Mutual funds

“Small drops of water makes big

ocean”
 Introduction
A mutual fund is a professionally-managed trust that pools the savings of
many investors and invests them in securities like stocks, bonds, short-
term money market instruments and commodities such as precious
metals.
Investors in a mutual fund have a common financial goal and their
money is invested in different asset classes in accordance with the fund’s
investment objective.
Investments in mutual funds involve comparatively small amounts,
giving retail investors the advantage of having finance professionals
control their money even if it is a few thousand rupees.
Mutual funds are pooled investment vehicles actively managed either by
professional fund managers or passively tracked by an index or industry.
 The funds are generally well diversified to offset potential losses.
They offer an attractive way for savings to be managed in a passive
manner without paying high fees or requiring constant attention from
individual investors.
Mutual funds present an option for investors who lack the time or
knowledge to make traditional and complex investment decisions.
 How does a mutual fund
operate/function?

The Asset Management Company is responsible for managing the

investments for the various schemes operated by the mutual fund.
Units of mutual funds
Let’s say that there is a box of 12 chocolates costing Rs. 40.
Four friends decide to buy these chocolates but they have
only Rs. 10 each and the shopkeeper only sells by the box. So
the friends then decide to each pool in the Rs.10 that they
have and buy the box of 12 chocolates. Now based on their
contribution, they each receive 3 chocolates or 3 units, if
equated with Mutual Funds.

And how do you calculate the cost of one unit? Simply divide
the total amount with the total number of chocolates: 40/12 =
3.33. So if you were to multiply the number of units (3) with
the cost per unit (3.33), you get the initial investment of Rs.
10. This results in each friend being a unit holder in the box of
chocolates that is collectively owned by all of them, with each
person being a part owner of the box. Thus unit refers to
the portion of mutual fund held by an investor
Net Asset Value (NAV)
 Just like a share has a price, a mutual fund unit has an NAV. To put
it simply, NAV represents the market value of each unit of a fund
or the price at which investors can buy or sell units.
 NAV is the total asset value per unit of the fund and is calculated
by the AMC at the end of every business day.
 In order to calculate the NAV of a mutual fund, you need to take
the current market value of the fund's assets minus the liabilities,
if any and divide it by the number of shares outstanding.

 For example, if the market value of securities of a Mutual Fund

scheme is 500 lakh and the Mutual Fund has issued 10 lakh units
of 10 each to investors, then the NAV per unit of the fund is 50
Example - NAV
Emerald Mutual Fund has introduced a
scheme size of Rs 100 crore and the value
of each unit is 10 and the present market
capitalisation is 200 crores. Calculate the
NAV

No. of units: 100 crore/10 = 10 crore

NAV = 200 crore/10 crore = Rs. 20 per unit

The value of each unit of Rs10 has become

Rs 20 now
Different types of mutual
funds
Based on the maturity period
1. Open-ended Fund
fund that is available for subscription and can be redeemed on a
continuous basis.
It is available for subscription throughout the year and investors can buy
and sell units at NAV related prices.
 These funds do not have a fixed maturity date.
The key feature of an open-ended fund is liquidity.

2. Close-ended Fund
A close-ended fund is a fund that has a defined maturity period, e.g. 3-6
years.
These funds are open for subscription for a specified period at the time
of initial launch. These funds are listed on a recognized stock exchange.
3. Interval Funds
Interval funds combine the features of open-ended and close-ended
funds.
 These funds may trade on stock exchanges and are open for sale or
redemption at predetermined intervals on the prevailing NAV.
Types of MF: Based on
investment objectives
1. Equity/Growth funds:
 funds invest a major part of its corpus in stocks and the investment
objective of these funds is long-term capital growth.
 When you buy shares of an equity mutual fund, you effectively become a
part owner of each of the securities in your fund’s portfolio.
 Equity funds invest minimum 65% of its corpus in equity and equity
related securities.
 These types of funds are suitable for investors with a long-term outlook
and higher risk appetite.
2. Debt/Income funds:
 Debt/ Income funds generally invest in securities such as bonds, corporate
debentures, government securities (gilts) and money market instruments.
 These funds invest minimum 65% of its corpus in fixed income securities.
 By investing in debt instruments, these funds provide low risk and stable
income to investors with preservation of capital.
 These funds tend to be less volatile than equity funds and produce regular
income.
 These funds are suitable for investors whose main objective is safety of
capital with moderate growth.
3. Balanced funds:
 Balanced funds invest in both equities and fixed income instruments in line
with the pre-determined investment objective of the scheme.
 These funds provide both stability of returns and capital appreciation to
investors.
 These funds with equal allocation to equities and fixed income securities
are ideal for investors looking for a combination of income and moderate
growth.
 They generally have an investment pattern of investing around 60% in
Equity and 40% in Debt instruments
4. Money market / liquid funds:
 funds invest in safer short-term instruments such as Treasury Bills,
Certificates of Deposit and Commercial Paper for a period of less than 91
days.
 Aim is to provide easy liquidity, preservation of capital and moderate
income.
 These funds are ideal for corporate and individual investors looking for
moderate returns on their surplus funds.
5. Gilt funds:
 Gilt funds invest exclusively in government securities. Although these funds
carry no credit risk, they are associated with interest rate risk.
 These funds are safer as they invest in government securities.
Some common MFs
Type of Fund Typical Investment
Equity or Equities like stocks
Growth Fund
Fixed Income Fixed income securities like
Fund government and corporate bonds
Money Market Short-term fixed income securities
Fund like treasury bills
Balanced Fund A mix of equities and fixed income
securities
Sector-specific Sectors like IT, Pharma, Auto etc.
Fund
Index Fund Equities or Fixed income securities
chosen to replicate a specific Index
for example S&P CNX Nifty
Some terms
Corpus: The money pooled in by the investors to invest in
mutual funds
Tax Saving Schemes:
These schemes offer tax rebates to the investors under
specific provisions of the Income Tax Act, 1961 as the
Government offers tax incentives for investment in specified
avenues. e.g. Equity Linked Savings Schemes (ELSS).
Pension schemes launched by the mutual funds also offer tax
benefits.
These schemes are growth oriented and invest pre-dominantly
in equities.
Fund of Funds (FoF) scheme
A scheme that invests primarily in other schemes of the same
mutual fund or other mutual funds is known as a FoF scheme.
AnFoF scheme enables the investors to achieve greater
diversification through one scheme.
Load or no load fund
A Load Fund is one that charges a percentage of NAV for
entry or exit. That is, each time one buys or sells units in
the fund, a charge will be payable.
This charge is used by the mutual fund for marketing and
distribution expenses.
Suppose the NAV per unit is Rs.10. If the entry as well as
exit load charged is 1%, then the investors who buy
would be required to pay Rs.10.10 and those who offer
their units for repurchase to the mutual fund will get only
Rs.9.90 per unit.
A no-load fund is one that does not charge for
entry or exit. It means the investors can enter the
fund/scheme at NAV and no additional charges are
payable on purchase or sale of units.
Sales or repurchase/redemption
price
The price or NAV a unit holder is charged
while investing in an open-ended scheme is
called sales price. It may include sales load,
if applicable.
Repurchase or redemption price is the price
or NAV at which an open-ended scheme
purchases or redeems its units from the
unit holders. It may include exit load, if
applicable.
Benefits of investing in mutual
funds
Professional Management
Diversification
Liquidity
Flexibility
Low transaction cost
Transparency
Well regulated
Regulations of MFs in India
Unit Trust of India was the first mutual fund set up in India in the
year 1963. In early 1990s, Government allowed public sector banks
and institutions to set up mutual funds.
In the year 1992, Securities and exchange Board of India (SEBI) Act
was passed.
As far as mutual funds are concerned, SEBI formulates policies and
regulates the mutual funds to protect the interest of the investors.
SEBI notified regulations for the mutual funds in 1993. Thereafter,
mutual funds sponsored by private sector entities were allowed to
enter the capital market.
The regulations were fully revised in 1996 and have been amended
thereafter from time to time. SEBI has also issued guidelines to the
mutual funds from time to time to protect the interests of
investors.
All mutual funds whether promoted by public sector or private
sector entities including those promoted by foreign entities are
governed by the same set of Regulations.
 Organization of MFs
Mutual fund is set up in the form of a trust that has a Sponsor, Trustees,
Asset Management Company (AMC), Custodian and unit holder.
Sponsor: The trust is established by a sponsor(s) who is like a promoter of
a company and the said Trust is registered with Securities and Exchange
Board of India (SEBI) as a Mutual Fund.
Trustee:
 The Trustees of the mutual fund hold its property for the benefit of unit holders.
 The trustees are vested with the power of superintendence and direction over the AMC.
 They monitor the performance and compliance of SEBI regulations by the mutual fund.
 The trustees are vested with the general power of superintendence and direction over
AMC.
 They manage the performance and compliance of SEBI Regulations by the mutual fund
AMC: An Asset Management Company (AMC) approved by SEBI manages
the fund by making investments in various types of securities. Success of
any of the mutual fund to a great extent depends on the efficiency of AMC
Custodian : Custodian, who is registered with SEBI, holds the securities of
various schemes of the fund in its custody.
Flexible investment options
available in mutual fund investments
Systematic Investment Plan (SIP): invest a fixed amount in
a mutual fund scheme at regular intervals.
Systematic Transfer Plan (STP): An STP is a plan that
allows investors to give consent to a mutual fund to
periodically transfer a certain amount / switch (redeem)
certain units from one scheme and invest in another
scheme of the same mutual fund house
Systematic Withdrawal Plan (SWP): An SWP allows an
investor to withdraw a designated sum of money and units
from the fund account at pre-defined regular intervals.
Fixed Maturity Plan (FMP): FMPs are close-ended debt
funds with a maturity period ranging from one month to
five years. These plans are predominantly debt-oriented,
while some may have a small equity component.