MUTUAL FUNDS

Mutual funds
The Securities and Exchange Board of India Regulations,
1993 defines Mutual Fund as

“Mutual Fund means a fund established in the form of trust

to raise money through the sale of units to the public or a
section of the public under one or more schemes for
investing in securities including money market instruments
or gold related instruments or real estate assets”.

Mutual funds are collective investment vehicles.

 Structure of Mutual Funds

• Fund Sponsor
• Trustees
• Asset Management Company (AMC)
• Custodians
• Registrar and Transfer agent
• Distributors/ Agents
 Fund Sponsor
• A ‘sponsor’ is a person who, acting alone or in
combination with another corporate body,
establishes a MF.
• The sponsor should have a sound financial
track record of over five years, have a positive
networth in all the immediately preceding five
years and integrity in all his business
transactions.
• In case of an existing MF, such fund which is in the
form of a trust and the trust deed has been approved
by the Board; the sponsor should contribute at least
40% of the net worth of the AMC.
 Trustees
• The MF can either be managed by the Board of
Trustees, which is a body of individuals, or by a Trust
Company, which is a corporate body.
• Most of the funds in India are managed by a Board of
Trustees.
• The trustees are appointed with the approval of SEBI.
Two thirds of trustees are independent persons and
are not associated with sponsors (or be associated
with them) in anymanner whatsoever.
• The trustees, being the primary guardians of
the unit holders’ funds and assets, have to be
persons of high repute and integrity.

• The Trustees, however, do not directly

manage the portfolio of MF.

• It is managed by the AMC as per the defined

objectives, in accordance with trust deed and
SEBI (MF) Regulations.
 Asset Management Company (AMC)

• The AMC, appointed by the sponsor or the

trustees and approved by SEBI, acts like the
investment manager of the trust.

• The AMC should have at least a net worth of

Rs. 10 crore.

• It functions under the supervision of its Board

of Directors, Trustees and the SEBI.
• In the name of the Trust, AMC floats and manages
different investment ‘schemes’ as per the SEBI
Regulations and the Investment Management
agreement signed with the Trustees.

• The regulations require non-interfering relationship

between the fund sponsors, trustees, custodians and
AMC.

• The asset management company is required to

obtain prior in-principle approval from the
recognised stock exchange(s) where units are
proposed to be listed.
 Custodians

• A custodian is appointed for safe keeping the

securities, gold or gold related instruments or
realestate mutual fund instruments and
participating in the clearing system through
approved depository.

• Custodian also records information on stock

splits and other corporate actions.
• No custodian in which the sponsor or its associate
holds 50 % or more of the voting rights of the share
capital of the custodian

• or where 50 % or more of the directors of the

custodian represent the interest of the sponsor or its
associates should act as custodian for a mutual fund
constituted by the same sponsor or any of its
associate or subsidiary company.
 Registrar and Transfer agent
• Registrar and transfer agent maintains record of the unit
holders account.
• A fund may choose to hire an independent party
registered with SEBI to provide such services or carryout
these activities in-house.
• If the work relating to the transfer of units is processed in-
house, the charges at competitive market rates may be
debited to the scheme.
• The registrar and transfer agent forms the most vital
interface between the unit holder and mutual fund.
 Distributors/ Agents

• To sell their products across the length and

breadth of the country, mutual funds take the
services of distributors/agents.

• Distributors comprise of banks, non-banking

financial companies and other distribution
companies.
 TYPES OF MFs/SCHEMES
A wide variety of MFs/Schemes cater to
different preferences of the investors based
on
• their financial position,
• risk tolerance and
• return expectations.
 1. Funds by Structure/Tenor

• Open ended Scheme

• Close ended Scheme
• Assured return schemes
• Interval Fund
 Open ended Scheme
•
An open-ended fund means a scheme of
mutual fund scheme which offers units for
sale without specifying any duration for
redemption.
• An open-ended fund or scheme is one that is
available for subscription and repurchase on a
continuous basis. These schemes do not have
a fixed maturity period. Investors can
conveniently buy and sell units at Net Asset
Value (NAV) related prices which are declared
on a daily basis. The key feature of open-end
schemes is liquidity
 Close-ended Fund Scheme
• A close-ended fund or scheme has a stipulated
maturity period e.g. 5-7 years. The fund is
open for subscription only during a specified
period at the time of launch of the scheme.
Investors can invest in the scheme at the time
of the initial public issue and thereafter they
can buy or sell the units of the scheme on the
stock exchanges where the units are listed.
 Assured return schemes
• Assures a specific return to the unit holders
irrespective of performance of the scheme,
which are fully guaranteed either by the
sponsor or AMC.
 Interval Fund

• This kind of fund combines the features of

open-ended and closed-ended schemes,
making the fund open for sale or redemption
during pre-determined intervals.
 Types of Mutual Funds

A. Schemes according to Maturity Period:

i. Open-ended Fund Scheme:.

ii. Close-ended Fund Scheme:
 Open-ended Fund Scheme
• An open-ended fund or scheme is one that is
available for subscription and repurchase on a
continuous basis. These schemes do not have
a fixed maturity period. Investors can
conveniently buy and sell units at Net Asset
Value (NAV) related prices which are declared
on a daily basis. The key feature of open-end
schemes is liquidity
B. Schemes according to Investment Objective:
• Growth I Equity Oriented Scheme
• Income I Debt Oriented Scheme
• Balanced Fund
• Money Market or Liquid Fund
• Gilt Fund
• Index Funds
• Physical assets
• Sector funds
• Fund of funds
 Growth I Equity Oriented Scheme

• The aim of growth funds is to provide capital

appreciation over the medium to long- term. Such
schemes normally invest a major part of their corpus in
equities. Such funds have comparatively high risks.
These schemes provide different options to the
'investors like dividend option, capital appreciation, etc.
and the investors may choose an option depending on
their preferences. Growth schemes are good for
investors having a long-term outlook seeking
appreciation over a period of time.
 Income I Debt Oriented Scheme

The aim of income funds is to provide regular and

steady income to investors. Such schemes generally
invest in fixed income securities such as bonds,
corporate debentures, Government securities and
money market instruments. Such funds are less risky
compared to equity schemes. These funds are not
affected because of fluctuations in equity markets.
However, opportunities of capital appreciation are
also limited in such funds.
 Balanced Fund
• The aim of balanced funds is to provide both
growth and regular income as such schemes
invest both in equities and fixed income
securities in the proportion indicated in their
offer documents. These are appropriate for
investors looking for moderate growth. These
funds are also affected because of fluctuations
in share prices in the stock markets.
 Money Market or Liquid Fund
• These funds are also income funds and their aim is to
provide easy liquidity, preservation of capital and
moderate income. These schemes invest exclusively
in safer short-term instruments such as treasury bills,
certificates of deposit, commercial paper and inter-
bank call money, government securities, etc.
Returns. on these schemes fluctuate much less
compared to other funds. These funds are
appropriate for corporate and individual investors as
a means to park their surplus funds for short periods.
 Gilt Fund

• These funds invest Government securities

have no default risk. due to change in interest
rates and other income or debt oriented
schemes.
 Index Funds
• Index Funds replicate the portfolio of a
particular index such as the BSE Sensitive
index, S&P NSE 50 index (Nifty), etc These
schemes invest in the securities in the same
weightage comprising of an index.
 Physical assets
• A significant change was made in January
2006, when SEBI permitted gold exchange
traded fund schemes that would invest in gold
and gold related instruments. Mutual Funds
have also been permitted to invest in Real
Estate since May 2008
 Sector Funds

• Sector funds invest in shares only of a specific

sector such as Pharmaceuticals, software,
energy and Banking etc.
 Funds of Funds

• Funds of Funds is a scheme wherein the assets

are invested in the existing schemes of mutual
funds.
 Market outcome
• At the end of March 2009 the mutual funds registered
with the SEBI stood at 44 and at the end of June 2009
the number was 43. As against 612 schemes in the year
2007-08, 551 new schemes were launched in 2008-09,
of which 55 were open-ended, 451 were close-ended
schemes and 45 were interval fund schemes.
• Aggregate sales of all the 551 schemes amounted to
Rs.1,031,770 million (US $ 20,251 million).
• The redemptions during the year were at Rs. 54,546,500
million (US $ 282,970 million).
Asset management 2009
 Steps involved in investing in
Mutual Funds.
Step One - Identify investment needs

Financial goals will vary, based on your age, lifestyle,

financial independence, family commitments, level of
income and expenses among many other factors.
Therefore, first step is to assess the needs.
Step Two - Choose the right Mutual Fund.
After having a clear strategy in mind, one must
decide the Mutual Fund and scheme in which
one wants to invest in. The offer document of
the scheme tells the objectives and provides
supplementary details like the track record of
other schemes managed by the same Fund
Manager. Some factors to evaluate before
choosing a particular Mutual Fund are: the
track record of performance over the last few
years in relation to the appropriate yardstick
and similar funds in the same category.
Step Three - Select the ideal mix of Schemes
Investing in just one Mutual Fund scheme may
not meet all the investment needs. One may
consider investing in a combination of Schemes
to achieve specific goals. The charts could prove
useful in selecting a combination of schemes
that will satisfy the needs.
Step Four - Invest regularly
By investing a fixed sum each month, one buys
fewer units when the price is higher and more
units when the price is low, thus bringing down
the average cost per unit. This is called rupee cost
averaging and is a disciplined investment strategy
followed by investors allover the world. With
many open-ended schemes offering systematic
investment plans, this regular investing habit is
made easy.
Step Five - Keep taxes in mind
If one is in a high tax bracket and have utilized fully
the exemptions under Section 80L of the Income Tax
Act, investing in growth funds that do not pay
dividends might be more tax efficient and improve
the post-tax return.
If one is in a low tax bracket and have not utilized
fully the exemption available under Section 80L,
selecting funds paying regular income could be more
tax efficient. Further, there are other benefits
available for investment in Mutual Funds under the
provisions of the prevailing tax laws.
Step Six - Start early
It is desirable to start investing early and stick to a regular
investment plan. The power of compounding earns
income on income and the money multiplies at a
compounded rate of return.

Step Seven - The final step

The last step is to get in touch with a Mutual Fund or
agent/broker and start investing. Reap the rewards in the
years to come. Mutual Funds are suitable for every kind
of investor whether starting a career or retiring, con­
servative or risk taking, growth oriented or income
seeking.
 Different methods of valuation

Valuation means to set the exact value of an asset on basis of

utility.
The different valuation TERMS are:
1. Cost price: The price which is paid for acquisition of an asset is
called cost price. It includes: a. Purchase price and other costs
incurred to bring asset to its working conditions for use. b. The
part of financing ,costs. c. Administration and other general
expenses related to asset, if such expenses are specificaLy
attributed to the asset.
2. Market Value: A value which an asset can fetch if sold in market
is called market value
3. Book value: The value of asset as recorded in books of accounts
is called Book Value.
4. Historical Value: It implies valuation of the
fixed asset at cost.
5. Realizable value: The value which will be
realized in market and received from sale of
an asset is called realizable value.
6. Replacement Value: It is the price at which
particular asset can be replaced.
7. Scrap Value: It is also known as break-up
value, it is the value obtained from the asset if
it is sold in the market after its useful life.
Valuation of units in mutual fund
• The net asset value of a mutual funds scheme
is basically the per unit market value of aII the
assets of the scheme.
To illustrate this better, a simple example will
help.
• Scheme Name : ABC
• Scheme Size : Rs. 50,00,00,000/- (Rupees fifty
crores) Face Value of units : Rs. 10/-
• No. of units: 5,00,00,000 (Scheme size/ Face value of
units )

• Investments: In shares
• Market value of shares: Rs. 75,00,00,000 (Rupees
Seventy five crores)

 NAV= Rs.75,00,00,000 / Rs. 5,00,00,000

( Market value of investments / No. of units )

 Thus each unit of Rs. 10/- is now worth Rs. 15/-.

• NAV is the value of the assets of each unit of
the scheme, or even simpler value of one unit
of the scheme.
 Evaluating Mutual funds

• Treynor Model
• Sharpe Model
 Treynor Model

• This model can be used to calculate the return

per unit of risk.

• This is done by assuming that all investors

averse to risk would like to maximize this
value.
The performance measure is calculates as:

(Average rate of return for portfolio ‘i’ during

a period – average rate of return on a risk-free
invetsment during the period) / slop of
portfolio ‘I’ characteristic line which
represents the portfolios relative volatility and
its systematic risk
 Sharpe model
• It measures the total risk, not merely
systematic risk (as in Treynor model) .
• The performance measure is calculated as
follows:
• (Average rate of return for portfolio ‘i’ during
a period – average rate of return on a risk-
free investment during the period) / standard
deviation of rate of returns for the portfolio
for the period.
Significance/advantages of mutual funds

• Professional Management: The investor avails of the services of

experienced and skilled professionals who are backed by a dedicated
investment research team which analyses the performance and prospects
of companies. and selects suitable investments to achieve the objectives
of the scheme.
• Diversification: Mutual Funds invest in a number of companies across a
broad cross-section of industries and sectors. This diversification reduces
the risk because seldom do all stocks decline at the same time and in the
same proportion. You achieve this diversification through a Mutual Fund
with far less money than you can do on your own.
• Convenient Administration : Investing in a Mutual Fund reduces
paperwork and helps you avoid many problems such as bad deliveries,
delayed payments and unnecessary follow up with brokers and
companies. Mutual Funds save your time and make investing easy and
convenient.
• Return Potential : Over a medium to long-term, Mutual Funds
have the potential to provide a higher return as they invest in
a diversified basket of selected securities.
• low Costs : Mutual Funds are a relatively less expensive, way
to invest compared to directly investing in the capital
'markets because the benefits of scale in brokerage, custodial
and other fees translate into lower costs for investors.
• liquidity : In open-ended schemes, you can get your money
back promptly at net asset value related prices from the
Mutual Fund itself. With close-ended schemes, you can sell
your units on a stock exchange at the prevailing market price
or avail of the facility of direct repurchase at NAV related
prices which some close-ended and interval schemes offer
you periodically.
• Transparency : You get regular information on the value of
your investment in addition to disclosure on the specific
investments made by your scheme, the proportion invested
in each class of assets and the fund manager's investment
strategy and outlook.

• Flexibility: Through features such as regular investment plans,

regular withdrawal plans and dividend reinvestment plans,
you can systematically invest or withdraw funds according to
your needs and convenience.

• Choice of Schemes: Mutual Funds offer a family of schemes

to suit your varying needs over a lifetime.
"Mutual funds provide stability of share prices, safety
to investors
and resources to prospective entrepreneurs".
• A mutual fund represent a vehicle for collective
investment. The pool of funds collected in a mutual
fund scheme is invested in scores of securities,
Individual investors can scarcely achieve such
diversification on their own. Also they lack expertise
in investment research and analysis and/or cannot
devote similar time and attention to their portfolio,
Also mutual fund schemes are periodically evaluated
by independent credit rating agencies such· as
CRISIL, Value research India. ICRA etc. Hence for the
small investors and for the new entrant mutual funds
is the best bet.
 Stability of share prices
• Mutual fund schemes buy and sell shares in
bulk. When the prices are crashing, mutual
fund schemes buy those securities thereby
creating demand for the stock. Sometimes in
order to avoid stock market crash,
government intervenes and ask the mutual
fund industry to step in to reduce the crisis
 Resources to prospective entrepreneur

• Mutual Fund firms through their research

wing are able to identify new and emerging
firms with healthy growth rate, Such are
nurtured through venture capital fund
schemes. Individual investors lack such
exposure. Mutual fund provides a link
between such firm & ultimate savers.
 Policy guidelines of Mutual funds
in India
• In India, mutual funds have come to be recognized in public
sector with the Unit Trust of India, banks and insurance
Corporations. These funds were administered by the directives
issued by RBI or Ministry of Finance, Central Government,
from time to time till the birth of SEBI.
• All the mutual funds including UTI are governed under the said
guidelines by SEBI vested with requisite powers under the SEBI
Act- 1999. Offshore funds are governed by the Ministry of
Finance, Government of India and RBI. MFs are governed by
the RBI. The regulations aim at improving investor protection,
facilitating competition, importing a greater degree of
flexibility and promoting innovation. Some of the revised
regulations are:
• The existing AMCs should increase their net
worth from Rs. 5 crore Rs. 10 crore within one
year of notification of regulations.

• AMCs can have cross trusteeship and

directorship provided there is no conflict of
interest.
• AMCs can undertake other fund-based business such as providing
investment management services. They have now been permitted to
diversify into management of pension funds, offshore funds, and venture
capital funds.

• AMCs can charge 1.25 per cent of weekly average NAV upto RS.100 crore
and 1 percent of NAV above Rs. 100 crore. They have been made
accountable to the investing public by linking up these remuneration to
the performance of MFs.
• The consent of investors must be obtained by Mutual Funds for making
any changes in the 'fundamental attributes' of a scheme on the basis of
which the unit holders had made initial investments.
• Mutual Funds can pay early bird incentive provided it is viewed as
interest payment for early investment with full disclosure.
• Mutual Funds can mention, while floating different schemes, indicate but
not assured return on those schemes.
• As per the recommendations of the Expert
Committee on valuation norms, it is now laid
down that all Mutual Funds must follow
common or uniform methods of valuation of
securities, accounting, reporting and
calculating NAVs. The valuation of investments
must now be made on a mark-to-market basis.
The dates when the secuity has to be treated
as ex-dividend, ex-rights and ex­bonus have
been brought on par with international
practice.
• Mutual Funds are now free to determine their portfolio
composition.
• All Mutual Funds have to use a standard format for scheme
prospectus.
• The immediate listing of schemes is not mandatory. All CEFs
(Closed Ended Funds) have to be listed within six months
from the closure of issue. OEFs (Open ended Funds) also have
been allowed to be listed.
• Mutual funds cannot make any investment in privately placed
(unlisted) securities issued by associated/group companies of
the sponsor.
• The aggregate investments of MFs in the listed and/or to be
listed securities of group companies of the sponsor should not
exceed 25 percent of the net assets of all their schemes.
 MMMF?
• Money Market Mutual Funds (MMMF) are
basically open ended mutual funds who invest
in highly liquid and safe securities like
commercial papers, certificates of deposits,
treasury bills and other short term money
market instruments.
 Regulations of MMMF
(i) Eligibility: The MMMFs can be set up by scheduled commercial banks
and public financial institutions as defined under Section 4A of the
Indian Companies Act, 1956, or through their existing mutual
funds/subsidiaries engaged in funds management.

(ii) Structure: The MMMFs can be set up either as Money Market Deposit
Accounts (MMDAs) or Money Market Mutual Funds (MMMFs).
(iii) Size: The limit for raising resources under the MMMF scheme should not
exceed 2 per cent of the sponsoring bank's fortnightly average
aggregate deposits during 1991-92. In the case of banks whose limit is
less than Rs. 500 million, it will be necessary for them to pool their limit
with other banks and jointly set up a MMMF. In the case of public
financial institutions, the limit should not exceed 2 per cent of the long-
term domestic borrowings as indicated in the latest available audited
balance sheets.
(iv) Subscription: As the MMMFs are primarily intended to be· a
vehicle for individual investors to participate in the money
markets, the units/shares of MMMFs can be issued only to
individuals. Individual Non-Resident Indians (NRIs) may also
subscribe to share/units of MMMFs on a non-repatriable
basis.
(v) Investment Size: MMMFs would be free to determine the
minimum size of investment by a single investor. The
investors cannot be guaranteed a minimum rate of return.
(vi) Lock-in Period: The minimum lock-in period for investment
would be 46 days.
(vii) MMMFs' Investments: The resources mobilized should be
invested exclusively in various money market instruments
subject to certain lower and upper limits (as per cent of
investible resources of MMMFs).
(viii) Reserve Requirements: In the case of MMMFs set
up by banks, the resources mobilized by them would
not be considered as part of their net demand and
time liabilities for purposes of reserve requirements,
and as such these resources would be free from any
reserve requirements.

(ix) Stamp Duty: The shares/units issued by MMMFs

would be subject to stamp duty.

(x) Regulatory Authority: The setting up of MMMFs

would require the prior authorization of the Reserve
Bank.