TOPIC: MUTUAL FUNDS

SUBJECT: BASICS OF FINANCIAL

SERVICE

FROM ROLL NO. 43 TO 48

MUTUAL FUND:
A trust that pools the savings of investors who share a common
financial goal is known as Mutual Fund. The money collected is
then invested in financial instruments such as shares, debentures and
other securities the income and capital appreciation realized are
shared by its unit holders in proportion to the number of units owned
by them. Investments in securities are spread over a wide cross
section of industries and sectors reducing the risk of the portfolio.
Mutual funds are mobilizers of saving of the small investors in
instruments like stock and money market instruments. Mutual funds
are corporation that accept money from investors and use this money
to buy stocks, long term bonds, and short term debt instruments issued
by businesses or Govt.
One of the main advantages of mutual funds is that they give small
investors access to professionally managed, diversified portfolios of
equities, bonds and other securities, which would be quite difficult (if
not impossible) to create with a small amount of capital. Each
shareholder participates proportionally in the gain or loss of the fund.
Mutual fund units, or shares, are issued and can typically be
purchased or redeemed as needed at the fund's current net asset value
(NAV) per share, which is sometimes expressed as NAVPS.
Thus a Mutual Fund is the most suitable investment for the common
man as it offers an opportunity to invest in a diversified,
professionally managed basket of securities at a relatively low cost.

HISTORY:
First Phase 1964-87
Unit Trust of India (UTI) was established on 1963 by an Act of
Parliament. The first scheme launched by UTI was Unit Scheme
1964. At the end of 1988 UTI had Rs.6, 700 crores of assets
under management.
Second Phase 1987-1993 (Entry of Public Sector Funds)
SBI Mutual Fund was the first non- UTI Mutual Fund
established in June 1987 followed by Canbank Mutual Fund
(Dec 87), Punjab National Bank Mutual Fund (Aug 89), Indian
Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of
Baroda Mutual Fund (Oct 92).
Third Phase 1993-2003 (Entry of Private Sector Funds)
Kothari Pioneer (now merged with Franklin Templeton) was the
first private sector mutual fund registered in July 1993. As at the
end of January 2003, there were 33 mutual funds with total
assets of Rs.1, 21,805 crores.
Fourth Phase since February 2003
In February 2003, following the repeal of the Unit Trust of India
Act 1963 UTI was bifurcated into two separate entities.

One is the Specified Undertaking of the Unit Trust of India with

assets under management of Rs.29, 835 crores as at the end of
January 2003, representing broadly, the assets of US 64 scheme,
assured return and certain other schemes. The Specified
Undertaking of Unit Trust of India, functioning under an
administrator and under the rules framed by Government of India
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and does not come under the purview of the Mutual Fund
Regulations.
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB,
BOB and LIC. It is registered with SEBI and functions under the
Mutual Fund Regulations.

ASSOCIATION OF MUTUAL FUNDS IN

INDIA:
Association of Mutual Funds in India (AMFI) was incorporated
on 22nd August, 1995.
(AMFI) modeled on the lines of a Self Regulating Organization
(SRO) with a view to 'promoting and protecting the interest of
mutual funds and their unit-holders, increasing public awareness
of mutual funds, and serving the investors interest by defining
and maintaining high ethical and professional standards in the
mutual funds industry'.
Association of Mutual Funds India has brought down the
Indian mutual fund industry to a professional and healthy
market with ethical lines enhancing and maintaining standards.
It follows the principle of both protecting and promoting the
interests of mutual funds as well as their unit holders.
AMFI interacts with SEBI and works according to SEBIs
guidelines in the mutual fund industry.

Net Asset Value (NAV):

NAV means Net Asset Value. The investments made by a
Mutual Fund are marked to market on daily basis. In other
words, we can say that current market value of such
investments is calculated on daily basis. NAV is arrived at after
deducting all liabilities (except unit capital) of the fund from the
realisable value of all assets and dividing by number of units
outstanding. Therefore, NAV on a particular day reflects the
realisable value that the investor will get for each unit if the
scheme is liquidated on that date. This NAV keeps on changing
with the changes in the market rates of equity and bond
markets. Therefore, the investments in Mutual Funds is not risk
free, but a good managed Fund can give you regular and higher
returns than when you can get from fixed deposits of a bank
etc.

FEATURES:
Mobilizing small savings:
Mutual funds mobilize funds by selling their own shares known
as units. This gives the benefit of convenience and satisfaction
of owning shares in many industries. Mutual fund invests in
various securities and passes on the returns to the investors.
Investment Avenue:
The basic characteristic of a mutual fund is that it provides an
ideal avenue for investment for investors and enables them to
earn a reasonable return with better liquidity. It offers investors a
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proportionate claim on the portfolio of assets that fluctuate in

value.
Professional management:
Mutual fund provides investors with the benefit of professional
and expert management of their funds. Mutual fund employee
professionals/experts who manage the investment portfolios
efficiently and profitably. Investors are relieved from the
responsibility of following the markets on a regular basis.
Diversified investment:
Mutual fund has the advantage of diversified investment of
funds in various industries and sectors. This is beneficial to
small investors who cannot afford to buy shares of established
companies at high prices. Mutual fund allows millions of
investors who have investments in variety of securities of
different companies.
Better liquidity:
Mutual fund have the distinct advantage of better liquidity of
investment. There is always a market available for mutual funds.
In case of mutual funds it is obligatory that units are listed and
traded thus offering our secondary markets for the funds. A high
level of liquidity is possible for the fund holders because of
more liquid securities in the mutual fund portfolio.
Reduced risks:
The risk on mutual fund is minimum. This is because of expert
management diversification, liquidity and economies of scale in
transaction cost.
Investment protection:
Mutual funds are regulated by guidelines and legislative
provisions put in place by regulatory agencies such as SEBI in
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order protect the investor interest the mutual funds are obligated
to follow the provisions laid down by the regulators.
Switching facility:
Mutual funds provide investors with the flexibility to switch
from one scheme to another, this flexibility enables investors to
switch from income scheme to growth scheme and from close
ended scheme to open ended scheme.
Tax benefits:
Mutual funds offer tax shelter to the investors by investing in
various tax saving schemes under the provisions provided by the
income tax act.
Low transaction cost:
The cost of purchase and sale of MFs is relatively lower.
Economic development:
MFs contribute to economic development by mobilizing
savings and channelizing them to more productive sectors of the
economy.

Structure of Mutual Funds in India:

Mutual Funds in India follow a 3-tier structure.
The first tier is the sponsor who thinks of starting the fund.
The second tier is the trustee. The Trustees role is not to manage
the money. Their job is only to see, whether the money is being
managed as per stated objectives. Trustees may be seen as the
internal regulators of a mutual fund.
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 Trustees appoint the Asset Management Company (AMC) who

forms the third tier, to manage investors money. The AMC in
return charges a fee for the services provided and this fee is
borne by the investors as it is deducted from the money
collected from them.

Functions of Mutual Fund:

1. Diversification:
Mutual funds serve as a way to make a diversified investment.
Although a mutual fund typically focuses on a specific asset
type, such as bonds or stocks, it allows for diversification within
that asset type. For instance, a stock fund could contain dozens
of different stocks. This allows investors to invest their money
in a number of different assets at once, making multiple
investments with one purchase. Diversification is designed to
use the gains of some assets to protect against losses in other
ones.

2. Investor Choices:
Mutual funds vary in the types of assets that they hold. This
allows individual investors to purchase shares in funds that meet
their particular needs and preferences. Mutual funds exist for
securities such as stocks and bonds, including some funds that
contain both stocks and bonds together, and they also are
available for money-market instruments, such as certificates of
deposit and treasury bills. Some mutual funds include cash,
according to the Securities and Exchange Commission.

3. Professional Management:
A mutual fund serves to provide investors with professional
management of their investment. For an amateur investor, it is a
tall task to manage a portfolio, especially to maintain a
diversified assortment of securities. The fund manager tackles
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that job with a mutual fund for all of the fund's shareholders. In
addition, a mutual fund simplifies the trading process for
investors. Instead of having to navigate the buying and selling of
stocks, including the financial details and the documentation, the
mutual fund company manages all trades for its shareholders.
4. Investor Goals:
Mutual funds exist to meet a wide range of investor goals. Some
mutual funds target steady, long-term growth, while others focus
on more short-term goals. For instance, an investor seeking a
conservative, low-risk investment with long-term returns could
invest in an index fund, which is a mutual fund designed to
grow at the same rate as a selected stock index, such as the
S&P- 500. Other more ambitious stock funds seek to produce
returns better than the market averages. Meanwhile, bond funds
target income as a primary goal over growth, because the bonds
in the fund produce a steady stream of interest payments to
investors.

Types of Mutual Funds:

Various types of mutual funds categories are designed to allow
investors to choose a scheme based on the risk they are willing to
take, the investable amount, their goals, the investment term, etc.

Mutual
funds

Open
Ended

Closed

Interva
l Fund
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Money
market

Debit
Gift

Flexible
Long Term
Bond
Short Term Bond

Equit

Balanced

Sectorial
Index

MIP or
Hybrid

Capital
Protection

Fixed maturity
plan

Tax
saver or
Mid cap/small cap

Ultra Short
Term Bond

Diversifie

Let us have a look at some important mutual fund schemes under the
following three categories based on maturity period of investment:

I.

Open-Ended: This scheme allows investors to buy or sell

units at any point in time. This does not have a fixed maturity
date.

1) Debt/Income:
In a debt/income scheme, a major part of the investable fund is
channelized towards debentures, government securities, and other
debt instruments. Although capital appreciation is low (compared
to the equity mutual funds), this is a relatively low risk-low return
investment avenue which is ideal for investors seeing a steady
income.
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2) Money Market/Liquid:
This ideal for investors looking to utilize their surplus funds in
short term instruments while awaiting better options. These
schemes invest in short term debt instruments and seek to provide
reasonable returns for the investors.
3) Equity/Growth:
Equities are a popular mutual fund category amongst retail
investors. Although it could be a high-risk investment in the short
term, investors can expect capital appreciation in the long run. If
you are at your prime earning stage and looking for long term
benefits, growth schemes could be an ideal investment.
i. Index Scheme:
An Index scheme is a widely popular concept in the west.
These follow a passive investment strategy where your
investments replicate the movements of bench indices Nifty,
Sensex, etc.
ii.

Sectorial Scheme:
Sectorial funds are invested in a specific sector like
infrastructure, IT, etc. or segments of capital market like large
caps, mid-caps etc. This scheme provides a relatively highrisk return opportunity within the equity space.

iii.

Tax Saving:
As them name suggests, this scheme offers tax benefits to its
investors. The funds are invested in equities thereby offering
long-term growth opportunities. Tax saving mutual funds
(called Equity Linked Savings Schemes) has a 3-year lock-in
period.

1. Balanced:
This scheme allows investors to enjoy growth and income at
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regular intervals. Funds are invested in both equities and fixed

income securities; the proportion is pre-determined and
disclosed in the scheme related offer document. These are ideal
for cautiously aggressive investors.
II.

Closed-ended:
In India, this type of scheme has a stipulated maturity period and
investors can invest only during the initial launch period known
as the NFO (New Fund Offer) period.
1) Capital protection:
The primary objective of this scheme is to safeguard the
principal amount while try to deliver reasonable returns. These
in high-quality fixed income securities with marginal exposure
to equities and mature along with the maturity period of the
scheme.
2) Fixed Maturity Plans (FMPs):
FMPs as per the name suggests, are mutual fund schemes with a
defined maturity period. These schemes normally comprise of
debt instrument which mature in line with the maturity of the
scheme, thereby earning through the interest component (also
called coupons) of the securities in the portfolio. FMPs are
normally passively managed, i.e. there is no active trading of
debt instruments in the portfolio. The expenses which are
charged to the scheme are hence, generally lower than actively
managed schemes.

III.

Interval:
Operating as a combination of open and closed ended schemes,
it allows investors to trade units at pre-defined intervals.

Which scheme should I invest in?

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When it comes to investing a scheme to invest in, one should look for
customized advice. Your best bet are the schemes that provide the
right combination of growth, stability and income, keeping your risk
appetite in mind.

ADVANTAGES OF MUTUAL FUNDS:

If mutual funds are emerging as the favorite investment
vehicle, it is because of the many advantages they have over
other forms and the avenues of investing, particularly for the
investor who has limited resources available in terms of
capital & the ability to carry out detailed research & market
monitoring. The following are the major advantages offered
by mutual funds to all investors:
1. Portfolio Diversification:
Each investor in the fund is a part owner of all the fund's
asset, thus enabling him to hold a diversified investment
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portfolio even with a small amount of investment that would

otherwise require big capital.
2. Reduction/ Diversification of Risk:
When an investor invests directly, all the risk of potential loss
is his own, whether he places a deposit with a company or a
bank, or he buys share on his own or in any other form. While
investing in the pool of funds with investors, the potential
losses are also shared with other investors. The risk reduction
is one of the most important benefits of a collective
investment vehicle like the mutual fund.
3. Reduction of Transaction Costs:
What is true of risk as also true of the transaction costs? The
investors bear all the costs or investing such as brokerage or
custody of securities. When going through a fund, he has the
benefit of economics of scale; the funds pay lesser costs
because of larger volumes, a benefit passed on to its investors.
4. Liquidity:
Often, investors hold shares or bonds they cannot directly,
easily & quickly sell. When they invest in the units or a fund,
they can generally cash their transaction anytime by selling
their units to the fund if open-ended or selling them in the
market if the fund is close-end. Liquidity of investment is
clearly a big benefit.
5. Convenience & Flexibility:
Mutual fund management companies offer many investor
services that a direct market investor cannot get. Investors can
easily transfer their holding from one scheme to the other, get
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updated market information & so on.

6. Tax Benefits:
In Case of individual & Hindu undivided Families (HUF) a
deduction up to Rs.9,000 from the Total Income will be
admissible in respect of income from investments specified in
section 80L, including income from units of the Mutual Fund.
Units of the scheme are not subject to Wealth-tax & Gift-tax.

Disadvantages of Investing through

Mutual funds:
1. No control Over Cost:
An investor in a mutual fund has no control of the overall costs of
investing. The investor pays investment management fees as long as
he remains with the fund. Fees are payable even if the value of his
investment is declining. A mutual fund investor also pays fund
distribution costs, which he would not incur in direct investing.
However this shortcoming only means that there is a cost to obtain the
mutual fund services.

2. The Wisdom of Professional Management:

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The average mutual fund manager is better at picking stocks than the
average non-professional, but charges fees.

3. Managing A Portfolio of Funds:

Availability of a large number of funds can actually mean too much
choice for the investor. He may again need advice on how to select a
fund to achieve his objectives, quite similar to the situation when he
has individual shares or bonds to select.

4. No Tailor-Made Portfolio:
Investor who invests on their own can build their own portfolios of
shares & bonds & other securities. Investing through fund means he
delegates this decision to the fund manager. The very high net-worth
individuals or large corporate investors may find this to be constraint
in achieving their managers help investor overcome this constraint by
offering families of funds - a large number of different schemes
within their own management company. An investor can choose from
different investment plans and constructs a portfolio to his choices.

5. No Control:
Unlike picking your own individual stocks, a mutual fund puts you in
the passenger seat of somebody else's car.

6. Dilution:
Mutual funds generally have such small holding of so many different
stocks that insanely great performances by a fund's top holdings still
doesn't make much of a difference in a mutual fund's total
performance.

7. Buried Costs:
Many mutual funds specialize in burying their costs & in hiring
salesman who do not make those costs clear to their clients.

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Taxing in mutual fund:

Since, April 1, 2003, all dividends, declared by debt-oriented mutual
funds (i.e. mutual funds with less than 50% of assets in equities), are
tax-free in the hands of the investor. A dividend distribution tax of
12.5% (including surcharge) is to be paid by the mutual fund on the
dividends declared by the fund. Long-term debt funds, government
securities funds (G-sec/gilt funds), monthly income plans (MIPs) are
examples of debt-oriented funds.
Section 2(42A):
Under Section 2(42A) of the Act, a unit of a mutual fund is treated
as short-term capital asset if the same is held for less than 12 months.
Section 10(38):
Under Section 10(38) of the Act, long term capital gains arising
from transfer of a unit of mutual fund is exempt from tax if the said
transaction is undertaken after October 1, 2004 and the securities
transaction tax is paid to the appropriate authority. Short-term capital
gains on equity-oriented funds are chargeable to tax @10%, Longterm capital gains on debt-oriented funds are subject to tax @20% of
capital gain after allowing indexation benefit or at 10% flat without
indexation benefit, whichever is less.
Section 112: Under Section 112 of the Act, capital gains, not
covered by the exemption under Section 10(38), chargeable on
transfer of long-term capital assets are subject to following rates
of tax:
Resident Individual & HUF -- 20% plus surcharge, education
cess.
Partnership firms & Indian companies -- 20% plus surcharge.
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 Foreign companies -- 20% (no surcharge).

Capital gains will be computed after taking into account the cost of
acquisition as adjusted by Cost Inflation Index, notified by the central
government.

Regulations:
Regulations ensure that schemes do not invest beyond a certain
percent of their NAVs in a single security. Some of the
guidelines regarding these are given below
No scheme can invest more than 15% of its NAV in rated debt
instruments of a single issuer. This limit may be increased to
20% with prior approval of Trustees. This restriction is not
applicable to Government securities.
No scheme can invest more than 10% of its NAV in unrated
paper of a single issuer and total investment by any scheme in
unrated papers cannot exceed 25% of NAV.
No fund, under all its schemes can hold more than 10% of
companys paid up capital
No scheme can invest more than 10% of its NAV in a single
company.
If a scheme invests in another scheme of the same or different
AMC, no fees will be charged. Aggregate inter scheme
investment cannot exceed 5% of net asset value of the mutual
fund.

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Portfolio Management Process In

Mutual Fund
Setting investment goals:
The first task of managing the portfolio of mutual fund is to
identify and set the goals for the proposed scheme the goal is set
keeping in mind the nature of the scheme, risk and return,
market condition, regulatory norms, size of the issue and
investor protection.
Identifying specific securities:
Efforts are made to analyse and identify the right securities
where the fund should invest in. security analyses is carried out
and risk and return characteristics are evaluated.
Portfolio designing:
It involves making an ideal mix of debt and equity securities of
corporate, govt. etc. It is concerned with decisions regarding the
type of securities to be bought, the quantum and timing of issue.
Portfolio design is carried out on the basis of research and
analyses of stock market and devising investment strategies. The
portfolio should be well diversified so as to reduce the total risk
of the portfolio.
Portfolio revision:
The portfolio must be reviewed periodically keeping in mind the
risk return characteristics; the revision of the portfolio is done
by keeping in mind the dynamic investment climate.

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Registration of mutual funds:

Every mutual fund shall be registered with SEBI through an
application to be made by the sponsor in a prescribed format
accompanied by an application fee of Rs.25000.
Every mutual fund shall pay Rs.25lakhs towards registration fee
and Rs: 2.5lakhs per annum as service fees.
Registration shall be granted by the board on fulfillment of
conditions such as sponsors, sound track record of 5yrs integrity,
net worth etc.

Evaluation of Mutual Funds:

It is essential that the performance of Mutual fund is evaluated
and appraised. Such appraisal helps the fund to compare itself
with other funds besides being a potential source of information
to the present and prospective investors.
Evaluation includes simple evaluation tools to sophisticated
models which take into consideration the risk and uncertainty
associated with the returns. Some of the models used are
Treynors Model and Sharpes Model

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