Financial Newsletter FIN-ESSE February ‘16

MUTUAL FUNDS

What is a Mutual Fund?

A mutual fund is an investment fund that pools money from many investors to invest it in a
set portfolio. Stocks, bonds and money market instruments are all examples of the types of
investments that may make up a mutual fund.

The mutual fund is managed by a professional investment manager who buys and sells
securities for the most effective growth of the fund. As a mutual fund investor, you become a
"shareholder" of the mutual fund. Whenever there are profits or losses, you share the
profit/loss with other investors, thereby lowering both risk as well as return.

Net Asset Value (NAV)

Net asset value (NAV) is a mutual fund's price per share. NAV of the fund is calculated by
dividing the total value of all the securities in its portfolio, less any liabilities, by the number
of fund shares outstanding. Shares of mutual fund may trade above NAV (at premium) or
below NAV (at discount).

Where,
Assets = closing price of all securities and their constitution in a mutual fund’s portfolio
Liabilities = fees, taxes and other expenses
NAV per share is computed once a day based on the closing market prices of the securities in
the fund's portfolio. All mutual funds' buy and sell orders are processed at the NAV of the
trade date.
Types of Mutual Funds
1. Open-End Fund: An open-end fund is a type of mutual fund that does not have
restrictions on the amount of shares the fund will issue. Open-end funds also buy back
shares when investors wish to sell. The majority of mutual funds are open-end.
2. Closed-End Fund: A closed-end fund is a type of mutual fund that raises a fixed
amount of capital only once through an IPO by issuing a fixed number of shares.
Closed-end funds cannot buy back shares.
3. Unit Investment Trust: UITs can issue to the public only once, when they are
created. They generally have a limited life span. UITs can also buy back shares at any
time. They can also be resold in the secondary market.

Amit | Dhruv | Nikhil | Nikita | Praneeth | Sriram | Sumeet | Suraj

Financial Newsletter FIN-ESSE February ‘16

MUTUAL FUNDS

Classification of Mutual Funds

Based on their principal investments, mutual funds can be categorized as:
1. Equity Funds: Equity funds are made up of investments of only common stock. They
may focus on a specific industry or sector. These funds can be riskier (and earn more
money) than other types.
2. Bond Funds: Bond funds invest in fixed income or debt securities. They provide a
fixed return and are usually low risk.
3. Balanced Funds: Balanced funds combine both stocks and bonds in the investment
pool and offer a moderate to low risk. While low risk may sound good, it is also
accompanied by lower rates of return.
4. Money Market Funds: Money market funds invest in short-term (less than one year)
securities characterized as a low-risk, low-return investment. Its objective is to earn
interest for shareholders while maintaining a net asset value (NAV) of $1 per share.

Some Key Terms used in Newspapers

Load: Load refers to the sales charges added to a mutual fund when you purchase it or sell it.
The load charge goes to the fund salesperson as a commission and payment for their research
services. Load charges can be up to 8.5 percent of the selling price.

Front-end load means you pay it when you buy the mutual fund. Back-end load means you
pay it when you sell the mutual fund.

Many mutual funds are no-load funds. It means that there is no sales fee charged and the
fund is direct-marketed so you can buy it without the help of a salesperson. In addition to no-
load funds, there are also low-load funds that charge up to 3.5 percent as a sales fee.

Large Cap Funds: Funds which invest a larger proportion of their corpus in companies with
large market capitalization are called large cap funds. These are generally the ones with at
least $10 billion market cap. Large cap funds are known to offer stable and sustainable
returns over a period of time.

Small Cap Funds: Funds which invest a larger proportion of their corpus in companies with
small market capitalization are called small cap funds. These are generally the ones below $2
billion market cap. Due to their exposure in high beta stocks, they are positioned on a high
risk return trade-off plane compared to a large cap funds.

Multi Cap Funds: These are diversified mutual funds which can invest in stocks across
market capitalization. That is, their portfolio comprises of large cap, midcap and small cap
stocks. They are relatively less risky compared to a pure mid cap or a small cap fund and are
suitable for not-so-aggressive investors.

Amit | Dhruv | Nikhil | Nikita | Praneeth | Sriram | Sumeet | Suraj

Financial Newsletter FIN-ESSE February ‘16

MUTUAL FUNDS

Sector Specific Funds: Mutual funds which invest in a particular sector or industry are said
to be sector-specific funds. Since the portfolio of such mutual funds consists mainly of
investment in one particular type of sector, they offer less amount of diversification and are
considered to be risky. Some of the sector-specific funds are Banking funds, Pharma funds,
Technology funds and FMCG funds.

Turnover Ratio: It measures a mutual fund’s level of trading activity in a given time period,
usually a year. An aggressive small-cap growth stock fund will generally experience higher
turnover than a large-cap value stock fund. All things being equal, investors should favour
low turnover funds. High turnover equates to higher brokerage transaction fees, which reduce
fund returns.

Expense Ratio: It is a measure of what it costs an investment company to operate a mutual

fund. An expense ratio is determined through an annual calculation, where a fund's operating
expenses are divided by the average dollar value of its assets under management. The largest
component of operating expenses is the fee paid to a fund's investment manager.

Fund Size or Asset Size: The total market value of the securities in a mutual fund's portfolio.
Bigger is not necessarily better. For bond, index and money market funds, which generally
operate in large market segments that are very liquid and are less affected by large block
trading transactions, bigger is actually better because expenses can be spread over more
investment assets.

Average Annual Return (AAR): AAR is a percentage figure used when reporting the
historical return, such as the three-, five- and 10-year average returns of a mutual fund. The
average annual return is stated net of a fund's operating expense ratio.

When selecting a mutual fund, not only the average annual return but also the fund's yearly
performance should be checked to fully appreciate the consistency of its annual total returns.
For example, a five-year average annual return of 10% looks attractive; however, if the yearly
returns (those that produced the average annual return) were +40%, +30%, -10%, +5% and -
15% (50 / 5 = 10%), the fund's recent performance (past three years) is absolutely awful.

Core-Satellite Investing
Core-satellite investing is an investment strategy designed to minimize costs, tax liability and
volatility while providing an opportunity to outperform the broad stock market as a whole.
The core of the portfolio consists of passive investments that track major market indices,
such as the S&P 500. The satellites are added to the portfolio in the form of actively
managed investments. For the actively managed portion, the goal is to earn greater returns
than those generated by the passive portion of the portfolio.

Amit | Dhruv | Nikhil | Nikita | Praneeth | Sriram | Sumeet | Suraj

Financial Newsletter FIN-ESSE February ‘16

MUTUAL FUNDS

Example

For the core portion of your portfolio, you could put half of the assets dedicated to stocks into
an index fund that tracks the S&P 500. Whereas, for the satellite portion, you could put 10%
of the portfolio into a high-yield bond fund and divide the remaining stock portion evenly
between a biotechnology fund and a commodities fund.

Investment Percentage
S&P 500 Index Fund 50%
Actively Managed High-Yield Bond
10%
Fund
Actively Managed Biotechnology Fund 20%
Actively Managed Commodities Fund 20%

Costs: The core portion of the portfolio (50%) minimizes costs because passive investments
track indices which change infrequently, thus minimizing transaction costs and capital gains
tax.

Volatility: Beta is a measure of stock market volatility which many investors prefer to avoid.
By dedicating a large portion of a portfolio to passive investments, the beta of the total
portfolio is reduced.

Returns: By allocating a minority of the portfolio to active management, the opportunity to

outperform the benchmark is in place, thus resulting in benchmark-beating returns for the
portfolio as a whole.

The core-satellite approach provides an opportunity to better-than-average performance,

limited volatility and cost control.

THANK YOU!

Amit | Dhruv | Nikhil | Nikita | Praneeth | Sriram | Sumeet | Suraj