Mutual Funds

Concept and role

• A common pool of money (limited means & knowledge)
• Mutuality in contribution and hence ‘mutual’ naming
• unequal share of participants
• Benefits from funds accrue to all participants
• Investment objectives (debt, equity, diversified, nifty,
power sector funds etc.)
• A mutual fund is a pool of investors’ money, invested in
a portfolio of securities as per the stated investment
objective.

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 Concept and role…Contd.
Benefits of MF over direct investing:
• Professional investment management
• Risk reduction through diversification
• Convenience
• Availability of alternative portfolio objectives and products
• Unit holders account administration and services ensuring
liquidity of investing
• Lower transaction and other costs
• Regulatory protection
•Relatively higher returns than other financial instruments vis-à-
vis their risks
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 Important characteristics of a Mutual Fund

• The ownership is in the hands of the investors who have pooled in their funds
so it is joint or mutual.
• It is managed by a team of investment professionals and other service
providers.
• The pool of funds is invested in a portfolio of marketable investments.
• The investors share is denominated by ‘units’ whose value is called as Net
Asset Value (NAV) which changes everyday.
• The investment portfolio is created according to the stated investment
objectives of the fund.
• Mutual Funds are also known as Financial Intermediaries In India, Mutual
Funds are constituted as TRUSTS.

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 Evolution

• Can be traced back to 1822 in Brussells.

•King William of the Netherlands formed “Societe
Generale de Belique”
• Was formed to facilitate small investments in foreign
government loans, which then offered more security and
returns than home industry
• This idea flourished more in UK and USA

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 Evolution…Contd.
IN UK
•Initially started as investment trust, founded by a single
individual who used his financial abilities and judgment
for the benefit of a group and who, in turn for his advice
and counsel, was allowed to retain a percentage of
profits made from numerous changes
• Foreign & Colonial was the first investment trust in Uk
in 1868
• 1880s was period of boom for these trusts followed by
some failures in period of British crash in 1890
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 Evolution…Contd.
• till mid-1920s MFs were informative and experimental
and incorporated under the Companies Act.
• during 1900-1914, UK fund managers invest their
clients’ funds in American securities
•From 1914-18, British MF sold a large portion of their
American stocks and bonds and reinvested in war loans
in British Govt which helped the industry to survive
• The first unit trust appeared in 1931, shortly after the
Wall Street crash
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 Evolution…Contd.
• Unit trusts conform to the basic pattern of open-ended
investment funds in UK
• By Jan, 1988 there were almost 1200 unit trusts managed by
more than 160 groups, popular because of the range of
investment opportunities they made available to the investors
• 1987 stock market crash some significant changes to the unit
trust industry
• other main event affecting the industry was the introduction of
the Financial Services Act
• By the end of 1997, there were $ 237 billion of assets
managed by 1455 open-ended funds
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 Evolution…Contd.
IN USA
• Origin could be traced back to private trustee system in
Boston during the second half of 19th century
• Boston Personal Property Trust, the first investment
trusts was organized in 1893
• Alexander Fund established in Philadelphia in 1907 by
W. Wallace Alexander that seems to have originated
many of the ideas adopted by mutual funds
• Mutual fund industry evolved in three phases (Pre-
1940, 1940-1970, and 1970 till present)
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 Evolution…Contd.
• Period before 1940, the period was infancy of mutual
fund, close ended funds were the dominant form of
mutual funds to mobilise money
• By the end of 1940s, the share of close ended funds
started shrinking in favour of open ended fund
• In 1940-1970, mutual fund evolved into an established
industry, Open-ended funds became the dominant form
of mutual funds

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 Evolution…Contd.
• The most striking feature of the phase (1970 to
present) has been the innovation in the investment
objectives
• Till this phase, funds were mobilised with an objective
of providing the benefit of diversification in equity
investment
• Number of schemes increased from 5 in 1987 to 22 in
1987
• The sales load also either reduced or eliminated after
1970, thereby increasing the number of investors
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 Evolution…Contd.

• By the end of 2000, assets managed by Mutual fund

industry increased to $ 7 trillion
• In 1990s, stocks and other financial assets gave
relatively higher returns and household shifted their
asset allocation away from real estates and other
tangible assets to financial assets

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 Evolution…Contd.

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 Evolution…Contd.

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 Evolution…Contd.

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AUM in Indian Mutual Fund industry

Industry has grown at a 20 per cent CAGR in the last four years
Market Share of Leading Mutual
Funds
 Types of Mutual Funds

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 Types

Depending on how they are offered for purchase and

redemption
1) Open-ended Funds
2) Closed-ended Funds
3) Interval Funds

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 Types…Contd.
Open-ended Fund
•Does not have a fix maturity date
• Offers units to investors for the first time (New Fund
Offer or NFO)
• Investors can buy and sell (redeem) units on a
continuous basis after NFO
• Prices for purchase and redemption on the basis of Net
Asset Values (NAVs)
•
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 Types…Contd.
Close-ended Fund
• Operate for a specific period
• Only NFO are accepted and no purchase once NFO
period is over
• Compulsory listing on Stock exchanges for liquidity
• Normally no redemption is possible before the maturity
date

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 Types…Contd.

Interval Funds
• Are a variant of close-ended funds
• Primarily a close-ended but become open-ended at
specific intervals
• Funds usually specify a ‘transaction period’ during
which the scheme is open for purchase and redemption

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 Types…Contd.

On the basis of Investment Objective and Portfolio

• Debt funds
• Equity funds
• Hybrid funds
• Other Types of Funds

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 Types…Contd.
Debt funds
• invest predominantly in debt securities
• have a fixed maturity date and pay a specific rate of
interest
• return from a debt fund is made up of interest income
and any capital appreciation/depreciation in value due to
changes in market places
• Inside debt funds various other sub categories
1) Money market funds of Liquid funds
2) Floating rate fund

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 Types…Contd.
3) Cash or Treasury Management funds
4) Gilt funds
5) Income funds
6) High-yield funds
7) Fixed maturity Plans (FMPs)
8) Short term Plans

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 Types…Contd.
Equity Funds:
1) Diversified Equity Funds
2) Thematic Equity Funds
3) Sector Equity Funds
Strategy-based Funds:
1) Equity Linked Saving Schemes (ELSS)
2) Value funds
3) Mid-cap funds
4) Small-cap funds
5) Large-cap funds

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 Equity Funds

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 Types…Contd.
Hybrid Funds:
1) Monthly Income Plans
2) Balanced Funds
3) Asset allocation Funds
4) Capital Protection-orientated Funds
Other Types of Funds:
1) Fund of Funds
2) International Funds
3) Arbitrage Funds
4) Exchange Traded Funds (ETFs)
5) Commodity Funds
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 Exchange Traded Funds

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 Classification Based on Risk- Return

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 Structure Framework of Mutual Funds

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 Legal Structure of MF in India
• Mutual funds are constituted as Trusts.
• The mutual fund trust is created by one or more Sponsors, who
are the main persons behind the mutual fund business.
• Every trust has beneficiaries. The beneficiaries, in the case of a
mutual fund trust, are the investors who invest in various schemes
of the mutual fund.
• The operations of the mutual fund trust are governed by a Trust
Deed, which is executed by the sponsors. SEBI has laid down
various clauses that need to be part of the Trust Deed.
• The Trust acts through its trustees. Therefore, the role of
protecting the beneficiaries (investors) is that of the Trustees.
• The first trustees are named in the Trust Deed, which also
prescribes the procedure for change in Trustees.

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• In order to perform the trusteeship role, either individuals may be
appointed as trustees or a Trustee company may be appointed.
When individuals are appointed trustees, they are jointly referred to
as Board of Trustees. A trustee company functions through its Board
of Directors.
• Day to day management of the schemes is handled by an Asset
Management Company (AMC). The AMC is appointed by the
sponsor or the Trustees.
• Although the AMC manages the schemes, custody of the assets of
the scheme (securities, gold, gold-related instruments & real estate
assets) is with a Custodian, who is appointed by the Trustees.
• Investors invest in various schemes of the mutual fund. The record of
investors and their unit-holding may be maintained by the AMC itself,
or it can appoint a Registrar & Transfer Agent (RTA).

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 Fund structure
• In India, Mutual funds have a 3-tier structure of
sponsor-trust-asset management company
• The structure of mutual fund is guided by SEBI (Mutual
Fund) Regulations, 1996 or subsequent guidelines of
SEBI
• The Sponsor creates the Mutual Fund and sets up the
AMC, which is structured as a Trust, managed by the
Trustees for the benefits of Unit holders. Trustees also
appoint the assets management company (AMC) to
manage the funds
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 Fund structure…contd.
• A normal mutual fund structure in India

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 Fund structure…contd.
• For example: HDFC decided to set up a mutual fund in
the year 1999. It partnered with Standard Life Investment
Ltd and created HDFC Asset Management Company
Limited in December 1999
• HDFC Mutual Fund was created as a trust and after
SEBI’s approval was obtained, the HDFC Trustee
Company appointed the HDFC AMC as the fund’s
investment manager in June 2000

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 Fund structure…contd.
Sponsor:
• is the promoter of the mutual fund, who sets up the
trust and the Asset Management Company (AMC),
appoints the board of trustees and the board of directors
of the AMC
• It also seeks regulatory approval for the mutual fund
• Eligibility criteria for a sponsor:
1) Have alteast 5 years of experience in financial services industry
2) Have a good financial track record of atleast last three years prior to registration
of the fund (positive networth is essential)
3) Contribute atleast 40% of the capital of the asset management company (AMC)

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 Fund structure…contd.
Trust:
• The structure of a mutual fund is a trust and its investors are beneficiaries
of the trust
• Trustees are appointed by the sponsor, with SEBI approval, to act on
behalf of the investors
• The trust deed is executed by the sponsor in favour of the trustees and it
deals with the establishment of the trust, the authority and responsibility
towards the unit holders and the AMC
• Trustees can be an identified set of individuals or a trustee company. The
Board of trustees comprising of at least 4 members oversee the working of
the mutual fund. At least two-thirds of the members of the board of trustees
have to be independent of the sponsor

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 Fund structure…contd.
Asset Management Company (AMC):
• is the investment manager of the mutual fund and is
responsible for running the day to day operations of the
mutual fund
• is appointed by the trustees of the fund, in consultation with
the sponsor and with the approval of SEBI
• rights and obligations of AMC are specified in agreement
signed between the Trustees and AMC
• its primary role is to manage the total contribution (the
fund) from investors and take investment decisions
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• The AMC needs to have a minimum net worth of Rs10 crore.
• An AMC cannot invest in its own schemes, unless the intention to
invest is disclosed in the Offer Document. Further, the AMC cannot
charge any fees for the investment.
• The appointment of an AMC can be terminated by a majority of the
trustees, or by 75% of the Unit-holders. However, any change in
the AMC is subject to prior approval of SEBI and the Unit-holders.
• Operations of AMCs are headed by a Managing Director,
Executive Director or Chief Executive Officer

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 Fund structure…contd.
Fund constituents:
• the functional departments in a typical AMC are
1) Fund management
2) Operations
3) Sales and marketing
4) Customer services
5) Compliance
6) Finance and accounts
• Core functions in these areas are done inhouse while
other functions may be outsourced to constituents
who offer specialised services
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• As per SEBI regulations:
– the directors of the asset management company need to be
persons having adequate professional experience in finance
and financial services related field
– the directors as well as key personnel of the AMC should
not have been found guilty of moral turpitude or convicted of
any economic offence or violation of any securities laws.
– Key personnel of the AMC should not have worked for any
asset management company or mutual fund or any
intermediary during the period when its registration was
suspended or cancelled at any time by SEBI.
– Prior approval of the trustees is required, before a person is
appointed as director on the board of the AMC.

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 Fund structure…contd.
Fund constituents and their roles:
Constituent Role
Custodian Hold and settle funds and services
R & T agents Keep and service investor folios
Banks Enable collection and payment
Auditor Audit scheme accounts
Distributors Distribute fund products to investors
Brokers Execute transactions in securities

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 Fund structure…contd.
Custodians:
• are usually large banks. It hold the cash and securities of
the mutual fund and are responsible for their safekeeping
and settle investment transactions using these funds and
securities
• are appointed by the sponsor but are independent of the
sponsor
• The sponsor cannot be appointed as custodians in entities
which they hold 50% or more of the equity capital; or have
50% or more of the Board representing as their nominees
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 Fund structure…contd.
Registrar and Transfer agents (R & T agents):
• are primarily responsible for creating and maintaining investor
records and servicing them
• accepts and process investor transactions
• investors records are kept in numbered accounts called folios
• also operates investor service centres (ISCs) which also acts
as the official points for accepting investor transactions with a
fund
• e.g. Computer Age Management Services (CAMS) is the R&T
agent for HDFC Mutual Fund

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 Fund structure…contd.
Banks:
• provides collection and payment services to mutual funds
• also involved in payment of redemption proceeds and
dividends
Auditors:
• audit the books of the mutual funds. It is mandatory to keep
separate set of books for each mutual fund scheme
• auditors for the AMC’s are distinct from the auditors of
the mutual fund

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 Fund structure…contd.
Brokers:
• executes the buy and sell transactions of the fund managers on
stock exchanges
Distributors:
• sells the mutual fund products to investors
• are empanelled by a mutual fund and offered commissions on
sale of the schemes
• may work for more than one mutual fund
• sponsor or an associate may act as a distributor for the fund
which they are associated

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 Example…
Mutual Fund Trust Kotak Mahindra Mutual Fund
Sponsor Kotak Mahindra Bank Limited

Trustee Kotak Mahindra Trustee Company Limited

AMC Kotak Mahindra Asset Management
Company Limited
Custodian Deutsche Bank AG, Mumbai
Standard Chartered Bank, Mumbai
Bank of Nova Scotia (custodian for Gold)
RTA Computer Age Management Services
Pvt. Ltd

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