scheme, a &ustification has to be provided for an investment made by the scheme or by any other scheme of the same mutual fund in that company or its subsidiaries. %hether the AMA has dealt through any associate broker in e"cess of CI of the 0uarterly business done by the mutual fund. In case the AMA has dealt through any broker other than an associate broker in e"cess of CI or more of the aggregate purchase and sale of securities made by the mutual fund in all its schemes, &ustification for this, and hether the AMA has recorded in riting the

hether all such investments have been reported to the

trustees on a 0uarterly basis. The utili;ation of the services of the sponsor or any of the AMA2s associates, employees, etc., and accounts. hether the relevant disclosures have been made in the annual

47

%hether the AMA has submitted 0uarterly reports on its activities and compiled ith the regulations.

%hether the transactions of the mutual fund are in accordance ith the trust deed. If the funds pertaining to a scheme have been invested in accordance regulations. ith the

%hether all activities of the AMA are in accordance ith the regulations. Details of transactions in securities by key personnel, on behalf of the AMA, every si" months. hether in their o n name or

%hether the AMA has filed the AMA, along

ith the trustees the detailed bio-data of all directors of ithin 5C days of their

ith their interest in other companies,

appointment7 any change in the interests of the directors. %hether the directors of the AMA have filed ith the trustees a statement of their

holding of securities at the end of financial year, along ith the dates of ac0uisition. If there is any conflict of interest bet een the manner in deployed its net orth and the interest of the unit-holders. %hether the necessary remedial steps have been taken by the trustees in case the conduct and business of the mutual fund is not in accordance ith the regulations. Aertifying that they have satisfied themselves that there have been no instances of self-dealing or front-running by any of the trustees, directors and key personnel of the AMA. Aertifying that the AMA has been managing the schemes independently of any other activities and the unit-holders interest has been protected. Aomments of the independent trustee on the report received from the AMA regarding the investments made by the mutual fund in the securities of the group companies of the sponsor. hich the AMA has

48

Aonfirmation that the mutual fund has not made any investment in any unlisted security of an associate or group company of the sponsor, any security issued by ay

of private placement by an associate or group company of the sponsor, or the listed securities of the group. Due Diligence The trustees are re0uired to e"ercise due diligence, hich includes general due diligence

and specific due diligence. =eneral due diligence re0uires the trustee to be discerning in the appointment of directors on the board of the AMA7 to revie the desirability of the

continuance of the AMA if substantial irregularities are observed7 to ensure that trust properties are protected, held and administered by proper persons7 to ensure that the service providers are registered ith the regulatory authority concerned etc. )pecific

due diligence entails obtaining internal audit reports from the independent auditors appointed by them7 obtaining compliance certificate from the AMA7 holding meetings +of trustees, and initiating action on the auditors2 reports7 ensuring compliance by the AMA7 prescribing the code of ethics and ensuring that the trustees, AMA and its personnel adhere to it7 and communicating in riting to the AMA about the deficiencies

and checking up on the rectification of the deficiencies.

Audit and valuation committee The audit committee is the most important instrument for making corporate governance a success. )!3I has asked the mutual funds to form audit committees through their boards of trusteesJdirectors of trustee companies. The trustees are re0uired to constitute an audit committee of the trustees for revie ing the internal audit system, as ell as the

recommendations of the internal and statutory auditors2 reports. The committee should also ensure that action is taken on the rectifications suggested by these auditors. The

49

committee shall be chaired by an independent trustee. As per )!3I guidelines, the AMA has to constitute an in-house valuation committee consisting of senior e"ecutives, including personnel from accounts, fund management and the compliance department, to revie the system and practices relating to the valuation of securities on a regular all the transactions of the mutual fund ith

basis. The trustees are re0uired to revie the associates on a regular basis.

>ortfolio disclosure Transparency is essential for corporate governance and portfolio disclosure is an important means of keeping the investors informed about the ay their moneys are

being used to create financial assets. Therefore, )!3I has made it mandatory for mutual funds to disclose the entire portfolio of any scheme.

Transparency in investment decisions )!3I has taken a far-reaching step to ards ensuring due diligence and transparency in all investment decisions by advising all mutual funds Kto maintain records in support of each investment decision decision2. hich ill indicate the date, facts and opinion leading to that

M(T(A1 F(/D) A/D )!1F-@!=(1AT-@G -@=A/I)ATI-/) The deregulation of financial services has posed several challenges to the policy-makers, economic administrators, academicians and researchers. -ne of most critical challenges is ho to face the market impact of undesirable activities of the financial services ith financial institutions. !conomic history is hich have played havoc in the market,

industry and the managers associated rife ith e"amples of such activities,

50

&eopardi;ing the transmission mechanism and market e0uilibrium.

They have

terminated the process of intermediation +and disintermediation, in the financial system, leading to a collapse of the system. Earious types of defense mechanisms have been devised to confront the challenges originating from deregulation. 3roadly, these

mechanisms are re-regulation of the market and its activities +e"ercised through legislative institutions,, and self-regulating +e"ercised through non-legislative, voluntary organisations,. 3oth these systems have certain advantages and disadvantages, and e"perience sho s that neither one should be relied on totally. 4o ever, a particular system can be more useful hen its implicit advantages apply to the given level of

market maturity, the market psychology and socio-economic environment.

@ole of AMFI
AMFI represents the AMAs in India. !stablished as a non-profit organisation on ## August 566C, the association is dedicated toB >romoting and protecting the interests of mutual funds and their unit-holders7 Increasing public a areness of mutual funds 7 and )erving the investors2 interest by defining and maintaining high ethical and professional standards in the mutual funds industry The vision of AMFI echoes the mission hich is Kto advance the interest of investment

companies and their shareholders, to promote public understanding of investment company business, and to serve the public interest by encouraging adherence to high ethical standards by all elements of the businesses. =iven the short span of time, operational limitations and emerging nature of mutual funds industry in India, AMFI has made a very significant contribution to the promotion of sound practices among mutual funds and to ards protecting the interest of its

51

members. 4o ever, it still does not function as an )@- to any significant e"tent,

hich

is mutual fund industry re0uires today. The various activities undertaken by AMFI are as underB

AMFI has brought out publications on investor a areness, code of ethics, model compliance, manual on mutual funds directory and a standard offer document.

AMFI has formed several committees and submitted their reports to )!3I in order to promote high professional standards. Among the committees are B +i, The valuation committee L for valuation of securities, appropriate accounting standards, valuation of traded and non-traded e0uities and valuation of non-traded debt securities 7 +ii, The committee on />A L to identify and recommend norms for recogni;ing />As of mutual funds, as ell as the principles and system

for provisioning such />As, and to suggest the standard and fre0uency of disclosures 7 +iii, (iv) The committee on compliance L to prepare a compliance manual7 The committee on inspection fees - to suggest the basis for the fees to be paid to the auditors appointed by )!3I. +v, The committee on advertising guidelines L to finali;e comprehensive guidelines for advertisement 7 +vi, The committee on derivatives L to formulate guidelines for trading in derivatives. +vii, +viii, The committee on the non-performing assets of mutual funds7 The committee on investors2 education and training and7

52

+i",

A committee

hich has devised the process of certification for

intermediaries selling mutual funds products. AMFI has finali;ed a testing programme for intermediaries and employees. The programme includes a comprehensive orkbook and 0uestion bank. AMFI has selected /)! to conduct the tests. /ational )tock !"change +/)!, is the prime stock e"change follo ed by 3ombay stock e"change +3)!,. Follo ing list provides information of mutual funds and !"change Traded Funds +!TF, of /)!.

1ist of Mutual Funds and !TFs in /)!

5, 3enchmark Asset Management Aompany >rivate 1imited #, 3irla )un 1ife Asset Management Aompany 1imited ?, Deutsche Asset Management +India, >rivate 1imited :, Fortis Investment Management +India, >rivate 1imited C, Franklin Templeton Asset Management +India, >vt. 1td D, 4DFA Asset Management Aompany 1imited 9, IDFA Asset Management Aompany >rivate 1imited ', 8otak Mahindra Asset Management Aompany 1imited 6, >rincipal >ub Asset Management Ao. >vt. 1td. 5$, Puantum Asset Management Ao. >rivate 1td 55, @eliance Aapital Asset Management 1imited 5#, @eligare Asset Management Ao. >vt. 1td 5?, )3I Funds Management >rivate 1imited 5:, Taurus Asset Management Aompany 1imited 5C (TI Asset Management Ao. 1td. 5D, )undaram 3/> >aribas Asset Management Aompany 1imited 59, IAIAI >rudential Asset Management Aompany 1imited

53

5', .M Financial Asset Management Aompany 1imited 56, 3harti ASA Investment Managers >rivate 1imited #$, 1MT Investment Management 1imited #5, D)> 3lack@ock Investment Managers >rivate 1imited ##, Aanara @obeco Asset Management Aompany 1imited #?, FI1 Fund Management >rivate 1imited #:, Motilal -s al Asset Management Aompany 1imited #C, A"is Asset Management Aompany 1imited #D, .> Morgan Asset Management India >rivate 1imited

1ist of <Top Ten Mutual Funds< in India )r. /o. /ame of Mutual Fund 5 D)> 3lack@ock %orld !nergy Mutual Fund # 3irla )un 1ife Aommodity !0uities Mutual Fund ? Fidelity =lobal @eal Assets Mutual Fund : 3irla )un 1ife Aommodity !0uities Mutual Fund C D%) =lobal Thematic -ffshore Mutual Fund D 3irla )un 1ife International !0uity Mutual Fund 9 D%) =lobal Agribusiness -ffshore Mutual Fund ' D)> 3lack@ock %orld Mining Mutual Fund 6 I/= -ptimi" =lobal Aommodities Mutual Fund 5$ I/= =lobal @eal !state Mutual Fund

54

A-/A1()I-/B T4! @-AD A4!AD F-@ M(T(A1 F(/D I/D()T@G I/ I/DIA A perceptible change is s eeping across the mutual fund landscape in India. Factors such as changing investor2s needs and their appetite for risk, emergence of Internet as a po erful service platform, and above all the gro ing commoditi;ation of mutual fund products are acting as ma&or catalysts putting pressure on industry players to formulate strategies to stay the course. In the changed scenario today, product innovation is increasingly becoming one of the key determinants of success. =iven the gro ing shifts in investors2 preference o ing to today2s uncertain economic environment, anticipating trends of emerging investor needs and positioning products for these gaps pose greater challenges for gro th for the industry players. customers has also emerged as a key area 3esides, attracting and retaining

here the need to have a greater focus is

strongly felt. 3uilding and sustaining a po erful brand is also becoming an issue of paramount importance. %ith investors today having a range of products to choose from, effective communication is re0uired to reach a ider audience. Increased deregulation of the financial markets in the country coupled ith the

introduction of derivative products offers tremendous scope for the industry to design and sell innovative schemes to suit individual customer needs. As it is being increasingly felt, ith the commoditi;ation of products looking imminent, service to investor and

performance ould be ma&or differentiators. Puest for si;e to survive is bound to stimulate consolidation activities in a big ay if the

early signs of a fe mergers are to be believed. =lobally, it has been seen that the top ten players account for a greater pie of the market share. %ith competition getting intense in the domestic industry, churning in the industry looks imminent.

55

!M!@=I/= A4A11A/=!)

The Indian Mutual Funds industry has emerged as a significant financial intermediary. It is assisting in the process of efficient resource allocation, providing strong support to the capital market and helping investors +particularly small investors, reali;e the benefits of stock market investing. The gro ing importance of Indian mutual funds in the market may be noted in terms of increased mobili;ation of funds and the gro ing number of investors2 accounts ith the mutual funds. The Indian mutual fund industry has stagnated at around @s.#$$$$$ crore assets for the last couple of years. The future gro th of Indian mutual fund industry upon ho ill depend

the industry is able to push the products and pull the savings from the

investors. The industry has to push itself to the investors on product, performance and services. The mutual fund industry needs to introduce innovative products from time to time, hich can satisfy investor2s re0uirements. The market has seen standard products

being introduced by most of the players. These products have met investor2s re0uirement in a bull market but products should also create a long-term investment habit among the investor. The key to investors returning to mutual funds funds ability to out perform the benchmark inde" on a constant basis. The follo ing challenges are re0uired to meet by the Mutual Funds Investor !ducation- /eed of the 4our The Indian mutual fund industry consists of both e0uity and debt schemes. The debt schemes during the last t o years have given very attractive rates of return. 4o ever, e0uity schemes, particularly the diversified schemes, mostly performed in line ith the ill be the

market. @egarding the relatively poor performances of the e0uity schemes, it is to be understood that henever the market has fallen by a substantial portion, the /AEs of

56

these funds have also suffered. It is some of the sector specific funds, particularly the IT sector funds, hich have given very poor performance. As far as safety of investment is concerned, it is safest investment avenues. rong to say that mutual funds are the

There is no guarantee of the return, as Mutual Fund

investment is sub&ect to market risks. /either there is a guarantee of the principal nor is there any insurance. From that point of vie , mutual fund investment is not safe and it entails some amount of risk. >eople should understand that this is no myth, it is a reality. (nlike the banks or government securities, there is no assurance of anything. That is hy creating a areness among the investing community becomes more that /AE could go do n, and there could be no

important. An investor should kno dividends also. @egarding

idening the reach of the Indian industry, the slo

market penetration is a

matter of cost, because to go to smaller to ns or distant places is a costly affair for these funds unlike 1IA and certain other government financial institutions. From the

beginning the mutual fund industry has concentrated on the rich pockets and also metropolitan to ns like Mumbai, Delhi, and Ahennai etc. It is a matter of time before they go to smaller to ns and other pockets savings and a here there are

ell to do rural population. -n restoring the confidence of Indian ill need to create a areness about

investors in mutual funds, first of all the industry

benefits of investing in mutual funds. The investor must understand that mutual funds ork differently from the other saving instruments like banks, post office, non-bank companies, or chit fund companies. There is a trustee, an AMA, auditors, and there is

)!3I. Thirdly, investors should do their home ork properly. Investors need to kno that the right level of risk tolerance actually depends upon his

age, the amount of investible funds available and his financial circumstances including

57

income level, &ob security, and family sei;e, etc... Mutual funds need to make investors kno that financial planning involves managing risks of investing. Investors must kno ithout risks and that these risks can be managed

that the mutual fund investing is not

by tailoring the investment portfolio to the investors risk appetite. -ne main fundamental is that great returns come only from assuming higher risks, but a higher risk portfolio does not guarantee higher returns. Also various studies on mutual fund schemes including yields of different schemes are being published by a number of financial ne spapers on a eekly basis. Investors should study these reports and keep

themselves informed about the performance of the various schemes of different funds. As far as disclosure standards are concerned, it is second to none in the orld. There

has been a lot of improvement in the regulatory frame ork. The activity that is important today is that the intermediaries i.e., the distributors, agents and brokers are distributing and selling the mutual funds, and pass out AMFI test. ho

ould need to become more disciplined

>roduct Innovations and Differentiations

The mutual fund industry in India has gro n from a single ()-D: to around D$$ schemes launched by various Mutual Funds today. 4o ever, the figure seems miniscule hen compared ith the schemes prevailing in the advanced countries. The Indian

market has metamorphosed into the predominant open ended era from the close ended one7 it has ushered investors into a present risk based return environment from the security of the guaranteed return times, yet, the product offerings have been largely vanilla as in debt, e0uity and balanced schemes. The primary innovation of the Indian industry came in the form of insurance linked ta" saving products introduced by (TI and 1IA Mutual Fund, but that as as far back as the pre 566$s. >roduct innovations

58

other ise seemed to have plateaued in the mutual fund industry although the occasional sector funds plans

e have seen

hich caught investor fancy because of the tech boom, serial

hich seemed to be tailored for corporate investors and inde" funds. Mutual

funds other ise for various reasons seemed to have adopted a very cautious approach to product innovations. 3ut ith the gro th in domestic financial markets, there is a

variety of products that can be offered to our investors such as international funds, regional funds, real assets funds, utility funds, municipal funds, capitali;ation based funds, commodity funds, natural resources funds, pension funds, structured funds etc., hich are already a norm in the international markets. The domestic property market is e"tremely disorgani;ed and needs to be brought ithin

the grasp of formal economic activity. @eal estate comprises of three types of properties vi;., personal, investment and infrastructure properties. =enerally, in developed

markets, investment in real estate can be either direct, or through holdings in e0uity of property companies or mortgage backed securities and is 0uite a lucrative investment choice as it not only provides returns similar to e0uities in the long term, but also offers a good hedge to inflation. o nership 4o ever, it is available in India only through direct

herein the tedious legal procedures, high costs and associated risks make it

an unlikely investment choice. )o the ob&ective of domestic real estate investment funds ill be to help investors invest in property conveniently, cost effectively and securely ith the help of professional management, thus providing them opportunities for capital gains as ell as regular income. A lot of ground ork still needs to be done before real

estate investment funds are introduced in our market. Although not as disorgani;ed as the real estate industry, the pension industry in India also needs to ake up to the changing global economics. A burgeoning middle class

population, increased life e"pectancy resulting in an increasing number of senior

59

citi;ens, societal shift to ards nuclear families, decreasing levels of &ob security, complete lack of a national social security system and an increasing sense of responsibility to ards retirement benefits has prompted a revie system. As a result, private pension fund products domestic market. of the e"isting pension ay in the

ill soon likely find their

>roduct differentiation presently is on the basis of investment ob&ectives, asset allocation performance and service. 4o ever, performance ith the commoditi;ation of products being inevitable, service and ill ske investor preferences. As investor kno ledge increases they ill

sho a demand for speciali;ed products and services. 4o ever, the financial industry as a hole has to travel a fe miles before e can get to that level.

Introduction of Aompulsory @ating

Investors ould certainly benefit from mandatory rating of mutual funds. %hile there

should be performance rating for the e"isting schemes, management rating should be introduced for ne schemes. Mandatory rating ould help the investor select a scheme

in accordance ith his risk tolerance level.

)trengthening of Aorporate =overnance

60

Institutionali;ation of financial and capital markets has underlined the importance of corporate governance among mutual funds, particularly as they have a considerable influence on the market. The agency problem, hich arises out of the separation of

management and control in modern organi;ations, can be significantly influenced by mutual funds by virtue of their being large investors. For e"ample, mutual funds can check shareholder activism to protect the interests of the organi;ation on one hand, and on the other, they can check management activism to protect interests of the shareholder. Mutual funds should design their o n corporate governance policy to control the activism of their fund managers. )!3I has taken some useful steps. 3ut should go further and design a mechanism to monitor corporate governance in mutual funds, as ell as appropriate penal action for any violation of the same. Another

important task is to set out the responsibilities and obligations of mutual funds in the sphere of the implementation of corporate governance in the organi;ations in have a stake as shareholders. hich they

To this end, )!3I could issue certain guidelines of

KIntentions and Interaction of good practices2, providing a broad frame ork to be follo ed in corporate dealings by the fund managers and other entities involved in asset management.

Developmental role by the regulator

)!3I has introduced a broad spectrum of policies to promote healthy regulation in the mutual funds industry and to protect the investors2 interest. 4o ever, not much is kno n about the official assessments made by )!3I It is not kno n hile taking regulatory initiatives.

hether )!3I has conducted any analysis regarding vital issues, like the

cost-return relationship of mutual fund investing, risk management practices, funds

61

management strategies, corporate governance, service delivery and the investors2 perceptions regarding the funds and regulators. In the (), )!A fre0uently conducts in depth studies in the interests of both the investors and industry. )!3I can consider similar steps to remove certain regulatory and operational eaknesses. The recent reforms in India and globali;ation offer tremendous opportunity for the Indian mutual fund. %hile liberali;ation by itself does not guarantee gro th,

institutionali;ation of liberali;ation, achieved through changes in the managerial mindset, can definitely produce the desired results. The Indian mutual funds industry can emerge as one of the strongest players in the global capital market by absorbing investment technology and modifying managerial practices in the regional conte"t, thinking and acting ith a global vision. hile

Despite the #$$? mutual fund scandals and the global financial crisis of #$$'-#$$6, the story of the mutual fund is far from over. In fact, the industry is still gro ing. In the (.). alone there are more than 5$,$$$ mutual funds, and if one accounts for all share classes of similar funds, fund holdings are measured in the trillions of dollars. Despite the launch of separate accounts, e"change-traded funds and other competing products, the mutual fund industry remains healthy and fund o nership continues to gro .

As belo

ith any investment, there are risks involved in buying mutual funds. These the overall market. Also, the advantages gained from mutual funds are not freeB ithdra al.

investment vehicles can e"perience market fluctuations and sometimes provide returns many of them carry loads, annual e"pense fees and penalties for early

3I31I-=@A>4G

62

4. )adhak L Mutual funds in India Association of Mutual Funds of India + Ealue research + .amfiindia.com,

.valueresearchonline.com,

.indiamutualfunds.com .marketriser.com

0 estionnaire

11 2ame o* the + stomer Mr1 3 Mrs1 3 Ms1 21 '&&ress3 Conta+t 31 4hat is the a"e "ro p yo *a+e in5 i1 ii1 iii1 i-1 -1 20630 30640 40650 50660 'bo-e 60

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51 4hat is the per month in+ome o* yo r *amily5 i1 8 109000

63

ii1 iii1 i-1

106309000 306509000 : 509000

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64

ii1 101 i1 ii1 iii1 i-1 -1

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65