Section 1

Nuts and Bolts

1.

Concept & Role of Mutual Funds

2.

Fund Structure and Constituents

3.

Legal & Regulatory Framework

Concept of Mutual Fund

A pool of money contributed by many investors

and collectively managed by an asset

management company
Investments made in accordance with stated
objectives
A financial intermediary that allows small investors
to participate in the securities market
Ownership of the fund is mutual and beneficial
An investor becomes part owner of the funds
assets when he buys into the fund
The investor is allotted units for the amount
subscribed.
2

What it means
Investors
Receive
dividend/capital
appreciation

Contribute
money

Trust
(pool of money)
Invest in
markets

Markets
(volatile, has fluctuation)
3

Receive
interest,
dividend or
capital growth

The MF Cycle

Characteristics
Investors own the mutual fund
Everyone else associated with the

fund earns a fee

Things which are mutual
Pool of money
Investment objective
Risk and return

Funds are invested in a portfolio of

marketable securities reflecting the

investment objective
Value of the portfolio and investors

holdings change with change in the

market value of investments.

Advantages

Disadvantages

No Control Over Costs

No Tailor Made

Portfolios
Managing a large
number of
funds/types.

History of Mutual Funds

Birthplace of Mutual Funds USA
History in India:
1964-1987 (Phase I) Growth of Unit Trust of India
1987-1993 (Phase II) Entry of Public Sector Funds
1993-1996 (Phase III) Emergence of Private Funds
1996-1999 (Phase IV) Growth and SEBI Regulation
1999-2004 (Phase V) Emergence of large & uniform

Industry
2004 onwards (Phase VI) Consolidation and Growth.

Types of Funds
Existing funds
Open-ended (OEF) &
Close-ended (CEF)
Growth, Income and
Hybrid
Equity, Debt and Balance
Load & No-Load
Guaranteed & NonGuaranteed
Tax-exempt & Non taxexempt

New Gen Mutual Funds

Fund of Fund
Commodity fund
Real Estate fund
Asset Allocation fund
Exchange-traded fund
Derivative fund
Capital Protection
Oriented Fund.

OEF & CEF

OEF
No fixed tenor
Continuous sale & purchase
by the fund
Subscription is not
mandatory
Redemption mandatory, with
certain obvious conditions
Fund size changes everyday
No secondary market trading
Redemption pressure on
fund managers is higher
Daily NAV (calc & disclosure)

10

CEF
Fixed tenor 1/3/5/7 years
Sale of units only during NFO
No subscription after closure of
NFO
Redemption in 2 ways
Exit window periodically

repurchase of units by the fund

Listing secondary market
trading of units, like stocks
Fund size either constant or

decreases
Lower redemption pressure on
fund managers
Weekly NAV (calc weekly but
disclosure daily).

Equity-oriented
Diversified
Sectoral
Thematic or Specialty
ASEAN fund, Infrastructure Fund

Growth & Value

Large, Mid & Small Cap
Dividend Yield or Equity Income
Index
ELSS

Primary objective: growth or capital appreciation.

11

Equity Funds: A fund that invests primarily in equity (ownership) instruments.

Equity Funds can be further classified as:

Diversified Equity Fund: investing in a mix of equity from different sectors
Index Funds: Portfolio replicates a selected Index
Sectoral Fund: invests in equity instruments of one sector for eg. Technology
Fund, Pharma Fund, Banking Fund etc.
Aggressive Growth Fund: target maximum capital appreciation, invest in less
researched or speculative shares
Growth Fund: This fund invests in equities of Growth companies only i.e. the
companies which have the potential to grow at higher rate in future
Large Cap/Mid Cap/Small Cap Fund: These Funds invests in equities of Large/Mid/
Small Cap companies respectively.
Specialty (or Thematic) Funds: have a narrow portfolio orientation and invest in
companies that meet pre-defined criteria. Eg. Infrastructure Fund or ASEAN Fund
Equity Linked Saving Scheme (ELSS) an Indian Variant: Investment in these
schemes entitle the investor an income tax deduction u/s 80C (max Rs. 1 lakh in
year 2007-08). These are open-ended funds but investment in these schemes
(including the reinvested dividends) gets locked-in for a period of 3 years.
Value Funds: try to seek out fundamentally sound companies whose shares are
currently under-priced in the market. These fund add those shares to their
portfolio that are selling at low price-earnings ratios, low market to book value
ratios and are believed to be undervalued compared to their true potential.
Equity Income or Dividend Yield Funds: invest in stocks which have a high Div
Yield
i.e., Div to Market Price ratio
12

Debt Oriented
Diversified Debt
Focussed/Sectoral Debt
Gilt Fund
Bond Fund
Fixed Maturity/Term Plan (FMP/FTP)
Liquid or Money Market MF

Primary objective: regular income.

13

Balance
Investment in more than one asset class
Debt and equity in various proportions

Primary objective: hybrid (regular income as

well as capital appreciation).

14

Fund of Funds
Invest in other schemes of same or other

mutual fund
Is considered like a Debt scheme for tax
purposes
2 advantages:
Since FOF is a mutual fund scheme, no tax on

income generated from buying and selling

securities
Allows fund managers to rebalance portfolio freely

Investor need not to decide when to sell units

and execute transactions

Convenience to the investor.
15

Commodity Fund
specialize in investing in different

commodities directly or through shares of

commodity companies or through
commodity futures contracts.
Example - Precious Metals Funds

As of date, Indian MF industry does not

have commodity funds except the ones

that invest in Gold.

16

Real Estate Fund

Invest in real estate directly, or fund real estate

developers, or buy shares of housing finance

companies
Fund to invest min 30 % corpus in real estate projects
Balance in equity, bonds/debentures of real estate cos.
Close-ended schemes with secondary market trading
Move to bring transparency, documentation and fair
valuation of property
Allow small investors with small investments to enjoy
upswing of property without downside of high stamp
duty, legal expenses, high initial investment, element
of black money and disposal at the right prices.

17

Asset Allocation Fund

Fund manager has the flexibility to change

the allocation of funds between equity and

debt based on perception about direction of
the market.

18

Exchange-traded fund
Passively managed fund that tracks a

benchmark index
An ETF is like a hybrid financial instrument,
a cross between an index fund and a stock
An equity-based ETF would invest in a basket

of stocks that reflects the composition of an

index, say Nifty or Sensex
These funds are freely traded on the stock
exchange and derive value from the
underlying asset, i.e., stocks.

19

Exchange Traded Funds (ETFs) were first launched in India in December 2001 by Benchmark AMC. Now, a total of

five ETFs are available to investors. ETFs are fundamentally different from normal funds and have thus developed
something of a reputation for complexity. While some of the details of how AMCs run ETFs are genuinely more
complex, that has nothing to do with investors. For the investors, ETFs are a straightforward instrument that offers
some interesting features. Let's see what makes ETFs different.
ETF are index funds. An index fund is an equity fund, which tracks a particular market index like the BSE Sensex or
the Nifty. The index fund holds the same stocks as the underlying index and in the same proportion as the index.
From an investment point of view, ETFs are simply index funds thatunlike normal index fundscan be bought
and sold at intra-day prices throughout a trading day. In this respect they are more like shares rather than like
mutual funds. Normal index funds are, of course, available only at end-of-day NAVs from fund distributors like any
other fund. ETFs, since they need to be transacted upon throughout the day, are bought and sold through
stockbrokers (using a demat account) just like shares.
However, behind the scenes, ETFs are very different from any other kind of fund. Where an ETF really differs from
an index fund is the manner in which it is created, bought and sold. In the case of normal mutual funds investors
pays cash to the fund, which in turn buys the stocks and bonds which constitute the fund. When ETFs are first set
up the initial participants will give the fund the basket of stocks, which constitute the underlying index and take
units of the fund in exchange. These market makers will in turn sell these units to investors just like a distributor
does. The market maker is usually a broker. Since ETFs are sold through brokers, you will pay brokerage in place of
loads. ETFs tend to have lower brokerage than normal funds have loads.
The NAV of an ETF is a fraction of the value of the index. Thus the NAV of an exchange-traded fund based on the
Nifty can be one-tenth of the value of the Nifty. If the Nifty is at 1500 points the NAV will be Rs 150. Effectively, this
fractional pricing means that a basket of stocks like the Nifty can be purchased by an investor with a much lower
outlay than it would otherwise be possible. Compare this with trying to replicate the index by purchasing individual
shares, where just one share of Infosys costs around Rs 4500. This also enables smaller initial investments than
what most index funds offer, which is specially useful if you are just trying out index investing. By comparison,
most nifty index funds require a minimum investment of Rs 5000.
In the case of other mutual fund schemes the fund buys back and sells units. In a way, an ETF resembles a closeend scheme, where the units are not sold back to the fund and investors buy and sell the fund units on the market.
However, there is obviously no discount to NAV like closed end funds. Also, unlike a close-end fund supply can be
altered by creating additional units or extinguished by withdrawing existing ones. Trading of the units ensures that
underlying stocks do not have to brought or sold. Investors entering and exiting do not also affect existing
investors. As a result an ETF has a much lower tracking error than an index fund. Currently the equity ETFs
available track the BSE Sensex, the S&P CNX Nifty and the S&P CNX Nifty Junior. The ETF on the Nifty Junior is in
20 the only option for passive investing in mid-cap shares. On the debt side a liquid ETF is available.
fact

Gold ETF
Gold ETFs invest in physical gold and derive

their value from the underlying asset

The price of gold ETFs will be directly linked

to the price of gold itself and hence the

returns from a gold ETF will more or less
equal to returns from gold bars or coins
Investors can buy or sell units of these

schemes, like any other stock listed on the

exchange, through brokers.

21

Derivative fund
Hedging
Futures
Options

Arbitraging
Stock Arbitrage
Index Arbitrage.

22

Capital Protection Oriented fund

Close-ended with no exit option
Debt scheme from a tax standpoint
No guarantee by the AMC or sponsor
Capital protection on account of the structure
Eg. Debt component of 80 in zero coupon bonds

which give 100 on maturity and investment of

the balance 20 in equity
With tools such as dynamic portfolio insurance,
increase equity component by a multiplier
Rating of the scheme mandatory.

23

Classification of funds
Risk
Sectoral funds have higher risk
Liquid or Money Market funds have least risk

Tenor
Equity funds require a long investment horizon
Liquid funds are for the short term liquidity needs

Investment objective
Equity funds suit growth objective
Debt funds suit income objective.

24

Risk-Return Hierarchy
Sectoral
funds
Equity
funds

Retur
n

Index
funds
Debt
Funds

Liquid
funds

25

ST debt
funds

Balanced
funds

Gilt
funds

Ris
k

Mutual Fund
Structure &
Constituents

26

MF Structure in India

A mutual fund has a 3-tier structure

Sponsor
Trustee

Trust
AMC

28

MF Structure in other countries

Structure in USA
Management Company Similar to AMC
Underwriter for Sales
Management Group Similar to Sponsor
Custodian
Structure in UK
Open Ended - Unit Trusts regulated by Securities
and Investment Board + by relevant SRO
Closed Ended - Investment Trusts like a
Company.
29

MF Constituents in India
SEBI

Sponsor
Trustee

Trust
AMC

Custodian &
Depository

Banker

R&T Agent

Securities
Dealer /
Broker
30

Distributor

Investor

Securities
Markets

Trust
Mutual funds in India constituted as a Public Trust

under Indian Trust Act, 1882

The trust is registered with the Office of Public
Trustee
OPT reports to the Charity Commissioner
The trust or the fund has no independent legal
capacity itself
Acts in relation to the trusts are taken on its behalf
by the trustees
Treated as a separate entity and a pass through
vehicle
Has its own auditors, separate from the AMC.
31

Sponsor
Promoter of the mutual fund
Creates a Trust under Indian Trusts Act, 1882

and registers it with Office of Public Trustee

Appoints Board of trustees/trustee company
Creates AMC under Indian Companies Act, 1956
Fulfills necessary formalities and applies to SEBI

for registration of the Trust as a Mutual Fund.

32

Sponsor Criteria
Min 5 years track record in financial

services
Bank, corporate or an FI
Profit making in at least 3 out of past 5
years, including the previous year
Positive Net Worth in last 5 years
At least 40% of the capital of the AMC
Net worth in the immediately preceding
year more than the capital contribution to
the AMC.
33

Trustee
Appointed by sponsor with SEBI approval
Have Registered ownership of investments
Formed either as Board of Trustees or

Trustee Company
Power to appoints all other constituents
Appoint AMC through the Investment

Management Agreement and delegate

powers.
34

Trustee Criteria
Minimum number of trustees is 4

2/3rd should be independent trustees i.e. no

connection of profit (what so ever) with the

sponsor
Meet at least 4 times in a year to review functioning of

AMC
Trustees hold the unit-holders money in fiduciary

capacity
All major decisions need trustee approval
Right to seek regular information and take remedial

action.
35

AMC
Required to be registered with SEBI
Appointed as Investment Manager of the mutual fund
Appointed by the trustees via an Investment

Management Agreement
Responsible for operational aspects of the mutual fund
Net Worth of at least Rs.10 crore at all times
At least 1/2 of the board members must be independent
Mostly, structured as a private limited company where

Sponsor and associates hold capital

Quarterly reporting to Trustees.
36

MF Constituents
SEBI

Sponsor
Trustee

Trust
AMC

Custodian &
Depository

Banker

R&T Agent

Securities
Dealer /
Broker
37

Distributor

Investor

Securities
Markets

Other Constituents
Custodian &
Depository
Banker

38

Investment back-office
Providing bank accounts & remittance services

Securities
Dealer /
Broker

Purchase and sale of securities

Not more than 5% through a related
broker
Research report to AMC

R&T Agent

Investor records and transactions

Distributor

Selling & Distributing schemes

Role Restrictions
Sponsor of a fund cannot be its custodian
Sponsor of a fund can be a distributor
Trustee of one mutual fund cannot be trustee of another

mutual fund
Exception is Independent trustees provided they obtain

approval of both the board of trustees

Trustee of one fund cannot be AMC of another
AMC of one fund cannot be Trustee of another
AMC cannot have any business interest other than fund

advisory.

39

Mergers & Takeovers

Scheme Merger
Scheme merged with another scheme of the same

AMC

AMC Takeover
AMC is taken over by another set of sponsors

AMC Merger
One AMC may merge with another AMC

Change of AMC/Trust
Trustees decide to change the AMC and handover

the scheme to a new AMC

Scheme Takeover
Just the schemes taken over by another set of

trustees.

40

Mergers & Takeovers

Scheme takeover (HDFCZurich, Birla-Apple)
One AMC buys schemes of another AMC
Organic growth in assets
No change in AMC stakes
AMC merger (HB-Taurus)
Two AMCs merge
Similar to merger of companies
Sponsor stakes change
AMC take-over (Zurich-ITC Threadneedle, Birla-Alliance)
Stake of one sponsor in a AMC bought out by another
Change in AMC and sponsor.

41

Mergers & Takeovers

Investor rights
Right to be informed
No prior approval required
Option to exit at NAV without exit load.

42

Regulatory framework
MoF
SAT

Supervisor of both SEBI & RBI

Created in 2003
Provide apex appeal mechanism
for actions taken by SEBI

Companies
Act
43

Registration of AMC and

Trustee Company
RoC for Compliance
RoC is supervised by DCA
DCA is a part of CLB which is
under Ministry of Law and
Justice
CLB is the interface for
prosecution and penalties.

Regulatory framework
Office of Public
Trustee

SRO

Industry
Association
44

Registration of Trust
Board of Trustees is accountable to
the OPT
Complaints against individual
trustees
Derive powers from regulator
Ability to make bye-laws
Regulate own members in a limited
way
Example : Stock exchanges NSE,
BSE etc.
Collective industry opinion
Guidelines &
recommendations
Example: Association of
Mutual Funds in India (AMFI).

Stop Check!

Mutual Funds in India are set up as

Company
Trust
Partnership
Association of persons
Issuing additional fresh units and redeeming the existing units

of a mutual fund scheme is the role of:

The
The
The
The

custodian
transfer agent
trustees
bankers

Minimum no of independent directors on the board of the AMC

50%
25%
75%
None of the above.

45

Session 2
The Process of Investing
4. The Offer Document
5. Fund Distribution and Sales Practices
7. Investor Services

46

The process of investing

Offer Document
KIM
Application and form of holding
Distribution channels
Investors rights & obligations.

47

Offer Document
Most important document for a prospective

investor
Legal offer from AMC to investor
Contains vital information about fund and

schemes
SEBI approved format.

48

Offer Document
Contents
Constitution of fund
Details of Sponsor, Trustee & AMC & key personnel

financial history for 3 years

Description of Scheme & Investment Objective/Strategy
Terms of Issue/Offer
Historical Statistics
Investors Rights and Services
Mandatory Disclaimer clause
Standard and Scheme-specific Risk Factors.
49

Details of Scheme offered

Dates of NFO
details regarding sale and repurchase

Minimum Subscription and Face Value

Initial Issue Expenses
current and past schemes

Special facilities to investors

Eligibility for investing
documentation

Procedure for applying, and subsequent

operations relating to transfer, redemption,

nomination, pledge and mode of holding of
units.

50

Load, Fee and Expenses

Load and the annual recurring expenses
Proposed scheme and other schemes
Comparison with offer document numbers

Scheme expenses for past 3 years

Condensed

years.

51

financial

information

for

Unit holder rights

Rights of unit holders
Right of proportionate beneficial ownership of schemes assets
Right to timely service
Right to information
Right to approve changes in fundamental attributes
Right to wind up a scheme
Right to terminate AMC services
Protection of rights and problem resolution

Details of information disclosure and their

periodicity
Documents available for inspection
Details of pending litigation and penalties .
52

Unit holder rights

Cannot sue the mutual fund
Can complain against AMC, sponsor and Board of

Trustees
75% unit holders can

wind up a scheme
seek AMC termination
Prospective investor has no rights
Right to redeem without load in case of change in

fundamental changes.

53

Due Diligence
SEBI approved format and content
Trustee Approval
Compliance Officer certifies that
Information contained therein is true and fair
Is in accordance with SEBI regulations
Fund constituents are all SEBI registered entities

The AMC is responsible for the contents and

the accuracy of information.

54

Offer Document
Validity of OD
For New Schemes - 6 months from the date of receipt by the

AMC of the letter containing observations from SEBI

Revised at least once every two years for OEFs
OD is printed only once for CEFs

Updated for every major change

Change in the AMC or Sponsor of the mutual fund
Change in the load structures
Changes in the fundamental attributes of the schemes
Changes in the investment options to investors; inclusion or

deletion of options

After completion of one year of an OEF,

condensed financial information mandatory

in the OD & KIM.

55

Fundamental Attributes
Scheme type
Investment objective
Investment pattern
Terms of the scheme with regard to liquidity
Fees and expenses
Valuation norms and accounting policies
Investment restrictions.

56

Changes in fundamental attributes

Approval from Trustees & SEBI
Public announcement by AMC
In case of OEF - Investors have to be

informed and option given to exit at NAV

without any exit load
In case of CEF investor approval is

required
New OD.

57

KIM
Abridged OD
KIM is mandatory with every application

form.

58

OD & KIM
Principle of BUYER BEWARE applies
An investor who invests without studying the

Offer Document cannot subsequently hold

the fund responsible
Investor has no recourse for not having

read the OD/KIM.

59

Investor Rights & Obligations

Investors Rights
Investors Obligations
Study the OD
Provide PAN
Monitor investment

Complaints Redressal Bodies

SEBI
RoC/DCA/CLB.

60

Sales Practices
No mandatory guidelines for distributor role & service to

investor
AMFI recommends certain practices for effective selling

To be fully aware of the important characteristics of the schemes

Know their clients
Identify clients
Understand each clients needs
Help a client chose his investments
Encourage regular investments
Provide personalized after sales service

Distribution Commissions are paid by fund houses

There are no rules governing the min and max
SEBI (vide Circular dated June 26, 2002) has banned rebating

of commissions
AMFI has also prohibited rebating as specified in AGNI.

61

Investor Services
Applying for & Redeeming units
Cut-off timing of 3:00 pm for same day NAV
the next day NAV is applied in case of

application received after 3:00 pm

in case of liquid funds 11:00 am is cut-off for
applying previous day NAV
Dividend Reinvestment Plan (DRP)
Systematic Investment Plan (SIP)
Systematic Withdrawal Plan (SWP)
Systematic Transfer Plans (STP).
62

Investor Services
Telephone/Internet transactions
Cheque Writing
Periodic statement and tax information
Loan against units

63

Investment Options
Investors can achieve income and growth

objectives
Growth option
Dividend-payout option
Regular
Ad-hoc
Dividend Re-investment option

Most funds provide multiple options and

the facility to switch between options.

64

Stop Check!

The front page of on offer document contains:

Date of its publication
Name and type of fund
Major objectives of the fund
1 and 2 above

The abridged offer document contains the

address of the following:

The Trustees of the mutual fund
The Directors of the AMC
the Registrar & Transfer Agents
1 and 2 above
2 and 3 above

Offer document has to be updated within

One year from date of issue
Two years from date of issue
Six months from date of issue
None of these

65

Session 3
Accounting, Valuation &
Taxation
6. Accounting, Valuation and Taxation

66

Accounting Policies
Investments to be marked to market

according to SEBI Guidelines

Unrealised appreciation cannot be distributed
Profit or loss on average cost basis
Dividend on ex-dividend date
Sale and purchase accounted on trade date
Brokerage and stamp duties are capitalized

and added to cost of acquisition or sale

proceeds.
67

Reporting Requirements
Audited accounts within 6 months of closure

of accounts
Publish unaudited abridged accounts within
30 days of the closure of the half-year
Summary of the accounts to be mailed to all
unit holders
File with SEBI

68

Copy of the annual report

Six monthly unaudited reports
Quarterly movement in net assets of the fund
Quarterly portfolio statements.

Specific Disclosures
Complete portfolio to be disclosed every six

months
Industry practice is monthly disclosure

Any item of expenditure which is more than

10% of total expenses

NPAs, provisioning and NPAs as percent of

total assets
Number of unit holders holding more than

25% of unit capital.

69

Net Asset Value

Frequency of NAV
Calculated and published at least every Wed

for CEFs
Calculated and published daily for OEFs
Updated on AMFI website by 8:00 pm (as

per text book) every business day

NAVs are rounded off up to four decimal
places for liquid/money market schemes
and upto two decimal places for all other
schemes.
70

Net Asset Value

NAV = Net Assets of the Scheme/No. of

Units Outstanding
Net Assets of the Scheme
+ Market Value of investments
+ Receivables
+ Other accrued income
+ Other assets
- Accrued Expenses
- Other payables
- Other liabilities.
71

Fees & Expenses

Initial Issues Expenses
Recurring Expenses
Investment Management Fee
Entry & Exit Load.

72

Initial Issue expenses

Expenses incurred in floating a new scheme
Max 6% of funds mobilized charged to scheme; excess borne

by AMC/sponsor
Only CEFs are permitted to charge IIE to the fund
Amortize on weekly basis until maturity

E.g. 6 crores amortized over a 5-year (260 weeks) tenor would

mean Rs. 230,769 charged every week as expense

No-load fund i.e. funds which do not charge initial issue

expenses can charge additional investment management fees

of 1%
w.e.f. Apr 2006 OEFs cannot charge initial issue expenses to the
scheme.

73

Recurring Expenses
Investment

management fees

Custodians

fees

Trustee

Fees

Registrar

and transfer agent fees

Marketing

and distribution expenses

Audit

fees

Legal

expenses

Costs

of mandatory advertisements and

communications to investors.

74

Expenses that cannot be charged

Penalties and fines for infraction of laws
Interest on delayed payments to unit holders
Legal, marketing and publication expenses not

attributable to any scheme

Expenses on investment and general management
Expenses on general administration, corporate

advertising and infrastructure costs

Expenses on fixed assets and software development

expenses
Such other costs as may be prohibited by SEBI.

75

Recurring Expenses
Overall ceiling on expenses, including

Investment management and advisory fees

Based on Weekly Average Net Assets (WANA)
Equity Funds
First 100 Crores 2.50%
100 - 400 Crores 2.25%
400 700 Crores 2.00%
Above 700 Crores 1.75%
For Bond funds, above figures are lower by

0.25%
Limit for FOFs is 0.75% of the Weekly Average
Net Assets.
76

Numerical
Q. An open-ended equity fund has Net Assets
of Rs. 3500 crores. What is the limit on
recurring expenses?
Q. A Bond fund has WANA of Rs. 850 crore.
What is the maximum recurring expenses it
can charge to the scheme?

77

Investment Management Fee

SEBI Limits Investment Management Fee
For the first Rs. 100 crore of net assets:

1.25%
For net assets exceeding Rs. 100 crore:
1.00%
IMA can be 1% more for no load funds

78

Numerical
Q. A load scheme has Net Assets of Rs. 400
crore. What is the ceiling on the Fund
Management Charges (FMC)?
Q. What is the ceiling on Investment
Management Fee in case of a no-load
scheme with Net Assets of Rs. 1500 crore?

79

Loads
Charged to recover sales and distribution expenses
Entry Load
At the time of sale of units i.e. subscription by investor
Charged on NAV and increases the sale price

Exit Load
At the time of repurchase of units i.e. redemption by investor
Charged on NAV and reduces the repurchase price

Load is a charge on the NAV

Load is defined as a percentage

CDSC is variable exit load, lower for longer duration of

holding
Loads are subject to SEBI Regulations*

* Change expected in Jan 2008 - In case of Direct

investment, no entry load to be charged to investor.
80

SEBI Regulations - Loads

OEFs
Maximum Exit load or Entry load : 7% of NAV
Repurchase price more than or equal to 93%
of the Sale price
CEFs
Max Entry or Exit Load: 5% of NAV
Repurchase price more than or equal to 95%
of the Sale Price (NAV in this case)
w.e.f. Apr 2006, CEFs cannot charge entry load.
81

Pricing of Units
Sale and repurchase price are NAV-based

SALE PRICE = NAV + Entry Load

REPURCHASE PRICE = NAV Exit Load

82

Non Performing Asset

An asset classified as non-performing if

interest or principal amount not been

received or remained outstanding for one
quarter from the due date
Deep Discount Bonds (DDBs) are classified as

NPAs if,
the grade falls to BB or below, OR
it is defaulting on other commitments, OR
in case of full Net worth erosion of the borrower.

83

Treatment of NPAs
Accrual to be stopped
Income accrued until date of classification

to be provided for
Provisioning for principal due
In graded manner after 3 months of

classification.
Complete write off in 15 months from

classification.

84

Non Performing Asset

Provision for NPAs
10% of BV - after 6 months past due date of

interest
20% of BV after 9 months past due date of

interest
20% of BV after 12 months past due date of

interest
25% of BV after 15 months past due date of

interest
25% of BV after 18 months past due date of
85

interest.

Valuation of Securities
Equity
Traded Securities Mark to Market i.e., last

quoted closing price on the stock exchange

where it is principally traded
Thinly Traded Securities Those securities
which are traded for less than 5 lacs AND less
than 50,000 shares Complex valuation
method is used if the security is not traded
for more than 30 days otherwise last traded
price.

86

Valuation of Securities
Debt
Traded Securities as quoted in market upto

last 15 days
Thinly Traded Securities those securities
(except GoI securities) where there is no
trade in marketable lot of Rs 5 Cr on
valuation date
Securities with maturity upto 182 days are
valued on the basis of amortization cost +
accrued interest.

87

Taxation
Mutual Fund is a pass through vehicle

hence not taxed

Mutual funds are exempt from tax under
section 10(23D) of Income Tax Act, 1961
Taxation for investor
Dividend
Capital Gain

Taxation as per Equity fund (at least 65%

of assets in domestic equity) or Other than

Equity fund.
88

Equity Funds (Min 65% domestic equity)

Dividend
Investor
NIL

DDT
NIL

89

Capital Gain
Short-Term
(not exceeding 12 months)
10% + SC +EC

Long-Term
(exceeding 12 months)
NIL

Other than Equity Funds

Capital Gain

Dividend
Investor

Short-Term
(not exceeding 12
months)
Marginal Tax Rate

NIL
DDT
As per grid
below
Liquid
Individua
l/HUF
Others
90

25% +
SC +
EC

Other than
Liquid
12.5% +
SC + EC
20.0% +
SC + EC

Long-Term
(exceeding 12 months)
Indexed Tax Rate

MF Taxation Summary

Equity

Debt

Short Term
Capital Gains

10%

As per Income Tax Slab

Long Term
Capital Gains

No capital gains tax payable.

However, securities transaction
tax payable at 0.25 percent of
the redemption price.

20% with Cost Inflation

Index benefit or 10%
without Cost Inflation
Index benefit, whichever
is lower

Dividend Income
in the hands of
investor

Nil

Nil

Nil

Individuals & HUFs

14.16%
Others - 22.66%

Tax Deducted at
Source

Nil

Nil

Securities
Transaction Tax

Payable at the time of

redemption @ 0.25%
irrespective of whether a gain
has been made or not

Not Applicable

Dividend
Distribution Tax

91

Other tax aspects

Securities Transaction Tax (STT)
54EC
Section 80C
Section 111A
Dividend Stripping

Section 94(7) of the IT act reads If a person buys or

acquires securities or units within a period of three
months prior to the record date fixed for declaration of
dividend and sells or transfers the same within a period
of nine months after such record date and the dividend
recd is exempt, then the loss if any, arising from such
purchase or sale shall be ignored to the extent such loss
does not exceed the amount of such dividend income.

92

Numerical
Q. Investor buys on March 31, 2005 and sells
on April 1, 2007. What is the indexation
adjustment factor?
2004-05
2005-06
2006-07
2007-08

520
548
582
624

Investor buys on April 1, 2005 and sells on

March 31, 2008. What is the indexation
adjustment factor?
93

Stop Check!
An open-ended fund with 10,000 units outstanding has the

following items on the balance sheet:

Investment at market value Rs, 1,00,000
Other assets
Rs. 20,000
Other LiabilitiesRs. 25,000

Calculate the NAV per unit:

Rs. 9.50
Rs. 12
Rs. 10
Rs. 14.5

Unit capital of a scheme is Rs. 20 million. The market value of

its investments is Rs. 55 million. The number of units is 1

million. The NAV is
Rs. 20
Rs. 75
Rs. 55
Not possible to say.

94

Stop Check!

An investor bought a unit in 1995 for Rs. 75,000. he sold

the units in 1998 for Rs. 125000. the cost inflation index
for 1995 and 1998 are 281 and 351. the capital gains
chargeable to tax are:
64,957
31,317
50,000
75,000

Income earned by a mutual fund registered with SEBI is

exempt from income tax as per section:

10(23D)
10(33)
Total income is taxable @ 33.2%
80C.

95

Session 4
Mutual Funds & Securities Markets
8. Investment Management

96

Mutual Funds & Securities Markets

Equity

Market and products

Asset classes
Investment styles
Value indicators
Debt

Market and products

Terminology
Investment styles
Investment restrictions.

97

Equity investing
Equity implies ownership
Equity instruments
Ordinary shares
Preference shares
Convertible debentures
Equity Warrants.

98

Equity investing
Classification of Equity
Large Cap/ Mid Cap/ Small Cap
Growth/ Value/ Cyclical
Equity terminology
Earnings per Share
Market Capitalization

Ratios
P/E Ratio
Dividend Yield.

99

Equity portfolio management

Approaches to Portfolio Management
Passive
Active

Investment Styles
Growth
Value

Securities Research
Fundamental Analysis
Quantitative Analysis
Technical Analysis

Portfolio Management Organization Structure

Fund Managers
Security Analysts & Researchers
Dealers.

100

Approaches to portfolio management

Active management
Aim for Out-performance
Higher fees
Selection and timing

Passive Management
Replicate a chosen Index
Low fees.

101

Growth vs. Value

a. MPS?
b. P/E?
c. DY?

102

Debt Investing
Debt implies lending/loan
Types of debt instruments
Govt. Securities
PSU Bonds
FI Bonds
Corporate Bonds
Debentures
Money Market Securities
Treasury Bills (T-Bills)
Commercial Paper (CP)
Certificate of Deposit (CD).
103

Debt Classification
Classification of Debt Securities
Tenor long or short
Credit quality
Government Securities/Corporate Securities/FI

Bonds

Secured/Unsecured
Market Traded/Non-traded
Interest
Periodic or Discounted
Fixed or Floating (Floater)

Call or Put option.

104

Debt Terminology
Par or Principal or Face Value
Coupon or Interest
Maturity or tenor
Callable
Puttable
Yield.

105

Measures of Bond Yield

Current Yield
Yield to Maturity
Yield Curve (TSIR).

106

Price & Yield

Increase in rates reduces

value of existing bonds

Decrease

in
rates
increases
value
of
existing bonds

Price

and
yield
inversely related

are

The relationship between

yield and tenor can be

plotted as the yield curve.

107

Current Yield and YTM

Coupon amount as a percentage of current

market price
If you bought an 8% bond at Rs. 110, the
current yield is,
= (8/110)*100
= 7.27%.

108

Interest Rate Sensitivity

Measured by a number called duration
If duration is 5 years, and interest changes by

1%, price of the bond will change in the

opposite direction, by 5%
Example: Duration of a bond is 3 years. Yield
spreads increases by 1.5%. What
is the
change in price?
= 1.5 *3
= -4.5%.
109

Risk in Bond Investing

Types of Risk

Interest Rate Risk

Reinvestment Risk
Default/Credit Risk
Inflation Risk
Liquidity Risk
Call Risk

Risk Measures
Yield Spreads & Credit Ratings
Duration.

110

Credit Risk
Probability of default by the borrower
Change in credit rating,
downgrade increases the yield & decreases

the price
upgrade decreases the yield & increases the
price.

111

Debt Portfolio Management

Buy & Hold
Portfolio exposed to interest rate risk

Duration Management
increase duration if rates are expected to fall
decrease duration if rates are expected to

rise
Credit Selection
Invest in low grade bonds that are likely to

be upgraded
Prepayment Prediction.
112

Investment Policy
Investment policy of each scheme dictated by

the schemes objective

SEBI imposes certain restrictions on mutual
funds to ensure investor protection
Minimum 20 investors per scheme
No one to hold more than 25% of the corpus

Record of Investment decisions to ensure

transparency.

113

Minimum Portfolio Diversification

Not more than 10% of NAV in a single company
Exceptions: Index & Sectoral funds

Rated Investment grade debt of a single issuer

cannot be more than 15% of NAV (extendable to

20% with AMC Board and Trustees approval)
Un-rated instruments
10% of Net Assets for single issuer
Overall 25% cap for investment in such securities

Unlisted shares
Max 10% of Net Assets for CEFs
Max 5% of Net Assets for OEFs.

114

Investment Restrictions
Invest only in marketable securities
Investment transactions only on delivery basis
Securities have to be bought in the name of

the scheme
A mutual fund under all its schemes, cannot

hold more than 10% of the paid-up capital of a

company
Equity with voting rights representing 10% of

paid-up capital of one stock.

115

Approved & Unapproved Investments

Temporary Investment in Bank FDs Max

15% of NAV
ADR/GDR investment permitted
lower of, 10% of net assets or $200 million
cap for mutual fund industry as a whole $4

billion
Limited investment in Treasury Bonds and

AAA rated corporate debt issued outside

India
No Lending.
116

Investment in Sponsor
No investment in unlisted securities of

sponsor or an associate or group company

of the sponsor
No investment in privately placed securities

of the sponsor or an associate

Investment

in listed securities of the

sponsor or associate company permitted
Max 25% of the net assets of the scheme.

117

Inter-scheme transfer
Transfers only on a delivery basis, at market

prices
Such transfers should not result in

significantly altering the investment

objectives of the schemes involved
Such transfer should not be of illiquid

securities, as defined in the valuation norms

One scheme can invest in another scheme,

up to 5% of net assets.
No fee is payable on these investments.
118

Other Restrictions
Mutual funds can borrow up to 20% of net

assets for a period not exceeding 6 months

Any

change in investment objectives

requires information to investor, and
provision of option to exit at NAV, without
exit load.

119

Stop Check!

Current market price of a 9% coupon bond,

when other bonds of similar maturities pay 11%

will be:
Above par
Below par
At par
Will be unrelated to other bonds

Technical analysis tries to predict future

movement of stock price by analyzing:

The financial working of a company
Stock price movement of a company
Both the above
None of the above.

120

Stop Check!

Mutual Fund scheme can borrow within certain

limits,

Upto 20% of net assets

For max 6 months
Both are true
Neither is true

Unlisted shares in a schemes portfolio can be a

maximum

5% of net assets in a CEF

10% of net assets in an OEF
Both are true
Neither is true.

121

Session 5
Return Concepts

9. Measuring & Evaluating Mutual Fund Performance

122

Computing Return
Return

defined as Income earned for

amount invested over a given period of time
Standardize as % per annum

Sources of return
Dividend
Change in NAV

Return Methods
Change in NAV or Absolute Return Method
Simple Total Return Method
ROI or Return with Dividend Reinvestment Method
CAGR Method.

123

Method 1: Change in NAV Method

Suitable for computing returns between

two dates
Annualize using 12/n or 365/n

(NAV at the end of Period-NAV at the

beginning of Period)*100
NAV at the beginning of Period

124

Numerical
Q. NAV at start of period was Rs. 13.70. at the
end of 16 months the NAV was 18.50.
Calculate the change in NAV.
= (18.50 13.70) X 100
13.70
= 35.04%
Annualized return
= 35.04 X 12/16
= 26.28%.
125

Simple Total Return

In this method, dividends distributed are

added to change in NAV to compute total

return

(Change in NAV + Dividend)*100

NAV at the beginning of period

126

Numerical
Q. NAV at start of period was Rs. 15.65. At
the end of the year it stood at Rs. 21.05.
During the year, investor received 10%
dividend.
Calculate the return earned by the investor.
= ((21.05-15.65)+1.00) X 100
15.65
= 40.89%.

127

ROI Method
The method assumes that dividends are reinvested, at

Ex-Div NAV
Value at end of period Value at beginning of period X
100
Value at Beginning
Value of holdings at the beginning of the period =
number of units at the beginning x begin NAV
Value of holdings end of the period = (number of units
held at the beginning + number of units re-invested) x
end NAV
128

Number of units re-invested = dividends/ex dividend

NAV.

Numerical
Q. On Jan 01, 2007 an investor bought 1000 units at 12.25.
He redeemed the investment on 01st Jan 2008 when the
funds NAV stood at 19.50. During the year he received
dividend at the rate of 10%. The ex-Div NAV was Rs.
15.10.
Calculate his ROI.
= Value of holding at start 1000 X 12.25 = 12,250
= No of units reinvested 1000 / 15.10 = 66.2252
= Value of holding at end 1066.2252 X 19.50 =
20,791.39
= ROI (20,791.39 12,250) X 100
12,250
= 69.73%.
129

CAGR
Compound Annual Growth Rate

rate at which investment has grown from begin

point to the end point, on an annual compounding

basis

A = P(1+r)n
V1 = V0(1+r)n
r = ((V1 / V0)1/n) -1
V1 = Amount at the end of Period
V0 = Principal
r = Rate of return
n = Number of periods.
130

Numerical
Q. An investor buys 1000 units of a fund at
Rs. 24.15 on Jan 07, 2007. On June 30,
2007 he receives dividends at the rate of
20%. The ex-dividend NAV was Rs. 30.60.
On Jan 01, 2008 the funds NAV was Rs.
32.25.
Compute the CAGR.

131

Solution
The value of investment at beginning

= 24.15 x 1000 = Rs. 24,150

Number of units reinvested
= 2000/30.60 = 65.36 units
End period value of investment
= 1065.36 x 32.25 = Rs. 34,357.84
Holding period
= 01/01/08 - 07/01/07 = 359 days
The CAGR is
= (34,357.84/24,150)365/359 - 1 x 100
= 43.11%.
132

SEBI Regulation
Standard measurements and computation
CAGR for funds that are over 1 year old
Return for 1,3 and 5 years, or since

inception, which ever is later

No annualisation for periods less than a

year.

133

Industry Practice
Less then 1 year, simple return without

compounding or annualisation
Growth Option: CAGR implicit in the change

in holding period NAVs

Dividend Option: CAGR implicit in the

change in value over the holding period,

assuming re-investment of dividend at exdividend NAV
Some funds use simple annualised return,

without compounding.
134

Evaluating fund performance

Evaluation of a fund
relative to the market as a whole
relative to other mutual funds
relative to other comparable investment

options
Rankings by external agencies
Economic Times
Lipper
CRISIL CPRs, RRR, CQR
CRISIL Volatility Rating
CRISIL Fund Management Practice.
135

Benchmarks
Relative

returns are important

absolute returns for mutual funds

than

Comparable passive portfolio is used as

benchmark
Usually a market index is used
Compare both risk and return, over the

same period
benchmark.

136

for

the

fund

and

the

SEBI Guidelines
Benchmark should reflect the asset allocation
Same as stated in the offer document
Growth fund with more than 60% in equity to

use a broad based index

Bond fund with more than 60% in bonds to

use a bond market index

Balanced funds to use tailor-made index
Liquid funds to use money market

instruments.
137

Other Measures of Performance

Size and portfolio composition
Credit quality

Rating profile of portfolio

Expense ratio

Higher

expense

ratio

hurts

long

term

investors
Tracking error

For index funds this should be nil

Portfolio turnover

Higher for short term & lower for longer term

funds.
138

Stop Check!
An investor purchased an open-ended fund when NAV was 20. 16

months later, the NAV stood at 22. the percent change in NAV in the
fund was:
7%
8%
7.5%
8.5%

Returns can be annualized and compounded only if the scheme has

completed:

30 days
12 months
6 months
24 months

An equity scheme is 90 days old. To compute its yield, it can use

Absolute return
Simple annualized return
Compounded annualized return
Any of these

139

Session 6
Financial Planning & Mutual Funds

10.
11.
12.
13.
14.

140

Helping Investors with Financial Planning

Recommending Financial Planning Strategies to Investors
Selecting the right Investment Products for Investors
Helping Investors understand risks in Fund Investing
Recommending Model Portfolios and Selecting the right fund

Financial Planning & Mutual Funds

Concept of financial planning
Financial Planning Strategies
Mapping life cycles & wealth cycles
Alternate investment products
Understanding Risk
Asset allocation
Model portfolios
Fund selection.

141

Financial Planning
It is an exercise aimed at
identifying all the financial needs
of an individual, translating the
needs into monetarily measurable
goals at different times in the
future and planning the financial
investments that will allow the
individual to provide for and
satisfy his future financial need
and achieve his life goals.

142

Who is a financial planner?

Is a person who uses the financial planning

process to help another person determine

how to meet his or her life goals
Key functions of a FP is to help people

identify their financial planning needs,

priorities and the products that are most
suitable to meet their needs.

143

Benefits of Financial Planning

To client
Provides direction and meaning to financial

decisions
Helps understand how decision in one area

effects other areas

Helps evaluate short and long term effects of

decisions on ones life goals

To Planner
Ability to establish long term relationships
Ability to build a profitable business.
144

Financial Planning Process

Establish & Define the Client Planner Relationship
Define the Clients Goals
Gather and Analyze Data
Determine and Shape the Risk Tolerance level
Recommend the appropriate Asset Allocation
Ascertain the Clients Tax Situation
Execute the Plan
Review Progress
145

Role of participants
Client

Financial
Planner

Discussion
Of Goals
& Asset
Allocation

146

Fund
Manager

Choice of
Schemes
& Fund
Manager

Portfolio
Investments

Market Analysis
& Choice of
Securities

Important factors
Set
SetMeasurable
MeasurableFinancial
FinancialGoals
Goals
Understand
Understandthe
theEffect
Effectof
ofEach
EachDecision
Decision
Re-evaluate
Re-evaluateFinancial
FinancialSituation
SituationPeriodically
Periodically
Start
StartPlanning
PlanningASAP
ASAP
Set
Setrealistic
realisticexpectations
expectations
Client
Clientis
isin-Charge
in-Chargeof
ofthe
theprocess
process

147

Classification of Investors
Life Cycle Stages
Wealth Cycle Stages

148

Life Cycle Stages

Childhood Stage
Young Unmarried Stage
Young Married Stage
Young Married with Children Stage
Married with Older Children Stage
Post family/Pre-retirement Stage
Retirement Stage.

149

Wealth Cycle Stages

Sowing or Accumulation Stage
Transition Stage
Reaping or Distribution Stage
Intergenerational Wealth Transfer Change
Sudden Wealth Surge Stage
Affluent investors
Wealth preserving
Wealth creating.

150

Other areas
Constraints to Financial Planning
Goal-Oriented Investing
Planning for Affluent Investors
Wealth Creating Individuals: These are

aggressive and tend to invest more in equity,

maybe even 70% to 80%
Wealth Preserving Individuals: Conservative
and thus tend to invest majority into income,
gilt and liquid funds.

151

Strategies for Investors

Invest whenever there is money!
Start Planning & Investing Early
Have realistic Expectations
Invest Regularly
Buy and Hold
may not be good strategy with stocks but is good in case of a

mutual fund for the investor willing to wait out a full market cycle

When to cash out needs more thought and skill

in case of stock sell out as the price rises beyond reason or

when fundamentals start to deteriorate

in case of mutual funds redeem when the goals have arrived
and money is needed or if the market appears overvalued in
terms of fundamentals and historic valuations.

152

Useful Strategies
Power of Compounding
Rupee Cost Averaging (RCA)
Value Averaging
Jacobs combined approach.

153

Power of Compounding
Investing for the long term
Higher the frequency, greater the growth
six-monthly compounding of 100 rupees for

10 years would yield Rs. 321 instead of Rs.

311 with annual compounding

154

Power of Compounding

FV = PV (1 + r)

Save More
Earn More
Start Early
155

The legend of compounding

Amount Invested = Rs. 10,000
Year of investment = 1977
Growth rate = 49%
Value of holding at the end of 2007 = ???
Which company am I?

156

Rupee Cost Averaging

Invest a predetermined amount regularly
Purchase more units when the market is

low; less when the markets are high

Reduces the average cost of purchase

Implemented through SIP

Disadvantage it doesnt tell you when to

buy, sell or switch.

157

RCA An Example
Mont
h

5
158

Amount
NAV per
Inves
Unit
ted

5000

5000

5000

5000

5000

Units
bough
t

Cumulative
Number of
Units

Value of
holding

10

500.0
0

500.00

5,000

15

333.3
3

833.33

12,500

20

250.0
0

1,083.33

21,667

12

416.6
7

1,500.00

18,000

625.0
0

2,125.00

17,000

Value Averaging
Invest regularly to achieve a predetermined

value
Book profits at highs, and add units at the
lows
Implemented through SWP
Reduces the average cost of purchase
Superior to RCA allows you to redeem at
the right opportunity.

159

VA An Example

Month

160

Target
Value

NAV per
Unit

Units
bough
t

500.00

500.00

5,000

5,000

Cumulative
Units

Value of
holdin
g

Current
portfoli
o value

5,000

10.0
0

10,00
0

15.0
0

166.67

666.67

7,500

10,000

15,00
0

20.0
0

83.33

750.00

13,333

15,000

20,00
0

12.0
0

916.67

1,666.67

9,000

20,000

25,00
0

8.00

1,458.33

3,125.00

13,333

25,000

30,00

VA another example
Mont
h

Target
Value

1,000

10.00

100.00

100.00

100.00

2,000

12.50

1,250.00

60.00

160.00

3,000

14.25

2,280.00

50.53

210.53

4,000

11.75

2,473.68

129.90

340.43

5,000

10.50

3,574.47

135.76

476.19

6,000

9.00

4,285.71

190.48

666.67

7,000

8.50

5,666.67

156.86

823.53

8,000

7.65

6,300.00

222.22

1,045.75

9,000

8.80

9,202.61

(23.02)

1,022.73

10

10,000

9.25

9,460.23

58.35

1,081.08

11

11,000

12.00

12,972.97

(164.41)

916.67

12

12,000

15.00

13,750.00

(116.67)

800.00

161

NAV (Rs)

Value of
Holding

Units to
invest

Cum no of
units

Jacobs Approach
Combine RCA and VA
Use an aggressive growth fund and a money

market fund of the same family.

162

Asset Allocation
Besides how much and for how long to invest,

the important question is where to invest

Equity, debt and money market products are
called asset classes
Asset allocation means determining the
percentage of investments to be held in equities,
bonds and money market/cash instruments
Over 94% of returns on a managed portfolio
come from the right level of asset allocation
between stocks and bonds/cash
The approach must incorporate product, investor
profile and preferences in the portfolio.
163

Types of Asset Allocation

Fixed
FixedAsset
AssetAllocation
Allocation

Portfolio is periodically re-balanced

Disciplined approach
Profit booking in rising & more investment in a falling market
Better if stocks continue to return more than bonds
Flexible
FlexibleAsset
AssetAllocation
Allocation

No re-balancing - proportions can vary when prices change

If equity returns are higher than debt, equity allocation will go
up faster
Better if bond returns are close to equity
Tactical
TacticalAsset
AssetAllocation
Allocation

making changes in asset allocation within the overall

percentage holding for extra return.
164

Asset Allocation Approaches

Benjamin Grahams 50/50 balance
a 50/50 split between debt and equity

Grahams 50:50 is the basic asset

allocation.

165

Grahams Portfolios
Portfolio Type

Portfolio Mix

Basic managed Portfolio 50% diversified equity value fund

25% Govt Securities fund
25% High grade corporate bond
fund

166

Basic Indexed Portfolio

50% total stock market/index fund

50% total bond market portfolio

Simple Managed
Portfolio

85% Balanced 60/40 fund

15% Medium term bond fund

Complex Managed
Portfolio

20% diversified equity fund

20% aggressive growth fund
10% specialty fund

Readymade Portfolio

100% Single Index fund with

60/40 equity/bond holding

Jacobs Investment Strategies

5%
15-30%

Liquid Funds
Income and Gilt Funds

Diversified Equity

65-80%

Accumulation Phase
167

Jacobs Investment Strategies

5%

Liquid Funds

15-30%

Diversified Equity

65-80%

Income and Gilt Funds

Distribution Phase

168

Asset Allocation Approaches

Bogles Approach
Bogle suggested variation to percentages

based on age, financial circumstances and

objectives
Bogles thumb rule
debt portion of an investors portfolio equal

to investors age.

169

Bogles Asset Allocation Strategy

Accumulati Distributi
on Stage on Stage
Younge 80% Equity
60%
r
Equity
20% Debt
Investo
40% Debt
r
Older 70% Equity
50%
Investo 30% Debt
Equity
r
50% Debt

170

Stop Check!

The strategy to maximize investment return in

the long run is:

Buy and hold investments for a long time

Liquidate poor performers from time to time
Liquidate good performers from time to time
Switch from poor performers to good performers

SIP is best example of

Rupee Cost Averaging
Value Averaging
Buy & Hold
None of these.

171

Alternate Investment Products

172

Alternate Investment Products

Physical/Real Assets vs. Financial Assets
Physical Assets Gold & Real Estate
High initial investment, liquidity concerns

Financial Assets
By class: equity, debt, money market
By issuer: Govt, FIs, Corporate, Banks
Guaranteed vs. Non-guaranteed

Government - G-Secs, PPF, KVPs, NSCs, RBI Relief Bonds

PSUs/FIs Bonds
Banks - FDs
Corporate - Shares, Debentures, Bonds, FDs
Insurer - Policies (With Profit or without profit, ULIPs)
Mutual Fund a combination asset.

173

Investment Products

Issuer

Product

Available to

Bank

Fixed Deposits

Investor, MFs

Shares

Investor, MFs

Bonds, Debentures

Investor, MFs

Fixed Deposits

Investor, MFs

Govt. Securities

Investor, MFs

PPF

Investor

Other personal
investments

Investor

Bonds

Investor, MFs

Insurance policies

Investor

Corporate

Government

FIs
Insurers

174

Quick
Wit

Tenor of RBI Bonds?

Min/Max investment in PPF?
Who assigns credit rating to Corporate securities?
Borrowers with lower rating need to give
higher/lower interest?
Tax benefit in NSC?
Liquidity in Mutual Funds higher/lower than equity?
Tax aspects of life Insurance proceeds?

175

Comparison of financial products

Convenienc
e

Return

Volatility

Liquidity

Moderate

High

Low

High

High-Low

FI Bonds

High

Moderate

High

Moderate

Moderate

Corp Debentures

Low

Moderate

Moderate

Moderate

Low

Company FDs

Moderate

Moderate

Low

Low

Low

Bank Deposits

High

Low

High

Low

High

PPF

High

Moderate

High

Low

Low-Moderate

LI (Traditional)

High

Low

High

Low

Low

LI (ULIPs)

High

High

High

Moderate High

Low-Moderate

Gold

Low

Moderate

High

Moderate

Moderate

Real Estate

Low

High

Moderate

High

Low

Mutual Funds

High

High

High

Moderate-High

High

Equity

176

Safety

Mutual Fund vs. Direct Equity

Feature

Direct Equity

Mutual
Fund

Stock selection ability

Low

High

Focussed activity

Low

High

Diversification

Low

High

Professional management

Low

High

Liquidity

Low

High

Transaction cost

High

Low

Convenience

Low

High

High

Low

Switches
Cheque writing facilities

Investing time, knowledge &

resources

177

Mutual Fund vs. Bank Deposit

Deposits
Contractual agreement
Guaranteed for repayment
No direct holding of a portfolio
of investment
Mutual Fund
No contractual agreement
No guarantee
Direct holding of a portfolio
Return commensurate with
risk.

178

Investor Perspective
Investment Objective

Risk Tolerance

Investment Horizon

Capital Appreciation

High

Long Term

FI Bonds

Income

Low

Medium-Long Term

Corp Debentures

Income

High-Moderate-Low

Medium-Long Term

Company FDs

Income

High-Moderate-Low

Medium

Bank Deposits

Income

Low

Short-Medium-Long
Term

PPF

Income

Low

Long Term

Risk Cover

Low

Long Term

Risk Cover, Capital Growth,

Income

High-Moderate-Low

Medium-Long Term

Inflation hedge

Low

Medium-Long Term

Real Estate

Capital Growth, Income

Low-Moderate

Long Term

Mutual Funds

Capital Growth, Income

High-Moderate-Low

Short-Medium-Long
Term

Equity

Life Insurance
(Traditional)
Life Insurance (ULIPs)
Gold

179

Why MF is the best option

Combine the advantages of all investment

products
flexibility, convenience, affordability, liquidity,

potential for high returns

Dispense the short comings of the other options
liquidity, low return expectation, risk

diversification
Returns are adjusted for market movements
Commensurate with level of risk.

180

Stop Check!

An investor in regular need of income should not select:

A bank deposit
A debt fund
An equity growth fund
PPF
Which of the following has highest level of liquidity
Equity
PPF
Company Fixed deposits
Mutual funds
Which of the following should not be viewed primarily as an

investment option?

181

Mutual funds
Equity shares
Life insurance
None of the above.

Risk in Mutual Fund Investing

182

Risk in MF investing
What is Risk?
Volatility of earnings viz. deviation (+ & - ) from

expected earnings
Possibility of Financial loss

Risk can be built into the investment planning by

Defining the risk appetite of the investor and

aligning investment objectives to risk tolerance

Evaluating and measuring risks of portfolio to keep
in line with the investors risk appetite
The right level of risk tolerance of any investor

depends upon age, investable funds,

circumstances including income level, job
security, family size etc.

183

Jacobs recommendation based on risk level

Jacobs Recommendation of portfolio

sub-allocation
Low-Risk (Conservative)
portfolio

50% G Secs + 50% MMMF

40% in Growth & Income

Moderate Risk (Cautiously + 30% Govt Bonds + 20%
Aggressive) portfolio
Growth Funds + 10%
Index Funds

High Risk (Aggressive)

Portfolio

184

25% Aggressive Growth

Funds + 25%
International Funds +
25% Sector Funds + 15%
High Yield Bond Funds +
10% Gold Funds

Type of risk in Equity Funds

Company Specific
Sector Specific
Market Risk
Company and Sector risk can be reduced with

diversification but market risk cannot be

diversified
Market Cycles
Portfolio performance over a market cycle
Equity more rewarding in the long-term.

185

Measures of Risk

Risk
Standard Deviation
Beta
Ex-marks
Alpha

Risk-adjusted

return
Sharpe Ratio
Treynor Ratio.

186

Standard Deviation
Best measure of risk
Measure of absolute or total risk of a portfolio
Dispersion around mean
Quality rating of the average
Higher S.D. indicates more volatile returns
Lower deviation means less risk

High S.D. need not mean poor performance

Sachin Tendulkar vs. Harbhajan Singh.

VOLATILITY!
187

Beta
Shows how sensitive a fund is to market moves
If the Sensex moves by 25%, a funds bet number will tell

you whether the funds return will be more or less than this
Beta value for an Index is taken as 1
Multiplying the beta value of a fund will expected

percentage movement of an index gives the expected

movement in the fund
Higher beta means higher impact of market returns
Lower beta means less risk
Higher beta funds do well in a rising market, lower beta

funds do better in a falling market.

SENSITIVITY!
188

Ex-Marks or R-Squared
Quality of Beta depends on Ex-marks

Beta depends upon the index used to calculate it

Beta calculated for large cap fund against a mid-cap index

has no meaning
Higher ex-marks means more reliable beta

Measures return from a fund and the market index and

measures the extent of correlation in their movement

Lower ex-marks mean lower correlation with market
returns
R-squared varies between 0 and 1
R-squared of an index fund would be 1 (or Ex-marks
100%).

SYMPATHY!
189

Ex-marks comparison
Same beta in both cases

190

Sharpe & Treynor Ratio

192

Stop Check!

Ex-marks (R-Squared) of a fund measures

How much of a funds movement is due to the market index

movement
How a fund's movement relates to the market index
movement
How much of a fluctuation has occurred in the funds NAV
over a historical period
How many marks a credit rating agency accords to a fund
Which is a better investment option?

Ex-marks 75% beta 0.9, gross dividend yield 8%

Ex-marks 80% beta 0.9, gross dividend yield 8%
Ex-marks 90% beta 0.9, gross dividend yield 9%
Either 1 or 3 above.

193

Recommending model
portfolios & Selecting the right
fund

194

Jacobs Four-Step Program

Develop long term goals

Investment avenues, time horizon, return and

risk
Determine asset allocation

Allocation to broad asset classes

Determine sector distribution

Allocation of sectors of the mutual fund industry

Select specific fund managers and their schemes

Compare products & choose actual funds to

invest in.
195

Jacobs Model Portfolios

Investor

196

Recommended Model Portfolio

Young, Unmarried
Professional

50% in Aggressive Equity Funds

25% in High Yield Bond Funds and Growth and
Income Funds
25% in Conservative Money Market Funds

Young Couple with

two Incomes and
two Children

10%
30%
25%
35%

in
in
in
in

Money Market
Aggressive Equity Funds
High Yield Bond Funds
Municipal Bond Funds

Older Couple Single

Income

30%
35%
25%
10%

in
in
in
in

Short-term municipal Funds

long-term Municipal Funds
moderately aggressive equity
emerging growth equity

Recently retired
couple

35% in conservative Equity funds

25% in moderately Aggressive Equity
40% in Money Market Funds

Fund Selection Bogles Approach

Equity
Category Diversified, Sectoral, Index etc
Strategy Growth and Value
Past Returns Compare with benchmark and with funds

in same category over same time frames

Fund Size, Age, Costs, Managers experience Bigger
Size, Longer Age, Lower Costs and Higher Fund
Managers experience are better
Characteristics Lower Cash Position, Low
Concentration, Lower portfolio turnover are generally
better; Higher Cap assumes less risk
Risk Statistics Low Beta, High Ex-Marks, High Div yield
are generally better.

197

Fund Selection Bogles Approach

Debt
Type Income/Gilt/Liquid etc
Fund Age & Size higher the age and
larger the size, the better
Costs lower the better
Loads lower the better
Average Maturity higher average maturity
means higher interest rate risk
Credit Quality More AAA rated securities,
more secure the fund.
198

Fund Selection Bogles Approach

Balanced
Portfolio Balance match investors
objective
Debt Portfolio Quality higher the better
Costs lower the better
Portfolio Statistics similar to equity funds.

199

Fund Selection Bogles Approach

MMMF
Costs lower the expense ratio the better
Yields higher the better
Quality higher is essential
Liquidity and turnover rate

Shorter term instruments are turned over

more frequently
Principal protection

Limited NAV fluctuation due to low duration

and low levels of interest rate risk.

200

Stop Check!

Which of the following portfolios is more

risky?

75% equity 25% debt

40% equity 60% debt
60% equity 40% debt
80% equity 20% debt

What would you suggest a client who has

won a lottery of Rs. 1 crore?

Invest the entire money in old economy stocks as they are

back in favour
Invest in an equity index fund since the index is at a historic
low
Invest in a safe liquid investment option and take the time
needed to work out a financial plan
Invest in IT stocks, since their valuation is quite attractive.
201

Stop Check!

What asset mix would you suggest to a 55

year old who plans to retire at 58?

40% equity schemes and 60% balanced scheme

40% equity schemes and 60% debt scheme
20% equity, 20% liquid funds and 60% debt scheme
100% monthly income scheme

What portfolio would you recommend to a

recently retired couple?

35% conservative equity, 25% moderately aggressive equity,

40% money market funds

30% short-term municipal funds, 35% long-term municipal
funds, 25% moderately aggressive, 10% emerging equity
50% aggressive equity, 25% high yield bond funds and growth
and income funds, 25% conservative MMMF
Either 2 or 3.
202

Stop Check!

For which of the following funds would you

consider average maturity as an

important factor in selecting the right fund?
A debt fund
A balanced fund
A money market or liquid fund
Both 1 and 2 above.

203

15. Business Ethics and Mutual Funds

Session 7
Business Ethics

204

Meaning of business ethics

Refers to rules of acceptable and good conduct in

business
All persons engaged in business should comply
with rules of good conduct and have strong ethics
These rules may be set by those who own and
manage the business, or by those agencies that
have the right to regulate the business
Business ethics are hard to enforce, hence
desirable that they be self imposed
In many countries, laws such as Consumer or
Investor Protection Act exist.
205

Need for business ethics

Have honest and fair business practices
Protect the interests of the customer or

investor
Good ethics also mean good business
Retention of customer and generates loyalty
Transparency in operations and to ensure

that both potential and existing customers

are treated at par.
206

Objectives of Business Ethics

Honest and transparent dealings with

customers
Protect clients and customer from being

exploited or cheated
Level playing field among all participants
Healthy competition for the benefit of all

customers.

207

Need for business Ethics in Mutual

Funds
Mutual funds are vehicles of collective investment

managed by asset managed companies for a fee

AMC takes help of many entities including distributors
and individual financial advisors
All entities need to abide by the rules of good conduct
Trustees, Directors of AMC set the rules for
distribution and employees
AMFI has also set rules of good conduct for AMCs, its
employees and distributors.

208

SEBI Objectives
Funds always conduct all activities in the

best interest of investors

Areas monitored by SEBI
Fund Structure & Governance
Exercise of Voting Rights by Funds
Fund Operations.

209

Implementing Business Ethics

Fund structure
Fiduciary responsibility for MFs
A fund holds the investors money in trust
The money continues to belong to investors
Fund managers only manage it
Structure designed to protect the investor

through a system of checks and balances on

the observance of ethical standards by all the
industry constituents
Ethical and honest behavior on the part of
the fund trustees and managers is essential.
210

Implementing Business Ethics

Fund Governance
Regulator prime concern is investor

protection
Protect the investor through a system of
independent controls or check and balances
Separation of functions
Independence of organizations
Independence of personnel.

211

Implementing Business Ethics

Fund Operations
Insider Trading
Preferential Treatment to Select Investors
Personal trading by Fund Manager &

employees
Compliance Officer
Code of Conduct for Distributors
AGNI.

212