Mutual Fund Concept

CONCEPT A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested in capital market instruments such as shares, debentures and other securities. The income earned through these investments and the capital appreciation realised are shared by its unit holders in proportion to the number of units owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart below describes broadly the working of a mutual fund

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Mutual Fund Operation Flow Chart

ORGANISATION OF A MUTUAL FUND There are many entities involved and the diagram below illustrates the organisational set up of a mutual fund

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Advantages of Mutual Funds If mutual funds are emerging as the favorite investment vehicle, it is because of the many advantages they have over other forma and avenues of investing, particularly for the investor who has limited resources available in terms of capital and ability to carry out detailed research and market monitoring. The following are the major benefits offered by mutual funds to all investors: i) Portfolio Diversification Mutual Funds spread the investment across different securities (stocks, bonds, money market instruments, real estate, fixed deposits etc.) by investing in a number of companies across a broad cross-section of industries and sectors (auto, textile, information technology etc.). This kind of a diversification may add to the stability of your returns and reduces the risk with far less money than you can do on your own. ii) Convenient and flexibility Mutual fund management companies offer many investor services that a direct market investor cannot get. Investors can easily transfer their holdings from one scheme to the other ,get updated market information iii) Professional Management Qualified investment professionals who seek to maximize returns and minimize risk monitor investor's money. The investment professional has experience in making investment decisions. It is the Fund Manager's job to (a) find the best securities for the fund, given the fund's stated investment objectives; and (b) keep track of investments and changes in market conditions and adjust the mix of the portfolio, as and when required.

iv) Liquidity Investor

hold share or bonds they cannot directly ,easily and quickly

sell.Investment in mutual fund on the other hand,is more liquid. An investor can liquidate the investment by selling the units to the fund if open ended, or selling them. v) Affordability Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy. vi) Variety Mutual funds offer a tremendous variety of schemes. This variety is beneficial in two ways: first, it offers different types of schemes to investors with different needs and risk appetites; secondly, it offers an opportunity to an investor to invest sums across a variety of schemes, both debt and equity. vii) Tax Benefits In case of Individuals and Hindu Undivided Families a deduction up to Rs. 9,000 from the Total Income will be admissible in respect of income from investments specified in Section 80L, including income from Units of the Mutual Fund. Units of the schemes are not subject to Wealth-Tax and Gift-Tax. .

Disadvantages of Mutual Funds While the benefits of investing through mutual funds far outweigh the disadvantages, an investor and his advisor will do well to be aware of few shortcomings of using the mutual fund as an investment vehicle. i) No Tailor-made-Portfolios Investors who invest on their own can build their own portfolios of shares, bonds and other securities.Investing through funds means, the investor delegates the decision of investing through which securities to fund manager. The very highnet-worth individuals or large corporates may find this as a constraint in achieving their objectives. However this constraint can be overcome to some extent by offering families of schemes to investor, within the same fund. ii) No control over costs Investor pays the investment management fees as long as he remains within the fund. Fees are usually payable as a percentage of the value of his investments, whether the fund value is rising or declining. The investor also pays the fund distribution cost, which he would not incur in direct investment. iii) Managing a Portfolio of Funds Availability of a large number of options from mutual funds can actually mean too much choice for the investor. He may again need advice on how to select a fund to achieve his objectives

TYPES OF MUTUAL FUND BY STRUCTURE •

Open –ended funds

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Close ended fund

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Interval funds

BY INVESTMENT OBJECTIVE •

Growth Funds

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Income funds

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Balance Funds

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Money Market Funds

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Gilt Funds

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Index Funds

ON THE BASIS OF LOAD •

Load Funds

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No Load Funds

OTHER SCHEMES •

Tax Saving schemes

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Industry Specific schemes

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Sector schemes

By Structure i) Open-ended Funds An open-end fund is one that is available for subscription all through the year. These do not have a fixed maturity. Investors can conveniently buy and sell units at Net Asset Value (NAV) related prices. Hence, the unit capital of the schemes keeps changing each day. Such schemes thus offer very high liquidity to investors and are becoming increasingly popular in India. ii) Closed-ended Funds A closed-end fund has a stipulated maturity period which generally ranging from 3 to 15 years. The fund is open for subscription only during a specified period. 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 they 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. Closed-ended schemes are usually more illiquid as compared to open-ended schemes . iii) Interval Funds Interval funds combine the features of open-ended and close-ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV based prices.

By Investment Objective i) Growth Funds The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a majority of their corpus in equities. It has been proven that returns from stocks, have outperformed most other kind of investments held over the long term. Growth schemes are ideal for investors having a long-term outlook seeking growth over a period of time. Growth funds are less volatile. ii) Income Funds 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 and Government securities. Income Funds are ideal for capital stability and regular income. iii) Balanced Funds The aim of balanced funds is to provide both growth and regular income. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents. In a rising stock market, the NAV of these schemes may not normally keep pace, or fall equally when the market falls. These are ideal for investors looking for a combination of income and moderate growth. iv) Money Market Funds The aim of money market funds is to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer shortterm instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market.

v) Gilt Fund 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 economic factors as is the case with income or debt oriented schemes. vi) Index Funds Index Funds replicate the portfolio of a particular index such as the BSE sensitive index, S&P NSE 50 index(Nifty).These schemes invest in the securities in the same weight age comprising of an index. NAV’s 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 disclosure in this regard is 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.

On the basis of Load i) Load Funds A Load Fund is one that charges a commission for entry or exit. That is, each time you buy or sell units in the fund, a commission will be payable. Typically entry and exit loads range from 1% to 2.5%. It could be worth paying the load, if the fund has a good performance history. ii) No-Load Funds A No-Load Fund is one that does not charge a commission for entry or exit. That is, no commission is payable on purchase or sale of units in the fund. The advantage of a no load fund is that the entire corpus is put to work.

Other Schemes i) Tax Saving Schemes These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws as the Government offers tax incentives for investment in specified avenues. Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction u/s 88 of the Income Tax Act, 1961. ii) Industry Specific Schemes Industry Specific Schemes invest only in the industries specified in the offer document. The investment of these funds is limited to specific industries like InfoTech, FMCG, and Pharmaceuticals etc. iii) Sectoral Schemes Funds are those, which invest exclusively in a specified industry or a group of industries or initial public offerings. In these funds or schemes the investor invests in the securities of only those sectors or industries which are specified in the offer documents. E.g. Pharmaceuticals, software, Fast Moving Consumers goods (FMCG), petroleum stocks, etc. the return on these funds is dependent on the performance of the respective sector/industries. While these funds may give higher returns, they are more risky compared to the diversified funds. Investors need to keep awatch on the performance of these sectors and must exit at an appropriate time.

WHAT IS AN ENTRY LOAD?

Investors have to bear expenses for availing of the services (professional management) of the mutual fund. The first expense that an investor has to incur is by way of Entry Load. This is charged to meet the selling and distribution expenses of the scheme. A major portion of the Entry Load is used for paying commissions to the distributor. The distributor (also called a mutual fund advisor) could be an Independent Financial Advisor, a bank or a large national distributor or a regional distributor etc. They are the intermediaries who help an investor with choosing the right scheme, financial planning and investing in scheme s from time to time to meet one’s requirements.

WHAT ARE EXIT LOADS? As there are Entry Loads, there exist Exit Loads as well. As Entry Loads increase the cost of buying, similarly Exit Loads reduce the amount received by the investor. Not all schemes have an Exit Load, and not all schemes have similar exit loads as well. Some schemes have Contingent Deferred Sales Charge (CDSC). This is nothing but a modified form of Exit Load, wherein the investor has to pay different Exit Loads depending upon his investment period. If the investor exits early, he will have to bear more Exit Load and if he remains invested for a longer period of time, his Exit Load will reduce. Thus the longer the investor remains invested, lesser is the Exit Load. After some time the Exit Load reduces to nil; i.e. if the investor exits after a specified time period, he will not have to bear any Exit Load.