Mutual Funds

A mutual fund is a corporate body (trust) that attracts

savings, which are then invested in money market, debt
market and capital market instruments such as shares and
debentures. A mutual fund acts as a link between the public
and the capital market. It is promoted by an agreement
between three entities, namely sponsor, trustee and Asset
Liability Management Company(ALM.)

Constituent of Mutual Fund

Sponsor: They are like the promoters of a company and are
responsible for starting the Mutual Fund. Mutual Fund such
as LIC, TATAs, and BIRLAs are examples for Sponsor. They
take the initiative of fulfilling all the initial measures required
for promoting the Mutual Funds.

Trustee: These are the people who act as the watch dog for
the properties of the mutual fund. Judges, Bankers and
insurance companies are appointed as Trustees, who will
look after the assets of the mutual Fund. Their main task is to
supervise the assets of the mutual fund, so that on any
account there should not be any erosion in the value of these
assets.

ALM:- The assets mobilized by the mutual fund are entrusted

in the ALM company for investment in various companies.
There will be diversified investments such as debt
instruments (Bonds or Bills), Equities and foreign securities.
As the ALM consists of experts in the field of investment
portfolio the profitability of the investments is not only
ensured, but it is also kept transparent through the
declaration of NAV’s.

History of Mutual Funds

In India first mutual fund started in 1964 when United Trust
of India( UTI) was established in the similar line of operation
of the UK based Investment Trust Companies.
Phase I – 1964 – 87: In 1963, UTI was set up by Parliament
under UTI act and given a monopoly. The first scheme
launched by UTI was Unit Scheme-64. Later in ’70’s and ’80’s,
UTI started offering some special purpose schemes like ULIP
and Children’s Gift Growth Fund. Master share, the first
equity fund was launched in 1986. These were launched to
suit the needs of different class of investors.
Phase II – 1987 – 93: 1987 marked the entry of non-UTI,
Public Sector mutual funds. Some of the mutual funds
launched during this period are SBI Mutual Fund, Canbank
Mutual Fund, LIC Mutual Fund, Indian Bank Mutual Fund, GIC
Mutual Fund and PNB Mutual Fund.
Also marked a spurt in launch of assured funds like Cantriple,
Magnum Triple, BOI Double Square Plus. Equity funds with
assured returns were launched which later ended in
disaster.
Phase III – 1993 – 96: Permission was granted for entry of
private sector funds. It gave greater choice to the Indian
Investors. These private funds have brought in with them the
latest product innovations, investment management
techniques and investor servicing technology that makes the
Indian mutual fund industry vibrant and growing. This phase
also marked the launch of an open-end funds.
Phase IV – 1996: Investor friendly regulatory measures have
been taken both by SEBI to protect the investor, and by the
government to enhance investor’s returns through tax
benefits.

ADVANTAGES OF MUTUAL FUNDS

i. Diversification
ii. Expert supervision and management.
iii. Liquidity.
iv. Reduced risk
v. Tax advantage.
vi. Low operating costs.
vii. Flexibility.
viii. Higher returns.
ix. Investor protection
• Portfolio diversification: It enables him to hold a
diversified investment portfolio even with a small
amount of investment like Rs. 2000/-.
• Professional management: The investment
management skills, along with the needed research into
available investment options, ensure a much better
return as compared to what an investor can manage on
his own.
• Reduction/Diversification of Risks: The potential losses
are also shared with other investors.
• Reduction of transaction costs: The investor has the
benefit of economies of scale; the funds pay lesser costs
because of larger volumes and it is passed on to the
investors.
• Wide Choice to suit risk-return profile: Investors can
choose the fund based on their risk tolerance and
expected returns.
• Liquidity: Investors may be unable to sell shares directly,
easily and quickly. When they invest in mutual funds,
they can cash their investment any time by selling the
units to the fund if it is open-ended and get the intrinsic
value. Investors can sell the units in the market if it is
closed-ended fund.
• Convenience and Flexibility: Investors can easily
transfer their holdings from one scheme to other, get
updated market information and so on. Funds also offer
additional benefits like regular investment and regular
withdrawal options.
• Transparency: Fund gives regular information to its
investors on the value of the investments in addition to
disclosure of portfolio held by their scheme, the
proportion invested in each class of assets and the fund
manager's investment strategy and outlook
Disadvantages :
• No control over costs: The investor pays investment
management fees as long as he remains with the fund,
even while the value of his investments are declining. He
also pays for funds distribution charges which he would
not incur in direct investments.
• No tailor-made portfolios: The very high net-worth
individuals or large corporate investors may find this to
be a constraint as they will not be able to build their
own portfolio of shares, bonds and other securities.
• Managing a portfolio of funds: Availability of a large
number of funds can actually mean too much choice for
the investor. So, he may again need advice on how to
select a fund to achieve his objectives.
• Delay in redemption: It takes 3-6 days for redemption
of the units and the money to flow back into the
investor’s account.

PROBLEMS OF MUTUAL FUNDS IN INDIA

1. Liquidity crisis.
2. Lack of innovation.
3. Inadequate research.
4. Conventional pattern of investment.
5. No provision for performance guarantee.
6. Inadequate disclosures.
7. Delays in service.
8. No rural sector investment base.
9. Poor risk management.

1. According to ownership: classified as

∙ Public sector mutual funds: United Trust of India(UTI) has
been
functioning in the arena of Mutual Fund business in India
since 1963-
1964. It was only after 23 years in 1987 that a second fund
was
established in India by the State Bank Of India. SBI mutual
fund was the
first among all the public sector commercial banks that
started operations
during November 1987. Thereafter a number of public
sector organisation
like IND Bank MF, CAN Bank MF, BOI MF, PNB MF LIC MF
etc joined
in the mutual fund business in a short span of time.

∙ Private sector Mutual Funds: the Government of India

allowed the private
sector corporates to join the Mutual Fund Industry on
 February 14, 1992.
SEBI regulations, 1996 provide guidelines for registration,
constitution,
management and schemes of mutual funds.

2. According to the scheme of operation: divided into

three categories:

∙ Open- ended schemes/funds: open ended scheme means a

scheme of
Mutual funds which offers units for sale without specifying
any duration
for redemption. These schemes do not have a fixed maturity
and entry to
the fund is always open to investors who can subscribe it at
any time. The
investor have a option to get their holdings redeemed at any
time. The fund
redeems or repurchases the units/ shares at periodically
announced rates.
These repurchase rates are based upon the net current
assets value of the
fund. The Unit scheme 1964 of UTI, ULIP,dhanraksha and
Dhanvirdhi of
LIC Mutual fund are some of the examples of open ended
schemes.
∙ Closed-ended schemes /funds: A closed ended scheme
means any scheme of mutual fund in which the period of
maturity of the scheme is specified. The corpus of close-
ended scheme is fixed and an investor can subscribe directly
to the scheme only at the time of initial issue. After the initial
issue is closed a person can buy or sell the units of the
scheme in the secondary market. It is always easier to
manage a close-ended scheme as the fund managers can
evolve long term investment strategies depending upon the
life of the scheme. Dhanshree and Dhanasamardhi of LIC
mutual fund, Canshare of Canara Bank, Ind Jyothi and Swaran
Jyothi of Indian Bank are some of the examples of closed
ended mutual fund schemes.

∙ Interval schemes/ funds: An interval scheme is a scheme of

Mutual fund
which is kept open for a specific interval and after that it
operates as a
closed scheme. Interval schemes have been permitted by the
SEBI in
recent years only. The scheme is open for scale or repurchase
at fixed
predetermined intervals which are disclosed in the offer
document.
3. According to portfolio:
∙ Income funds: These funds aim at providing maximum
current return to
the investor. There may be income funds of two types.
Some funds may
concentrate on low risk, constant returns while others,
may aim at
maximum return even at the cost of some risk.

∙ Growth funds: These funds aim at providing capital

appreciation in the
value of investment. Such funds invest in growth oriented
securities have
a potential to appreciate in long run.

10-
15
% 4; Series1; 1; Series1;
0.1; 10% 0.1; 10%
5%
10-20% 20-30%
60-70% 50-60%

Growth Fund (investment in equity shares, bonds,

debentures, etc)

∙ Balanced or conservative funds: Balanced funds spend

both on common
stock and preferred stock. Some part of funds is spent on
buying equity
while other part is used in acquiring interest bearing
debentures and
preference shares ensuring certain amount of dividend.

∙ Stock/ equity fund: These are mainly invested in shares of

the companies.
The investments may vary from blue chip companies to
newly established
companies.

∙ Bond funds: These funds employ their resources in

bonds. These
investments ensure fixed and regular income.

∙ Specialised funds: These invest in a particular type of

securities of
companies dealing in a particular product, firms in a
particular industry
or of certain income producing securities.

∙ Leverage funds: These maximise capital appreciation.

These may even use borrowed funds for buying
speculative stock which ensures a profit in the future.
∙ Taxation funds: Mutual funds may be designed to suit the
tax payers. The
contributors to such funds get some concession in income
tax.

∙ Money market mutual funds: These instruments include

treasury bills,
dated government securities with an unexpired maturity of
upon one year, call and notice money, commercial paper,
commercial bills accepted
by banks and certificates of deposits.

4. According to location:
∙ Domestic funds. These are the funds which mobilise
savings of people
within the country where investment are made.

∙ Off-shore funds: Off-shore mutual funds are those which

raise or
mobilise funds in country other than where investments
are to be made.
These funds attract foreign savings for investment in India.

5. According to market capitalisation.

6. Other types of mutual funds: Such as Loan funds, and
Non-loan funds based upon the expenses/ fees to be
charged. Hub and spoke funds which are basically fund of
funds, etc
7. Specialised funds: These are funds set up for some
specialized purpose. (a) International funds: They consist
of foreign securities.
(b) Global funds: Here, the stocks are traded in market
throughout the world with the exception of the country
which launches the fund.
(c) Regional or country funds: These may be confined to
continents. In India, they are called off- shore funds.
(d) Sector funds: They are specializing in a particular
industry and are regarded as aggressive funds. Example is
India Development Bonds.

Benefits of Mutual Funds

From the point of view of banks

1. It provides an opportunity to invest its funds in

profitable stock
2. Banks can give loan on security of stock
3. Liquidity of stock is possible though stock exchange
4. Money market mutual fund provided short-term fund
deployment.
5. Demand of stock by banks increase dynamism in capital
market.
6. Higher interest rates can be offered for depositors by
higher returns from mutual funds.
From the point of view of foreign investors

1. Mutual funds can attract foreign investment: Examples-

merry lynch, Morgon Stanley.
2. Capital market gets additional funds by which it is made
more dynamic.
3. Foreign exchange rate is maintained due to the inflow
of foreign funds.
4. It strengthens the capital market and enables further
growth.

From the point of view of Domestic investor

1. It provides him regular income without much risks
2. It ensures a higher return on his investment
3. It provides liquidity as he can encash the units any time
4. It ensures growth of his investment
5. Experts services are made available to the individual
6. It also provides tax shelter to the individual

From the point of view of Government

1. It provided short-term funds to government as there is
money market mutual funds.
2. Government promoters investment trusts such as Unit
Trust of India for attracting savings of middle and lower
income group
3. Government can regulate capital market through the
control of mutual funds.
4. It provides better opportunities for government to
invest its funds in a profitable venture. Example: LIC
mutual fund
5. Government can meet its revenue and capital
expenditure with the income derived from mutual funds.

From the point of view of Economy

1. Mutual funds ensure adequate funds to secondary

sector
2. The return on mutual funds is an indication of the
functioning of the economy
3. Small investors are mobilized and huge investments
undertaken
4. Government sponsored mutual funds attract public
funds which promote savings in the economy
5. Government ensures equal distribution of funds to
various companies through its own mutual funds.

From the point of view of Capital Markets

1. It attracts funds from the mutual funds

2. Huge volume of transaction are ensured
3. Wide fluctuations in the market prices are prevented by
the presence of mutual funds
4. A fair return is given to the unit holders and it helps in
bringing transparency to the capital market.
The Fund Sponsor
• Any person or corporate body that establishes the Fund
and registers it with SEBI.
• Form a Trust and appoint a Board of Trustees.
• Appoints Custodian and Asset Management Company
either directly or through Trust, in accordance with SEBI
regulations.
SEBI regulations also define that a sponsor must contribute
at least 40% to the net worth of the asset management
company.
Trustees
• Created through a document called the Trust Deed that
is executed by the Fund Sponsor and registered with
SEBI.
• The Trust-the mutual fund may be managed by a Board
of Trustees- a body of individuals or a Trust Company- a
corporate body.
• Protector of unit holders interests.
• 2/3 of the trustees shall be independent persons and
shall not be associated with the sponsors.
Rights of Trustees:
• Approve each of the schemes floated by the AMC.
• The right to request any necessary information from the
AMC.
• May take corrective action if they believe that the
conduct of the fund's business is not in accordance with
SEBI Regulations.
• Have the right to dismiss the AMC,
• Ensure that, any shortfall in net worth of the AMC is
made up.
Obligations of the Trustees:
• Enter into an investment management agreement with
the AMC.
• Ensure that the fund's transactions are in accordance
with the Trust Deed.
• Furnish to SEBI on a half-yearly basis, a report on the
fund's activities
• Ensure that no change in the fundamental attributes of
any scheme or the trust or any other change which
would affect the interest of unit holders is happens
without informing the unit holders.
• Review the investor complaints received and the
redressal of the same by the AMC.

Asset Management Company

• Acts as an invest manager of the Trust under the Board
Supervision and direction of the Trustees.
• Has to be approved and registered with SEBI.
• Will float and manage the different investment schemes
in the name of Trust and in accordance with SEBI
regulations.
• Acts in interest of the unit-holders and reports to the
trustees.
• At least 50% of directors on the board are independent
of the sponsor or the trustees.
Obligation of Asset Management Company:

✔ Float investment schemes only after receiving prior

approval from the Trustees and SEBI.

✔ Send quarterly reports to Trustees.

✔ Make the required disclosures to the investors in areas

such as calculation of NAV and repurchase price.

✔ Must maintain a net worth of at least Rs. 10 crores at all

times.

✔ Will not purchase or sell securities through any broker,

which is average of 5% or more of the aggregate
purchases and sale of securities made by the mutual
fund in all its schemes.

✔ AMC cannot act as a trustee of any other mutual fund.

✔ Do not undertake any other activity conflicting with

managing the fund.

Structure of Mutual Funds

Custodian
• Has the responsibility of physical handling and safe
keeping of the securities.
• Should be independent of the sponsors and registered
with SEBI.
Depositories
• Indian capital markets are moving away from physical
certificates for securities to ‘dematerialized’ form with a
Depository.
• Will hold the dematerialized security holdings of the
Mutual Fund.

Mutual Funds are primary vehicles for large collective

investments, working on the principle of pooling funds. A
substantial portion of the investments happen at the retail
level. Agents and distributors are a vital link between the
mutual funds and investors.
Agents
- Is a broker between the fund and the investor and acts
on behalf of the principal.
- He is not exclusive to the fund and also sells other
financial services. This in a way helps him to act as a
financial advisor.
Distribution Companies
- Is a company which sells mutual funds on behalf of the
fund.
- It has several employees or sub-broker under it.
- It manages distribution for several funds and receives
commission for its services.

Banks and NBFCs

- Several banks, particularly private and foreign banks are
involved in a fund distribution by providing similar
services like that of distribution companies.
- They work on commission basis.
Direct Marketing
- Mutual funds sell their own products through their
sales officers and employees of the AMC.
- This channel is normally used to mobilise funds from
high net worth individuals and institutional investors.

Agent Commissions
- No rules prescribed for governing the maximum or
minimum commissions payable by a fund to its agents.
 - As per SEBI regulations, 1996 all initial expenses
including brokerage charges paid to agents cannot
exceed 6% of resources raised under the scheme.
- Excess distribution charges have to be borne by the
AMC.
- A no-load fund is authorized to charge the schemes
with the commissions paid to agents as part of the
regular management and marketing expenses allowed
by SEBI.

Calculating Net Asset Value

Unit Capital is the investor’s subscriptions. In mutual funds it
is not treated as a liability.
Investments made on behalf of the investors are reflected on
the assets side of the balance sheet.
There are liabilities of short-term nature.
Fund’s Net Asset = Asset – Liabilities
Net Asset Value = Net Assets of the scheme / No. of
Outstanding Units
i.e
NAV = (Market value of investments + Receivables + Other
Accrued Income + Other assets – Accrued Expenses – Other
Payables – Other liabilities) / ( No. of Units Outstanding as at
the NAV date)
The factors affecting the NAV are as following:

⮚ Capital Gains or Losses on the sale or purchase of the

Investment securities.

⮚ Dividend and income earned on the assets.

⮚ Capital Appreciation in the underlying value of the

stocks held in the portfolio.

⮚ Other assets and liabilities.

⮚ Number of units sold or purchased.

SEBI regulations for NAV

• The day on which NAV is calculated by a fund is called
valuation date.
• NAV of all schemes must be calculated and published
at least weekly.
• This is applicable to both open-end and closed-end fund.
• Some closed end funds (Monthly Income Schemes) that
are not listed on stock exchange may publish it monthly-
quarterly.

Investment in Mutual Funds

Debt Instruments

Sectoral Instruments

Mutual
Equity Instruments
Funds

Indexed Bonds

Government Securities

Debt Instruments: Mutual funds invest in debt instrument

of companies, which carry attractive interest rates. By this,
the mutual fund ensures a reasonable return for its
investors. These will improve the Net Asset value of the
Mutual fund. In fact, debt instruments are safe for
investment, as they are backed by securities. For example,
mortgage debentures of companies.
Sectoral Investment:- Mutual Funds invest in different
sectors of the economy. They may invest in fertilizer
companies or pesticide companies in the primary sector. In
the secondary sector, they may invest in power, iron &
steel and cement industries by which infrastructure
companies are promoted. In the services sector, hotel
industry and hospital along with banking and insurance
companies ‘shares are preferred.

Equity based:- Investment are made by mutual funds in

equity based companies, wherein the fundamentals of the
company are good. If the company has good resources
with a high earning per share, naturally such companies
will be regarded more attractive for investment. There are
fast moving consumer goods companies (FMCG) which
have found more favour for investment.

Index bond:- Index based investments are those which are

called heavy weight age based companies. These
companies have more volume and have higher value in the
stock market. Such companies decide the Index of the
market. There are also Sensex companies (sensitivity
based) and Nifty companies. Thus, mutual funds will prefer
such companies whose Index is high and which will decide
the market conditions.
Government Securities:- Initially, stock markets were
dealing with both company securities and government
securities. But after the stock scam (Harshad Metha),the
Government has delinked the treasury securities from
stock market. We have now a separate market for
Government securities. This enables mutual funds to
invest there. There are also statutory obligations to invest
in Government securities.
Types of risks associated with Mutual Fund Investment
Risk is an inherent aspect of every form of investment. For
Mutual Fund investments, risks would include variability,
or period-by-period fluctuations in total return.
Market risk: At times the prices or yields of all the
securities in a particular market rise or fall due to broad
outside influences. This change in price is due to 'market
risk'.
Inflation risk: Sometimes referred to as 'loss of purchasing
power'. Whenever the rate of inflation exceeds the
earnings on your investment, you run the risk that you'll
actually be able to buy less, not more.
Credit risk: In short, how stable is the company or entity to
which you lend your money when you invest? How certain
are you that it will be able to pay the interest you are
promised, or repay your principal when the investment
matures?
Interest rate risk: Interest rate movements in the Indian
debt markets can be volatile leading to the possibility of
large price movements up or down in debt and money
market securities and thereby to possibly large movements
in the NAV.
Other risks associated are:
● Investment risks
● Liquidity risk
● Changes in the government policy

SEBI GUIDELINES ON MUTUAL FUNDS

Mutual funds in India are now governed under the
Securities and Exchange Board of India(Mutual Fund)
Regulations,1996. SEBI has provided a four tier system for
managing the affairs of mutual funds. The four
constituents in the organisation of a mutual funds are:
1. The sponsoring company, called Sponsor: SEBI(mutual
funds) Regulations define Sponsor as any person who
acting alone or in combination with another body
corporate, establishes a mutual fund. SBI Mutual fund is
sponsored by State Bank of India, LICMF is sponsored by
Life Insurance Corporation (LIC) of India. Sponsors have to
comply with the following regulations laid down by SEBI.
a. Application and fee: a sponsor has to file an application
for registration of a mutual fund in the prescribed form
along with an application with a fee of Rs.1,00,000. the
sponsors must furnish all information and give
clarifications as may be required by the board.

b. Eligibility criteria: the sponsor may be granted a

certificate of registration provided following conditions are
satisfied.
i. The sponsor has a sound track record and general
reputation of fairness and integrity in all his business
transactions for not less than 5 years.
ii. The sponsor has contributed at least 40% of the worth
of AMC.
iii. A trustee has been appointed by the sponsors who will
act as trustee for the mutual fund.
iv. An AMC is appointed to manage and operate the
scheme of such funds.
v. A custodian is appointed to keep custody of the
securities and carry out the custodian activities.

c. Grant of certificate of registration.

d. Annual fee.

2.The trustees: SEBI(mutual fund) Amendment

regulations. 1999 defines a trustee as “a person who holds
the property of the mutual fund in trust for the benefit of
the unit-holders and includes a trustee company and the
directors of the trustee company.” SEBI (mutual fund)
regulations, 1996 from 16 to 18 contain guidelines with
regard to operation of trustees.

3. Asset management company (AMC):

SEBI regulations require that mutual funds be managed by
a separate body corporate. The sponsor or the trustee
shall appoint an AMC. The application for the approval of
AMC has to be made in Form D. The appointment of AMC
can be terminated by majority of the trustees or by 75% of
the unit-holders of the scheme. Any change in the
appointment of AMC requires the prior approval of the
Board and the unit-holders.

4. Custodian: custodian is defined under SEBI (mutual

funds) Regulations 1996 as “a person who has been
granted a certificate of registration to carry on the
business of custodian of securities under the securities and
Exchange Board of India ( custodian of securities)
Regulations, 1996. Custodian provides custodial services
and ensures safe-keeping of securities. He performs the
following functions.
i. Maintains accounts of securities of a client.
ii. Collects the benefits or rights accruing to the client in
respect of securities.
iii. Maintains and reconciles the records of securities.
iv. Helps in transfer of the securities in the name of trust.
v. Prevents any manipulation of records and documents.
The following are the SEBI regulations with regard to
custodian.

Appointment of custodian (SEBI Regulation 26)

i. The mutual fund shall appoint a custodian to carry out
the custodian services for the schemes of the fund and
sent intimation of the same to the board within fifteen
days of the appointment of the custodian.
ii. No custodian in which the sponsor or its associates holds
50% or more of the voting rights of the share capital of the
custodian or where 50 % or more of the directors of the
custodian represent the interest of the sponsor or its
associates, shall act as custodian for a mutual fund
constitutes by the same sponsor or any of its associate
or subsidiary company.