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MUTUAL FUND BASICS |
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Introduction |
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Different investment avenues are available to investors. Mutual funds
also offer good investment opportunities to the investors. Like all
investments, they also carry certain risks. The investors should compare
the risks and expected yields after adjustment of tax on various
instruments while taking investment decisions. The investors may seek
advice from experts and consultants including agents and distributors of
mutual funds schemes while making investment decisions.
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| With an objective to make the investors aware of functioning of mutual
funds, an attempt has been made to provide information in
question-answer format which may help the investors in taking investment
decisions. |
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What is a Mutual Fund? |
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Mutual fund is a mechanism for pooling the resources by issuing
units to the investors and investing funds in securities in
accordance with objectives as disclosed in offer document.
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Investments in securities are spread across a wide cross-section of
industries and sectors and thus the risk is reduced. Diversification
reduces the risk because all stocks may not move in the same direction
in the same proportion at the same time. Mutual fund issues units to the
investors in accordance with quantum of money invested by them.
Investors of mutual funds are known as unitholders.
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| The profits or losses are shared by the investors in
proportion to their investments. The mutual funds normally
come out with a number of schemes with different investment
objectives which are launched from time to time. A mutual
fund is required to be registered with Securities and
Exchange Board of India (SEBI) which regulates securities markets before
it can collect funds from the public. |
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What is the history of Mutual Funds in India and role of SEBI in mutual
funds industry? |
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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.
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In the year 1992, Securities and exchange
Board of India (SEBI) Act was
passed. The objectives of SEBI are – to protect the interest of
investors in securities and to promote the development of
and to regulate the securities market.
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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.
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| 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. There is no distinction in regulatory
requirements for these mutual funds and all are subject to monitoring
and inspections by SEBI. The risks associated with the schemes launched
by the mutual funds sponsored by these entities are of
similar type. |
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How is a mutual fund set up? |
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A mutual fund is set up in the form of a trust, which has sponsor,
trustees, asset management company (AMC) and custodian. The trust is
established by a sponsor or more than one sponsor who is like promoter
of a company. The trustees of the mutual fund hold its property for the
benefit of the unitholders. Asset Management Company (AMC) approved by
SEBI manages the funds by making investments in various types of
securities. Custodian, who is registered with SEBI, holds the securities
of various schemes of the fund in its custody. The trustees are vested
with the general power of superintendence and direction over AMC. They
monitor the performance and compliance of SEBI Regulations by the mutual
fund.
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| SEBI Regulations require that at least two thirds of the directors of
trustee company or board of trustees must be independent i.e. they
should not be associated with the sponsors. Also, 50% of the directors
of AMC must be independent. All mutual funds are required to be
registered with SEBI before they launch any scheme. |
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What is Net Asset Value (NAV) of a scheme? |
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The performance of a particular scheme of a mutual fund is denoted by
Net Asset Value (NAV).
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| Mutual funds invest the money collected from the investors in securities
markets. In simple words, Net Asset Value is the market value of the
securities held by the scheme. Since market value of securities changes
every day, NAV of a scheme also varies on day to day basis. The NAV per
unit is the market value of securities of a scheme divided by the total
number of units of the scheme on any particular date. For example, if
the market value of securities of a mutual fund scheme is Rs 200 lakhs
and the mutual fund has issued 10 lakhs units of Rs. 10 each to the
investors, then the NAV per unit of the fund is Rs.20. NAV is required
to be disclosed by the mutual funds on a regular basis - daily or weekly
- depending on the type of scheme. |
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What are the different types of mutual fund schemes? |
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Schemes according to Maturity Period: |
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A mutual fund scheme can be classified into open-ended scheme or
close-ended scheme depending on its maturity period. |
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Open-ended Fund/ Scheme
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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. |
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Close-ended Fund/ Scheme |
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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. In order to provide an exit route to the investors, some
close-ended funds give an option of selling back the units to the mutual
fund through periodic repurchase at NAV related prices. SEBI Regulations
stipulate that at least one of the two exit routes is provided to the
investor i.e. either repurchase facility or through listing on stock
exchanges. These mutual funds schemes disclose NAV generally on weekly
basis. |
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Schemes according to Investment Objective: |
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A scheme can also be classified as growth scheme, income scheme, or
balanced scheme considering its investment objective. Such schemes may
be open-ended or close-ended schemes as described earlier. Such schemes
may be classified mainly as follows: |
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Growth / Equity Oriented Scheme |
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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. The investors must indicate the option
in the application form. The mutual funds also allow the investors to
change the options at a later date. Growth schemes are good for
investors having a long-term outlook seeking appreciation over a period
of time. |
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Income / Debt Oriented Scheme |
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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. The NAVs of such funds are affected because of change in interest
rates in the country. If the interest rates fall, NAVs of such funds are
likely to increase in the short run and vice versa. However, long term
investors may not bother about these fluctuations. |
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Balanced Fund |
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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. They generally invest 40-60%
in equity and debt instruments. These funds are also affected because of
fluctuations in share prices in the stock markets. However, NAVs of such
funds are likely to be less volatile compared to pure equity funds |
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Money Market or Liquid Fund |
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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. |
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Gilt Fund |
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These funds invest exclusively in government securities. Government
securities have no default risk. NAVs of these schemes also fluctuate
due to change in interest rates and other economic factors as is the
case with income or debt oriented schemes. |
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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. NAVs of
such schemes would rise or fall in accordance with the rise or fall in
the index, though not exactly by the same percentage due to some factors
known as "tracking error" in technical terms. Necessary disclosures in
this regard are made in the offer document of the mutual fund scheme.
There are also exchange traded index funds launched by the mutual funds
which are traded on the stock exchanges. |
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What are sector specific funds/schemes? |
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| These are the funds/schemes which invest in the securities of only those
sectors or industries as specified in the offer documents. e.g.
Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum
stocks, etc. The returns in these funds are dependent on the performance
of the respective sectors/industries. While these funds may give higher
returns, they are more risky compared to diversified funds. Investors
need to keep a watch on the performance of those sectors/industries and
must exit at an appropriate time. They may also seek advice of an
expert. |
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What are Tax Saving Schemes? |
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| 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. Their growth opportunities and risks
associated are like any equity-oriented scheme. |
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What is a Load or no-load Fund?
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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. The investors should
take the loads into consideration while making investment as these
affect their yields/returns. However, the investors should also consider
the performance track record and service standards of the mutual fund
which are more important. Efficient funds may give higher returns in
spite of loads.
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| 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. |
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Can a mutual fund impose fresh load or increase the load beyond the level mentioned in the offer documents? |
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| Mutual funds cannot
increase the load beyond the level mentioned in the
offer document. Any change in the load will be
applicable only to prospective investments and not to
the original investments. In case of imposition of fresh
loads or increase in existing loads, the mutual funds
are required to amend their offer documents so that the
new investors are aware of loads at the time of
investments. |
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What is a sales or repurchase/redemption price? |
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The price or NAV a unitholder 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 | |
