-Mutual Funds-

Introduction
The Mutual Fund Industry

The genesis of the mutual fund industry in India can be traced back to 1964
with the setting up of the Unit Trust of India (UTI) by the Government of
India. Since then UTI has grown to be a dominant player in the industry. UTI
is governed by a special legislation, the Unit Trust of India Act, 1963.

The industry was opened up for wider participation in 1987 when public
sector banks and insurance companies were permitted to set up mutual
funds. Since then, 6 public sector banks have set up mutual funds. Also the
two Insurance companies LIC and GIC have established mutual funds.
Securities Exchange Board of India (SEBI) formulated the Mutual Fund
(Regulation) 1993, which for the first time established a comprehensive
regulatory framework for the mutual fund industry. Since then several
mutual funds have been set up by the private and joint sectors.

Growth of Mutual Funds

The Indian Mutual fund industry has passed through three phases.The first
phase was between 1964 and 1987 when Unit Trust of India was the only
player.By the end of 1988,UTI had total asset of Rs 6,700 crores. The
second phase was between 1987 and 1993 during which period 8 funds
were established (6 by banks and one each by LIC and GIC).This resulted
in the total assets under management to grow to Rs 61,028 crores at the
end of 1994 and the number of schemes were 167.

The third phase began with the entry of private and foreign sectors in the
Mutual fund industry in 1993. Several private sectors Mutual Funds were
launched in 1993 and 1994. The share of the private players has risen
rapidly since then. Currently there are 34 Mutual Fund organisations in
India. Kothari Pioneer Mutual fund was the first fund to be established by
the private sector in association with a foreign fund.
This signaled a growth phase in the industry and at the end of financial year
2000, 32 funds were functioning with Rs. 1,13,005 crores as total assets
under management. As on August end 2000, there were 33 funds with 391
schemes and assets under management with Rs. 1,02,849 crores. The
Securities and Exchange Board of India (SEBI) came out with
comprehensive regulation in 1993 which defined the structure of Mutual
Fund and Asset Management Companies for the first time.

Growth Mutual Funds

The Indian Mutual fund industry has passed through three phases.The first
phase was between 1964 and 1987 when Unit Trust of India was the only
player.By the end of 1988,UTI had total asset of Rs 6,700 crores. The
second phase was between 1987 and 1993 during which period 8 funds
were established (6 by banks and one each by LIC and GIC).This resulted
in the total assets under management to grow to Rs 61,028 crores at the
end of 1994 and the number of schemes were 167.

The third phase began with the entry of private and foreign sectors in the
Mutual fund industry in 1993. Several private sectors Mutual Funds were
launched in 1993 and 1994. The share of the private players has risen
rapidly since then. Currently there are 34 Mutual Fund organisations in
India. Kothari Pioneer Mutual fund was the first fund to be established by
the private sector in association with a foreign fund.

This signaled a growth phase in the industry and at the end of financial year
2000, 32 funds were functioning with Rs. 1,13,005 crores as total assets
under management. As on August end 2000, there were 33 funds with 391
schemes and assets under management with Rs. 1,02,849 crores. The
Securities and Exchange Board of India (SEBI) came out with
comprehensive regulation in 1993 which defined the structure of Mutual
Fund and Asset Management Companies for the first time.
What is a Mutual Fund

Like most developed and developing countries the mutual fund cult has
been catching on in India. There are various reasons for this. Mutual funds
make it easy and less costly for investors to satisfy their need for capital
growth, income and/or income preservation.

And in addition to this a mutual fund brings the benefits of diversification and
money management to the individual investor, providing an opportunity for
financial success that was once available only to a select few. 

Understanding Mutual funds is easy as it's such a simple concept: a mutual

fund is a company that pools the money of many investors -- its
shareholders -- to invest in a variety of different securities. Investments may
be in stocks, bonds, money market securities or some combination of these.
Those securities are professionally managed on behalf of the shareholders,
and each investor holds a pro rata share of the portfolio -- entitled to any
profits when the securities are sold, but subject to any losses in value as
well.

For the individual investor, mutual funds provide the benefit of having
someone else manage your investments and diversify your money over
many different securities that may not be available or affordable to you
otherwise. Today, minimum investment requirements on many funds are
low enough that even the smallest investor can get started in mutual funds.

A mutual fund, by its very nature, is diversified -- its assets are invested in
many different securities. Beyond that, there are many different types of
mutual funds with different objectives and levels of growth potential,
furthering your chances to diversify.
Why invest in Mutual Funds.

Investing in mutual has various benefits which makes it an ideal investment

avenue. Following are some of the primary benefits.

Professional investment management

One of the primary benefits of mutual funds is that an investor has access to
professional management. A good investment manager is certainly worth
the fees you will pay. Good mutual fund managers with an excellent
research team can do a better job of monitoring the companies they have
chosen to invest in than you can, unless you have time to spend on
researching the companies you select for your portfolio. That is because
Mutual funds hire full-time, high-level investment professionals. Funds can
afford to do so as they manage large pools of money. The managers have
real-time access to crucial market information and are able to execute
trades on the largest and most cost-effective scale. When you buy a mutual
fund, the primary asset you are buying is the manager, who will be
controlling which assets are chosen to meet the funds' stated investment
objectives.

Diversification

A crucial element in investing is asset allocation. It plays a very big part in

the success of any portfolio. However, small investors do not have enough
money to properly allocate their assets. By pooling your funds with others,
you can quickly benefit from greater diversification. Mutual funds invest in a
broad range of securities. This limits investment risk by reducing the effect
of a possible decline in the value of any one security. Mutual fund unit-
holders can benefit from diversification techniques usually available only to
investors wealthy enough to buy significant positions in a wide variety of
securities.

Low Cost

A mutual fund let's you participate in a diversified portfolio for as little as

Rs.5,000, and sometimes less. And with a no-load fund, you pay little or no
sales charges to own them.
Convenience and Flexibility

Investing in mutual funds has it’s own convenience. While you own just one
security rather than many, you still enjoy the benefits of a diversified
portfolio and a wide range of services. Fund managers decide what
securities to trade, collect the interest payments and see that your dividends
on portfolio securities are received and your rights exercised. It also uses
the services of a high quality custodian and registrar. Another big advantage
is that you can move your funds easily from one fund to another within a
mutual fund family. This allows you to easily rebalance your portfolio to
respond to significant fund management or economic changes.

Liquidity

In open-ended schemes, you can get your money back promptly at net
asset value related prices from the mutual fund itself.

Transparency

Regulations for mutual funds have made the industry very transparent. You
can track the investments that have been made on you behalf and the
specific investments made by the mutual fund scheme to see where your
money is going. In addition to this, you get regular information on the value
of your investment.

Variety

There is no shortage of variety when investing in mutual funds. You can find
a mutual fund that matches just about any investing strategy you select.
There are funds that focus on blue-chip stocks, technology stocks, bonds or
a mix of stocks and bonds. The greatest challenge can be sorting through
the variety and picking the best for you.

Professional investment management

One of the primary benefits of mutual funds is that an investor has access to
professional management. A good investment manager is certainly worth
the fees you will pay. Good mutual fund managers with an excellent
research team can do a better job of monitoring the companies they have
chosen to invest in than you can, unless you have time to spend on
researching the companies you select for your portfolio. That is because
Mutual funds hire full-time, high-level investment professionals. Funds can
afford to do so as they manage large pools of money. The managers have
real-time access to crucial market information and are able to execute
trades on the largest and most cost-effective scale. When you buy a mutual
fund, the primary asset you are buying is the manager, who will be
controlling which assets are chosen to meet the funds' stated investment
objectives.

Diversification

A crucial element in investing is asset allocation. It plays a very big part in

the success of any portfolio. However, small investors do not have enough
money to properly allocate their assets. By pooling your funds with others,
you can quickly benefit from greater diversification. Mutual funds invest in a
broad range of securities. This limits investment risk by reducing the effect
of a possible decline in the value of any one security. Mutual fund unit-
holders can benefit from diversification techniques usually available only to
investors wealthy enough to buy significant positions in a wide variety of
securities.

Low Cost

A crucial element in investing is asset allocation. It plays a very big part in

the success of any portfolio. However, small investors do not have enough
money to properly allocate their assets. By pooling your funds with others,
you can quickly benefit from greater diversification. Mutual funds invest in a
broad range of securities. This limits investment risk by reducing the effect
of a possible decline in the value of any one security. Mutual fund unit-
holders can benefit from diversification techniques usually available only to
investors wealthy enough to buy significant positions in a wide variety of
securities.
Convenience & Flexibility

Investing in mutual funds has it�s own convenience. While you own just
one security rather than many, you still enjoy the benefits of a diversified
portfolio and a wide range of services. Fund managers decide what
securities to trade, collect the interest payments and see that your dividends
on portfolio securities are received and your rights exercised. It also uses
the services of a high quality custodian and registrar. Another big advantage
is that you can move your funds easily from one fund to another within a
mutual fund family. This allows you to easily rebalance your portfolio to
respond to significant fund management or economic changes.

Liquidity

In open-ended schemes, you can get your money back promptly at net
asset value related prices from the mutual fund itself.

Transparency

Regulations for mutual funds have made the industry very transparent. You
can track the investments that have been made on you behalf and the
specific investments made by the mutual fund scheme to see where your
money is going. In addition to this, you get regular information on the value
of your investment.

Variety

There is no shortage of variety when investing in mutual funds. You can find
a mutual fund that matches just about any investing strategy you select.
There are funds that focus on blue-chip stocks, technology stocks, bonds or
a mix of stocks and bonds. The greatest challenge can be sorting through
the variety and picking the best for you.
Types of Mutual Funds

Getting a handle on what's under the hood helps you become a better
investor and put together a more successful portfolio. To do this one must
know the different types of funds that cater to investor needs, whatever the
age, financial position, risk tolerance and return expectations. The mutual
fund schemes can be classified according to both their investment objective
(like income, growth, tax saving) as well as the number of units (if these are
unlimited then the fund is an open-ended one while if there are limited units
then the fund is close-ended).

This section provides descriptions of the characteristics -- such as

investment objective and potential for volatility of your investment -- of
various categories of funds. These descriptions are organized by the type of
securities purchased by each fund: equities, fixed-income, money market
instruments, or some combination of these.

Open-ended Schemes

Open-ended schemes do not have a fixed maturity period. Investors can

buy or sell units at NAV-related prices from and to the mutual fund on any
business day. These schemes have unlimited capitalization, open-ended
schemes do not have a fixed maturity, there is no cap on the amount you
can buy from the fund and the unit capital can keep growing. These funds
are not generally listed on any exchange.

Open-ended schemes are preferred for their liquidity. Such funds can issue
and redeem units any time during the life of a scheme. Hence, unit capital of
open-ended funds can fluctuate on a daily basis. The advantages of open-
ended funds over close-ended are as follows:

Any time exit option, The issuing company directly takes the responsibility of
providing an entry and an exit. This provides ready liquidity to the investors
and avoids reliance on transfer deeds, signature verifications and bad
deliveries. Any time entry option, An open-ended fund allows one to enter
the fund at any time and even to invest at regular intervals.
Close-ended Schemes

Close-ended schemes have fixed maturity periods. Investors can buy into
these funds during the period when these funds are open in the initial issue.
After that such schemes can not issue new units except in case of bonus or
rights issue. However, after the initial issue, you can buy or sell units of the
scheme on the stock exchanges where they are listed. The market price of
the units could vary from the NAV of the scheme due to demand and supply
factors, investors� expectations and other market factors

Classification according to investment objectives

Mutual funds can be further classified based on their specific investment

objective such as growth of capital, safety of principal, current income or
tax-exempt income.
In general mutual funds fall into three general categories: 
1] Equity Funds are those that invest in shares or equity of companies. 
2] Fixed-Income Funds invest in government or corporate securities that
offer fixed rates of return are 
3] While funds that invest in a combination of both stocks and bonds are
called Balanced Funds. 

Growth Funds

Growth funds primarily look for growth of capital with secondary emphasis
on dividend. Such funds invest in shares with a potential for growth and
capital appreciation. They invest in well-established companies where the
company itself and the industry in which it operates are thought to have
good long-term growth potential, and hence growth funds provide low
current income. Growth funds generally incur higher risks than income funds
in an effort to secure more pronounced growth.

Some growth funds concentrate on one or more industry sectors and also
invest in a broad range of industries. Growth funds are suitable for investors
who can afford to assume the risk of potential loss in value of their
investment in the hope of achieving substantial and rapid gains. They are
not suitable for investors who must conserve their principal or who must
maximize current income

Growth & Income Funds

Growth and income funds seek long-term growth of capital as well as

current income. The investment strategies used to reach these goals vary
among funds. Some invest in a dual portfolio consisting of growth stocks
and income stocks, or a combination of growth stocks, stocks paying high
dividends, preferred stocks, convertible securities or fixed-income securities
such as corporate bonds and money market instruments. Others may invest
in growth stocks and earn current income by selling covered call options on
their portfolio stocks.

Growth and income funds have low to moderate stability of principal and
moderate potential for current income and growth. They are suitable for
investors who can assume some risk to achieve growth of capital but who
also want to maintain a moderate level of current income.

Fixed-Income Funds

Fixed income funds primarily look to provide current income consistent with
the preservation of capital. These funds invest in corporate bonds or
government-backed mortgage securities that have a fixed rate of return.
Within the fixed-income category, funds vary greatly in their stability of
principal and in their dividend yields. High-yield funds, which seek to
maximize yield by investing in lower-rated bonds of longer maturities, entail
less stability of principal than fixed-income funds that invest in higher-rated
but lower-yielding securities.

Some fixed-income funds seek to minimize risk by investing exclusively in

securities whose timely payment of interest and principal is backed by the
full faith and credit of the Indian Government. Fixed-income funds are
suitable for investors who want to maximize current income and who can
assume a degree of capital risk in order to do so.
Balanced

The Balanced fund aims to provide both growth and income. These funds
invest in both shares and fixed income securities in the proportion indicated
in their offer documents. Ideal for investors who are looking for a
combination of income and moderate growth.

Money Market Funds / Liquid Funds

For the cautious investor, these funds provide a very high stability of
principal while seeking a moderate to high current income. They invest in
highly liquid, virtually risk-free, short-term debt securities of agencies of the
Indian Government, banks and corporations and Treasury Bills. Because of
their short-term investments, money market mutual funds are able to keep a
virtually constant unit price; only the yield fluctuates.

Therefore, they are an attractive alternative to bank accounts. With yields

that are generally competitive with - and usually higher than -- yields on
bank savings account, they offer several advantages. Money can be
withdrawn any time without penalty. Although not insured, money market
funds invest only in highly liquid, short-term, top-rated money market
instruments. Money market funds are suitable for investors who want high
stability of principal and current income with immediate liquidity.

Specialty Sector Funds

These funds invest in securities of a specific industry or sector of the

economy such as health care, technology, leisure, utilities or precious
metals. The funds enable investors to diversify holdings among many
companies within an industry, a more conservative approach than investing
directly in one particular company.

Sector funds offer the opportunity for sharp capital gains in cases where the
fund's industry is "in favor" but also entail the risk of capital losses when the
industry is out of favor. While sector funds restrict holdings to a particular
industry, other specialty funds such as index funds give investors a broadly
diversified portfolio and attempt to mirror the performance of various market
averages.

Index funds generally buy shares in all the companies composing the BSE
Sensex or NSE Nifty or other broad stock market indices. They are not
suitable for investors who must conserve their principal or maximize current
income.

Risk vs Reward

Having understood the basics of mutual funds the next step is to build a
successful investment portfolio. Before you can begin to build a portfolio,
one should understand some other elements of mutual fund investing and
how they can affect the potential value of your investments over the years.
The first thing that has to be kept in mind is that when you invest in mutual
funds, there is no guarantee that you will end up with more money when you
withdraw your investment than what you started out with. That is the
potential of loss is always there. The loss of value in your investment is what
is considered risk in investing.

Even so, the opportunity for investment growth that is possible through
investments in mutual funds far exceeds that concern for most investors.
Here’s why.

At the cornerstone of investing is the basic principal that the greater the risk
you take, the greater the potential reward. Or stated in another way, you get
what you pay for and you get paid a higher return only when you're willing to
accept more volatility.

Risk then, refers to the volatility -- the up and down activity in the markets
and individual issues that occurs constantly over time. This volatility can be
caused by a number of factors -- interest rate changes, inflation or general
economic conditions. It is this variability, uncertainty and potential for loss,
that causes investors to worry. We all fear the possibility that a stock we
invest in will fall substantially. But it is this very volatility that is the exact
reason that you can expect to earn a higher long-term return from these
investments than from a savings account.

Different types of mutual funds have different levels of volatility or potential

price change, and those with the greater chance of losing value are also the
funds that can produce the greater returns for you over time. So risk has two
sides: it causes the value of your investments to fluctuate, but it is precisely
the reason you can expect to earn higher returns.

You might find it helpful to remember that all financial investments will
fluctuate. There are very few perfectly safe havens and those simply don't
pay enough to beat inflation over the long run.

Type of risk

All investments involve some form of risk. Consider these common types of
risk and evaluate them against potential rewards when you select an
investment.

Market risk

At times the prices or yields of all the securities in a particular market rise or
fall due to broad outside influences. When this happens, the stock prices of
both an outstanding, highly profitable company and a fledgling corporation
may be affected. This change in price is due to "market risk". Also known as
systematic risk.

Inflation risk

Sometimes referred to as "loss of purchasing power." Whenever inflation

rises forward faster than the earnings on your investment, you run the risk
that you'll actually be able to buy less, not more. Inflation risk also occurs
when prices rise faster than your returns.

Credit risk

In short, how stable is the company or entity to which you lend your money
when you invest? How certain are you that it will be able to pay the interest
you are promised, or repay your principal when the investment matures?

Interest Rate Risk

Changing interest rates affect both equities and bonds in many ways.
Investors are reminded that "predicting" which way rates will go is rarely
successful. A diversified portfolio can help in offseting these changes.

Exchange risk

A number of companies generate revenues in foreign currencies and may

have investments or expenses also denominated in foreign currencies.
Changes in exchange rates may, therefore, have a positive or negative
impact on companies which in turn would have an effect on the investment
of the fund.
Investment risk

The sectoral fund schemes, investments will be predominantly in equities of

select companies in the particular sectors. Accordingly, the NAV of the
schemes are linked to the equity performance of such companies and may
be more volatile than a more diversified portfolio of equities.

Changes in Government Policy

Changes in Government policy especially in regard to the tax benefits may

impact the business prospects of the companies leading to an impact on the
investments made by the fund

Effect of loss of key professionals and inability to adapt business to the

rapid technological change.

An industries' key asset is often the personnel who run the business i.e.
intellectual properties of the key employees of the respective companies.
Given the ever-changing complexion of few industries and the high
obsolescence levels, availability of qualified, trained and motivated
personnel is very critical for the success of industries in few sectors. It is,
therefore, necessary to attract key personnel and also to retain them to
meet the changing environment and challenges the sector offers. Failure or
inability to attract/retain such qualified key personnel may impact the
prospects of the companies in the particular sector in which the fund
invests.

Choosing a fund

Mutual fund is the best investment tool for the retail investor as it offers the
twin benefits of good returns and safety as compared with other avenues
such as bank deposits or stock investing. Having looked at the various types
of mutual funds, one has to now go about selecting a fund suiting your
requirements. Choose the wrong fund and you would have been better off
keeping money in a bank fixed deposit.Keep in mind the points listed below
and you could at least marginalise your investment risk.
Past performance

While past performance is not an indicator of the future it does throw some
light on the investment philosophies of the fund, how it has performed in the
past and the kind of returns it is offering to the investor over a period of time.
Also check out the two-year and one-year returns for consistency. How did
these funds perform in the bull and bear markets of the immediate past?
Tracking the performance in the bear market is particularly important
because the true test of a portfolio is often revealed in how little it falls in a
bad market.

Know your fund manager

The success of a fund to a great extent depends on the fund manager. The
same fund managers manage most successful funds. Ask before investing,
has the fund manager or strategy changed recently? For instance, the
portfolio manager who generated the fund�s successful performance may
no longer be managing the fund.

Does it suit your risk profile

Certain sector-specific schemes come with a high-risk high-return tag. Such

plans are suspect to crashes in case the industry loses the marketmen�s
fancy. If the investor is totally risk averse he can opt for pure debt schemes
with little or no risk. Most prefer the balanced schemes which invest in the
equity and debt markets. Growth and pure equity plans give greater returns
than pure debt plans but their risk is higher.

Read the prospectus

The prospectus says a lot about the fund. A reading of the fund�s
prospectus is a must to learn about its investment strategy and the risk that
it will expose you to. Funds with higher rates of return may take risks that
are beyond your comfort level and are inconsistent with your financial goals.
But remember that all funds carry some level of risk. Just because a fund
invests in government or corporate bonds does not mean it does not have
significant risk. Thinking about your long-term investment strategies and
tolerance for risk can help you decide what type of fund is best suited for
you.

How will the fund affect the diversification of your portfolio

When choosing a mutual fund, you should consider how your interest in that
fund affects the overall diversification of your investment portfolio.
Maintaining a diversified and balanced portfolio is key to maintaining an
acceptable level of risk.

What it Costs you?

A fund with high costs must perform better than a low-cost fund to generate
the same returns for you. Even small differences in fees can translate into
large differences in returns over time.

Finally, don�t pick a fund simply because it has shown a spurt in value in
the current rally. Ferret out information of a fund for atleast three years. The
one thing to remember while investing in equity funds is that it makes no
sense to get in and out of a fund with each turn of the market. Like stocks,
the right equity mutual fund will pay off big -- if you have the patience.
Similarly, it makes little sense to hold on to a fund that lags behind the total
market year after year.

Equity Schemes

Equity Schemes are schemes, which have less than 50 per cent
investments in Equity shares of domestic companies.

As far as Equity Schemes are concerned no Distribution Tax is payable on

dividend. In the hands of the investors, dividend is tax-free.
Other Schemes

For schemes other than equity, in the hands of the investors, dividend is
tax-free. However, Distribution Tax on dividend @ 12.81 per cent to be paid
by Mutual Funds.

Tax implications of Capital Gains

The difference between the sale consideration (selling price) and the cost of
acquisition (purchase price) of the asset is called capital gain. If the investor
sells his units and earns capital gains he is liable to pay capital gains tax.

Capital gains are of two types: Short Term and Long Term Capital Gains.

Short Term Capital Gain

The holding period of the Mutual Fund units is less than or equal to 12
months from the date of allotment of units then short term capital gains is
applicable.

On Short Term capital gains no Indexation benefit is applicable.

Tax and TDS Rate (excluding surcharge)

Resident Indians and Domestic Companies

The Gain will be added to the total income of the Investor and taxed at the
marginal rate of tax. No TDS.

NRIs: 30 per cent TDS from the gain.

Long Term Capital Gain

The holding period of Mutual Fund units is more than 12 months from the
date of allotment of units.

On Long Term capital gains Indexation benefit is applicable.

Tax and TDS Rate (excluding surcharge)

Resident Indians and Domestic Companies

The Gain will be taxed

A) at 20 per cent with indexation benefit or

B) B) at 10 per cent without indexation benefit, whichever is lower. No TDS.

NRIs: 20 per cent TDS from the Gain

Surcharge

Resident Indians : If the Gain exceeds Rs 8.5 lakhs, surcharge is payable
by investors @ 10 per cent.

Domestic Companies: Payable by the investor @ 2.5 per cent.

NRIs: If the Gain from the Fund exceeds Rs 8.5 lakhs, surcharge is
deducted at source @ 2.5 per cent.

Indexation

Indexation means that the purchase price is marked up by an inflation index

resulting in lower capital gains and hence lower tax.

                          Inflation index for the year of transfer

Inflation index =   ----------------------------------------------------

                         Inflation index for the year of acquisition.