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AMFI Certification Examination Tutorial AMFI Certification Examination Tutorial

About the AMFI Examination

Candidates can take the computer based exam at the NSE centers or the written exams conducted by UTIICM The exam is now available in 2 languages : Hindi and English
The computer based exam is only in English. The written exam is in English and Hindi

Registration on the NSE exams can be done on-line at www.nseindia.com Registration for written exams can be done by downloading the application forms from www.iicm.com
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Question Paper Design

Each chapter has a weightage in the exams.


Not disclosed by AMFI Indicated in the CIEL book

There are 72 questions


44 questions of 1 mark each ; 28 questions of 2 marks each 42 questions from part 1; 30 questions from part 2

The paper is generated by randomly choosing from the question bank


The question paper for each candidate is different In the written exam, there are 5 sets of papers in the hall
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Attempting the paper

There are 2 hours to do the paper, most people do it in 1 hour Written exam
There is an answer sheet with boxes for each question. Color the appropriate box with pencil. Valuation is done using an optical reader. Results are announced in 10 days.

NSE Online exam


Answers are chosen with the click of the mouse Results is known as soon as the paper is submitted
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Some Tips

It is not a great idea to read the paper fully, attempt questions as you see them.
Reading fatigue sets in.

Mark and keep aside questions for which you are not sure of the answers, revert only to these questions.
Revising all questions can create confusion. Do not revise and redo the questions that have been already attempted.

Negative marking
25% of the marks of a question is reduced for a wrong answer.
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Approximate Weighting
Concept, History & Type of Mutual Funds (10 Marks) Fund Structure & Constituents (4 Marks) Legal & Regulatory Framework (5 Marks) Offer Document (9 Marks) Mutual Fund Distribution & Sales Practices (6 Marks) Accounting Valuation & Taxation (9 Marks) Investor Services (3 Marks) Investment Management (6 Marks) Return, Risk, Performance & Fund Selection (8 Marks)
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Approximate Weighting -2

Financial Planning Concept & Process (4 Marks) Life Cycles & Wealth Cycles (4 Marks) Creating & Recommending a Model Portfolio (5 Marks) Investment Strategies (5 Marks) Investment Products (7 Marks) Business Ethics for Mutual Fund (4 Marks)

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Chapter 1 Concept, History & Type of Mutual Funds

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What is a Mutual Fund?

A mutual fund is a pool of investors money The money collected is invested based on pre-specified investment objectives
HDFC Income Fund DSPML Top 100 Equity Fund

The investment objective of a fund determines its investment portfolio and its risk and return. The benefits from the pool is shared only by the investors who contributed to it

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Proportionate Share
Contribution to the pool is not equal
Hence the share is not equal, but proportionate

Investor A Investor B Investor C Total Gain over time Current Value

10000 20000 30000 60000 12000 72000 Current Value of the Investment is proportionate

12000 24000 36000

72000
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Nature of the Pool

The contribution to the pool depends upon the type of scheme


In an open-ended scheme investors can invest and redeem at any time In a closed-end fund, contribution to the fund happens only at the time of creation of the pool and redemption at the time of maturity

Method to measure the contribution is standardized Share of the pool is called Unit

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Units Vs. Shares

Shares

Units

Investor in shares - Share holder Mutual fund investor - Unit holder Holds the share of the company Share has a face value First time issue - IPO (Initial Public Offering) Subsequent transactions in stock exchange Holds the units of the fund Unit has a face value First time issue - NFO (New Fund Offer) Subsequent transaction through the fund (sometimes listed)

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Portfolio of a Fund
The money pooled is invested in a portfolio of marketable securities such as:
Equity shares Bonds and debentures Money market instruments Derivatives

Securities are tradable and have a market price. The portfolio value changes with changes in the market price of the underlying securities. The value of the investors holding changes with a change in the portfolio value. If we divide the value of the portfolio by the number of units, we get the net asset value (NAV) per unit.
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Valuation of Portfolio - Example


Consider a pool of money contributed by different investors. Investor A Investor B Investor C Investor D Investor E Total Rs. 3000000 Rs. 1000000 Rs. 500000 Rs. 400000 Rs. 56000 Rs. 4956000

14 NumericalsNuvo Limited 2008 exam; only for understanding Copyright Aditya Birla not in the

Valuation of Portfolio - 2

Security

No. of Shares

Day 1 Market Price Market Value Market Price

Day 10 Market Value

L&T Finolex Sun Pharma ICICI Bank Total

1000 2000 1000 1000

2700 53 1400 750

2700000 106000 1400000 750000 4956000

2900 57 1300 700

2900000 1140000 1300000 700000 6040000

If the NAV of the fund was Rs.10 at the start, it would now be Rs.12.18 at the end of 10 days, when the value of the portfolio moved up.
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Note: Numericals not in the exam; only for understanding

Assets and Liabilities of the Fund

The total assets of a mutual fund refers to the current value of its portfolio.
No other long-term assets are held in the balance sheet. Current assets and accrued income are added to the portfolio value.

The assets are funded completely by the investors contribution


No long-term liabilities in the balance sheet. Current liabilities and accrued expenses are deducted from the portfolio value.
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Net Assets

Net assets of the mutual fund = Market value of the portfolio + (Accrued income and current assets) - (Accrued expenses and current liabilities) Net asset value of a unit (NAV) = Net assets / Number of units Net assets of the fund = NAV * Number of units

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Advantages of a Mutual Fund


Portfolio Diversification
The portfolio is spread across industries, companies, issuers and maturities.

Low Transaction Cost


Benefits of economies of scale accrue to the investor since the fund invests large sums of money in the market.

Professional Managers
The fund managers have expertise in sector evaluation and security selection.

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Advantages of Mutual Funds - 2

Reduction in Risk
Portfolio diversification and professional management of the funds leads to a reduction in risk for the investor.

Flexibility
The choice of products and options allow investors to structure their investment and returns in the way that suits them.

Liquidity
Mutual fund portfolios are managed to provide liquidity and easy exit options to investors.
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Disadvantages of Mutual Funds


No Customization
The selection of sectors and securities in the portfolio is according to the view of the fund manager.

No control over fund management cost


Investors do not directly control fund running expenses Upper limit on costs is prescribed by regulation

Too many options to choose from


Fund selection can be difficult when there are too many of the same kind.
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History of Mutual Funds Phase I (1964 to 1987)


UTI was set up and governed by Unit Trust of India Act ,1963 First scheme was Unit Scheme 1964 First diversified equity scheme was Master share launched in 1986

Phase II (1987 to 1993)


Banks and insurance companies allowed to set up funds in 1987 SBI mutual fund was the first bank-sponsored fund SEBI was formed in 1988 and regulatory powers given in 1992

Phase III (1993 to 1996)


Kothari Pioneer was the first private sector mutual fund in 1993
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History of Mutual Funds - 2


Phase IV (1996 to 1999)
Three Tier structure of Sponsor - Trust AMC was implemented. Dividends from mutual funds became exempt from tax in 1999.

Phase V (1999 to 2004)


The UTI Act was repealed and UTI came into Sebis fold in 2003. Assets in 2001 were Rs1,50,000 crore.

Phase VI (2004 onwards)


Marked by mergers, acquisitions and entry of international players. Currently there are 35 players managing nearly 600,000 crore in assets.

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Classification of Mutual Funds


Mutual fund products can be classified as follows: Based on Life Span
Open and closed end funds

Based on Asset Class


Equity, debt, money markets, gilts and the like Funds may also invest in a combination of asset classes

Based on Management Style


Passive and active funds

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Open-ended Funds
No fixed maturity date. Offered during NFO for the first time.
Investors can buy redeem on a continuous basis after the fund re-opens for transactions. On-going transactions are done at NAV-based prices.

Unit capital is not fixed but changes with purchase and redemption. Transactions can be restricted by the fund under special situations.
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Closed End Funds

Specified maturity date


Offered during the NFO for the first time Redeemed on maturity date

Closed for further purchase and redemption after NFO


Some funds may offer redemption at NAV-based prices

Listed on Stock exchange


Prices determined by liquidity in the market Can be at premium or discount to NAV

Unit capital does not change after NFO


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Equity Funds

Pre-dominantly invest in equity markets


Diversified portfolio of equity shares Select set of equity shares based on selection criterion

Diversified equity funds


ELSS is a special case with tax concessions

Growth funds & Value funds Mid & small stock funds Index funds Specialty funds (sector and thematic funds)

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Debt Funds

Predominantly invest in the debt markets


Diversified debt funds Select set based on some criterion

Income funds or diversified debt funds Gilt funds short and long term gilt fund Liquid and money market funds Serial plans or fixed maturity plans Erstwhile assured return funds

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Hybrid Funds

Investment in more than one asset class


Debt and equity in varying proportions Pre-dominantly debt with some exposure to equity
MIPs Education plans and childrens plans

Pre-dominantly equity with some exposure to debt


Balanced funds Retirement plans Growth & Income funds

Asset allocation funds


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Other Funds
Commodity funds
Invest in commodity stocks and futures

Real estate funds


Invest in real estate linked products and in property

International funds
Invest in global ETFs, funds and securities

Fund of funds
Invest in other funds Two layers of management fees

ETFs
Passive funds linked to an index Bought and sold on the exchange
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Basis for Classification

Risk
Sector funds are most risky; money market funds are least risky

Tenor
Equity funds require a long investment horizon; liquid funds are for the short term liquidity needs

Investment objective
Equity funds suit growth objectives; debt funds suit income objectives
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Classification - Asset class


Fund type
Equity Funds Income Funds Money Market Funds (Liquid) Hybrid Funds Commodity Funds Real Estate Funds Fund of Funds Gilt Funds High Yield Debt Funds -

Securities held
Shares

- Bonds / Government securities - Short maturity fixed income instruments Shares & fixed income instruments Gold, commodity stocks and futures Real estate Other funds Government securities Debt instruments with lower credit rating
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Classification - Asset class


Equity Fixed Income Hybrid Special purpose Sector, Diversified Country, Regional, Global Value, Growth, Combination Large cap, Mid cap, Small cap G-Sec, Gilt, High yield Floating rate income MIP, Balanced Fund, Asset Allocation Fund Childrens fund Pension Fund ELSS

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Classification - Management Style


Passive Funds
No active call on stock or proportion Follows a chosen market index in terms of stocks and weightage in the portfolio Index Funds, ETFs follow a passive style

Active Funds
Actively managed by the fund manager Tries to deliver better returns than the market index A particular market index is chosen as benchmark

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Chapter 2 Fund Structure and Constituents

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Mutual Fund Structures

Mutual funds may be structured as a company or as a trust


In a company structure, investors hold shares. In a trust, investors are the beneficiaries. In the UK, closed-end funds are set up as companies and open-end funds as unit trusts. In USA , funds are set up as investment companies.

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Mutual Fund Structure in India

In India, the structure to be followed by mutual funds is specified in Sebis (Mutual Fund) Regulations of 1996.
Three-tier structure of Sponsor, Trust, AMC (Asset Management Company)

Sponsor promotes the fund and sets up the AMC. The mutual fund is the trust supervised by the trustees. Trustees appoint the AMC to manage the funds. Sebis regulations lays down the eligibility norms, role and responsibilities of each constituent.
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Sponsor of a Mutual Fund


The sponsor is the promoter of the mutual fund The role of the sponsor includes
Setting up the trust & AMC and contribute capital Appointing the members of the Board of trustees and AMC Appointing the custodian Seeking regulatory approvals

A sponsor of a mutual fund can be


An Indian company /Bank /Financial institution (Reliance) A Foreign entity (JPMorgan, Fidelity) A Joint venture (ICICI Prudential, Birla Sunlife)

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Regulatory Norms

Sebis regulations for mutual funds has laid down the eligibility norms for a sponsor:
At least 5 years experience in the financial services industry Good financial track record
Positive net worth in the immediately preceding three years

At least 40% of the AMCs capital to be contributed by the sponsor.

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Trustees of a Mutual Fund

The sponsor registers the mutual fund as a trust and appoints the trustees with the approval of SEBI
The trustees can be constituted either as Board of Trustees or Trustee Company Trustees have to meet at least 6 times in a year Trustees are paid a fee for their services

Trustees have fiduciary responsibility to protect the interest of the investors The authority and responsibility of the trustees are laid down in the trust deed
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Role of the Trustees

Registered ownership of investments is with the trust At least two-thirds of the trustees should be independent of the sponsor Trustees of one mutual fund cannot be trustee of another mutual fund
Independent trustee Board approval

Right to seek regular information and remedial action All major decisions need trustee approval
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Asset Management Company (AMC)


The AMC is the investment manager of a mutual fund appointed by the trustees:
Set up by the sponsor as a public or private company through contribution of capital. The investment management agreement lays down the role and responsibilities of the AMC. The AMC reports to the trustees periodically and have to provide all information when ever required.

The creation, marketing and management of mutual fund products is the responsibility of the AMC.
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Regulatory Norms for AMC

The AMC has to be registered with Sebi which has laid down the eligibility norms :
An AMC must have a net worth of at least Rs. 10 crore at all times. 50% of the members of the board have to be independent. The AMC of one mutual fund cannot be the AMC/Trustee of another mutual fund. An AMC cannot engage in any business other than investment management. The AMC must make periodic statutory disclosures to SEBI.

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Outsourced Functions of AMC


The core function of the AMC is the management of the fund portfolio.
Functions other than core activities are outsourced to constituents

The constituents of a mutual fund are appointed to take care of specific activities:
Appointed by the AMC
Custodians are an exception and are appointed by the sponsor directly

Should be registered with SEBI & approved by Trustees Paid a service fee Governed by the agreement entered into with the AMC and Sebis regulations
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Role of Other Constituents

Different constituents and their roles are:


Custodian R & T Agents Banks Auditors Distributors Brokers s Hold funds & securities Keep records & service investor needs Handle collection & payment Audit scheme accounts Distribute fund products to investors Execute security transactions

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Custodians
Custodians hold the cash and securities of the mutual fund and are responsible for the safekeeping of the assets The custodian must be an entity independent of the sponsor The functions of the custodian include:
Complete the transactions, deliver & accept cash & securities Track and complete corporate actions & payouts
Rights, bonus, dividends, & interests Sale & buy back offers, redemptions

Coordination with depository participants (DP) Some custodians may offer fund accounting & valuation services
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R & T Agents
The R&T agents are the record keepers of a mutual fund They operate Investor Service Centers (ISCs) that are official points to accept and process transactions They are primarily responsible to provide investor services and are paid a fee for their services
Issue & redeem units, update unit capital Enable investor transactions Create, maintain and update investor records Bank the payment instruments & notify AMC Process redemption and dividend payouts Send periodic statutory information to investors
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Other Constituents

Banks
Provide collection services Investor cheques / DDs are collected into scheme accounts

Auditors
Audit the books of mutual funds Separate auditors for AMC accounts

Brokers
Execute buying & selling stocks as instructed by the fund managers Give research reports on securities to the AMC
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Distributors
AMCs appoint non-exclusive distributors to sell mutual fund units A distributor can appoint multiple sub-brokers A distributor can be
An individual (IFA - Independent Financial Advisor) Institutions such as banks Non-banking finance companies (NBFC) Broking & distribution companies

IFAs & employees of corporate distributors have to


Clear AMFI Certification Exam Empanel with a mutual fund Take refresher course once in five years
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Take-over and Merger Scheme Take-over


Schemes of one fund are taken-over by another fund.

AMC Take-over
Sponsor of one AMC sells their equity holding to another sponsor.

AMC Merger
Two AMCs merge their operations Structure of AMC and holdings of the sponsors change.

AMC Change
Trustees may terminate one AMC and appoint another.
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Unit holders & Merger, Take-over


Re-organization requires the approval of trustees and SEBI AMC merger/ take-over requires the approval of high court Investors of open-ended schemes
Need not approve the merger / take over Need to be informed advertisements & individual communication Need to given the option to exit without paying exit load

75% of voting rights must approve the reorganization in case of a close-end scheme
Approval sought through postal ballot No response is deemed to be an approval

Key documents are amended after the change


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Chapter 3 Legal and Regulatory Framework

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SEBI - Primary Regulator

All activities of mutual funds are defined and regulated by SEBI Investor complaints redressal is done by trustees, AMC & SEBI UTI came under SEBIs regulation in 2003
Now all the UTI schemes are managed by UTI AMC UTIs Assured returns scheme are under a special undertaking

Role of RBI Bank sponsored mutual funds are regulated by both SEBI & RBI RBI also regulates money markets and gilt markets
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Other Regulators
The ministry of finance is the apex supervisor
SEBI and RBI are governed by Acts of Parliament
(SEBI Act 1992, RBI Act 1949)

Appeals against SEBI are made to the Securities Appellate Tribunal

The Company Law Board (CLB) is the regulator under the Companys Act 1956
AMC & trustee company are formed as companies Complaints against directors are escalated to CLB Dept of company affairs can prosecute the company directors The Registrar of companies ensures compliance
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Other Regulators -2

Indian Trust Act


Mutual funds are set up as trusts Governed by Indian Trust Act,1882 Office of the Public Trustee and Charity Commissioner supervise the Board of trustee company

Stock Exchange
Listing regulations govern the schemes listed on the stock exchange

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Self- Regulatory Organizations


Self-regulatory organizations (SROs) are the second tier in the regulatory structure
Formed as an industry association & registered with regulatory body Granted SRO status by the regulator Given limited powers by the regulator

AMFI is not a Self Regulatory Organization


AMFI is an association of mutual funds It provides guidelines to mutual funds Regulations are issued by SEBI AMFI board is appointed by AMCs and made up of AMC representatives
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Rights of Unit holders


Unit holders of a mutual fund have certain rights
Timely service Receive information that may affect their investments

Units holders with 75% or more of unit capital


Can terminate an AMC Can wind up a scheme

There are limits to investors rights:


No legal recourse to the mutual fund itself No recourse for failure to read the offer document Investors are not shareholders in the AMC Investments are not protected under Companies Act
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Chapter 4 Offer Document

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Source of Information

The offer document (OD)provides all information that an investor needs to evaluate a mutual fund
The OD is first prepared at the time of an NFO It is a legal document Investors are required to read the OD before investing

The AMC prepares the OD with the approval of the trustees


The format is prescribed by Sebi Has to be filed with Sebi for approval Sebi can ask for changes
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Due Diligence Certificate

The AMC is responsible for the accuracy of information in the OD The Due diligence certificate is signed by the compliance officer of the AMC
It is part of the offer document

The due diligence certificate states that


The OD is prepared as per Sebis regulations Information in the OD is accurate All the constituents associated with the mutual fund are registered with Sebi
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Updating the OD

The OD must have relevant information to help make appropriate investment decisions The OD prepared at the time of the NFO will have to be updated for changes Sebi prescribes the frequency with which the OD has to be revised
OD of open ended schemes are revised every two years OD of closed-end schemes do not require revision

(The format and revision rules have been changed by Sebi with effect from June 1, 2008)
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Addendum to OD

The changes in the material information in the offer document is intimated through an addendum
Attached as an appendix to the OD Approved by trustees and notified to Sebi Has to be published in two news papers and displayed in all OPoAs

The information in the addendum is included in the OD when the OD is revised Change in material information includes
Change in sponsor, AMC Change in fundamental attributes, loads, options in the scheme
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Contents of the OD - Risks

The risk in a mutual fund scheme may be standard or scheme specific risks Standard risks are common to all mutual fund schemes
All schemes are subject to market risks Past performance is not indicative of future performance

Scheme specific risks depend upon the investment objective, asset allocation and strategy of a fund
A sector fund has risk of concentration The first scheme of a fund house has the risk of no past history

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Contents of the OD- Constituents

The OD gives background information about the constituents of the mutual fund. Information about the sponsor in the OD includes:
Name and financial history of the past three years Liability of the sponsor for assured return scheme, if any

Information about the trustees includes:


Name and address of the trustees Details of independent trustees Summary of trust deed provision

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Contents of the OD- Constituents

Information about the AMC includes:


Details of the directors Information of the key personnel

Information is provided of other constituents such as custodian, R&T agent and auditor The offer document gives information for the preceding three years Information in the OD is limited to the schemes of the fund house.

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Fundamental Attributes of a Scheme

The fundamental attributes of a scheme define the risk and return characteristics of a scheme
Type of scheme Investment objective Investment Pattern Terms with regard to liquidity Fes and expenses Accounting and valuation and investment norms

The suitability of a scheme for an investors needs depends on its fundamental attributes
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Change in Fundamental Attributes

The fundamental attributes of a scheme may change


Approval of the trustees and Sebi is required Investors need to be informed of the change and given the option to exit without paying exit load Details have to be published in at least two national papers

The OD of a scheme has to be revised The investment by the investor may require review for continued suitability

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Financial Information in the OD

The OD provides information of the performance of existing schemes for the last three years
Financial summary of existing schemes Investor complaints and redressal for existing schemes

The OD provides the details of expenses of existing schemes


Expenses as a percentage of weekly average net assets Variation between estimates and actuals Loads and initial expenses

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Information on Investor Services

The offer document will give information on the services and information that an investor can expect
Process for addressing investor grievance Information that is given and their periodicity

Investors can ask to inspect documents related to the fund


Investment management agreement and Trust deed Annual reports of AMC and schemes Agreements entered into with R&T agent, custodian and other constituents

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Information on Investments

Information on the investment pattern and strategy of the fund


Allocation to asset classes and types of securities No information on specific securities the fund may invest in

Details of the borrowing policy of the fund Details of the investment in the sponsor group companies Policy on inter-scheme transfers and valuation of securities Information on the method of calculating NAV, sale and redemption price

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Operational Details of the Scheme

The OD gives information that is essential for the investor to complete the investment process
The period of NFO The NFO price for subsequent transactions Minimum initial and subsequent investment Plans ,options and loads Availability of forms, payment instruments and submission Investors eligible to invest Facilities such as switch and SIPs Date of commencement of on-going purchase and sale
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Key Information Memorandum (KIM)

KIM is the abridged version of the OD


Must accompany every application form Is updated regularly Key information is available both in the OD and KIM

A first time investor should refer to the OD for information. An existing investor can use the KIM for continuing transactions The format of the KIM is prescribed by Sebi

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Information in the KIM


The KIM contains the crucial information required by an investor
Investment objective, asset allocation Scheme specific operational details Expenses and loads Details of key constituents Performance history of the scheme and its benchmark Investor rights and services

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Chapter 5 Mutual Fund Distribution & Sales Practices

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Types of Investors
Offer document clearly specifies the investors eligible to invest in the mutual fund scheme
Some schemes may have restrictions

Some categories of investors are:


Individuals & Hindu undivided Families (HUF) Companies & Partnership firms Trusts & charitable institutions Banks & Financial institutions Non-banking finance companies (NBFC) Insurance companies Provident funds Mutual funds Foreign Institutional Investors (FII) Non resident Indians (NRI) & Persons of Indian Origin (PIO)
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Features of Investor Categories

Resident investor is the largest segment of investors Institutional investors


Are smaller in number, larger in ticket size

They need to have specific internal approval for investing

FIIS need to register with SEBI before investing Foreign citizens and overseas corporate bodies are not allowed to invest in mutual funds NRIs and PIOs can invest without separate approval from RBI

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Individual Investors

Individual investors require advice to make their investments


Retail or HNI

The documents
PAN mandatory for all investors including NRI KYC norms to be fulfilled for all investments above Rs.50,000

Upto three joint holders are allowed


Complete address to be provided for first holder All communication goes to the first holder

Bank details have to be provided mandatorily


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Institutional Investors

Have specific needs and investment profile


Prudential guidelines

Need Board approval before investment


Approval, Trust Deed, RoC, MoA to be submitted for investment

List of Authorized signatories is mandatory May not require investment advise May not go through intermediaries
Direct sales channels

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Intermediaries
Mutual funds may employ distributors to reach their products (channels) There are non-exclusive individual and institutional channels Individual distributors
Establish personal long term relationship with investors Hand-hold the investor through the process Have evolved as financial planners providing personalized service

Institutional channels
Have large depositor / client base Client acquisition process is standardized
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Features of distribution channels


Individual distributors (IFA)
Agreement with AMC Non-exclusive Have sub-brokers Limited research information to clients

Institutional
Have many employees and sub-brokers Large foot print in terms of branches AMC deals with single entity instead of large number of investors Have established client base & offer multiple products Able to give research based advice
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Appointment of Distributors
AMC appoints the distributor
SEBI approval is not required The sponsor can be a distributor Employees cannot be distributors

The distributor enters into an agreement with the AMC


Terms of appointment Periodicity of commission payment

The distributor is the investors contact with the mutual fund


Copy of KIM to be given along with application to the investor Information to investor that there is no recourse to distributor Units will be allotted to the investor at Public Offer Price
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Commission to Distributors
Primary form of remuneration for the distributor is commission
Commission is split as up-front and trail Commission is paid at the discretion of the fund No maximum / minimum limit prescribed by SEBI Commission is influenced by market practice Equity schemes have higher commission than debt schemes No commission for own investment

Distributors tend to pass the commission to the investor (rebating)


This practice is banned by SEBI

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Guidelines on Selling Practices


Product to be sold keeping the interest of the investor in mind
No specific regulation on investor servicing

AMFI guidelines are:


Mutual funds are not accountable for the sub-brokers activities Distributors should have complete knowledge of offered products They should know the clients need and profile Chosen product must meet the clients requirements They should encourage good long-term investment habits They should provide good & efficient service

Mutual funds should follow SEBI guidelines for marketing


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Chapter 6 Accounting, Valuation, and Taxation

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Unit Capital and Portfolio Value


Number of outstanding units multiplied by face value per unit is the unit capital.
This is shown on the liability side of the balance sheet. This is also called the corpus of the scheme.

The investment portfolio, along with any accrued income and receivables represents the assets of the scheme. A scheme has some short-term liabilities, payables and accrued expenses. Nets assets of a scheme are computed as assets minus liabilities. Net asset value (NAV) is a per unit representation of a schemes net assets and is computed as
Net assets/Number of units outstanding

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NAV Computation and Posting

NAV is calculated every business day, also called as valuation day, for all mutual fund schemes. NAV has to be posted on the AMFI website every business day by 9 pm. NAV is impacted by the following factors:
Purchase and sale of investments by fund managers Valuation of investments held in the portfolio Valuation of other assets and liabilities of the scheme Sale and purchase of units by investors
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NAV Representation
Expense and income are accrued on a daily basis. Calculation of NAV includes all incomes and expenses accrued until the valuation date. Any transaction that impacts the NAV by more than 1% should not be excluded in computation.
Any errors to computation to be rectified in 7 business days.

NAV is rounded off to 4 decimal points for liquid funds, and two decimal points for other schemes. NAV is published in the newspapers for investor information.

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Applicable NAV

The price at which investors can buy or sell their units depends on the NAV after adjustment for the load. Applicable NAV depends on the cut-off time for the transaction.
For all non-liquid schemes, the cut-off time for both purchase and redemption is 3 pm. The cut-off time for liquid fund purchases is 12 noon

NAV is computed on business days for all schemes.


for liquid funds, NAV is computed every calendar day.

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Loads

The price at which an investor purchases or redeems a mutual fund unit is based on the NAV, adjusted for load. Load refers to expenses incurred on marketing and distribution of a scheme that can be recovered from the price. Loads are of two types: Entry load applies for purchases; exit load applies for redemptions. Entry load means the investor pays a purchase price that is more than the NAV, by the amount of load. Exit load means the investor receives a redemtpion price that is less than the NAV, by the amount of load.
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Entry Load

An investor wants to invest Rs 5000 in XYZ Growth Fund which has an NAV of Rs 45. The investor also has to pay an entry load of 2.25%. The price at which the units will be allotted is
NAV + Load = Rs 45+ 2.25% of Rs 45

= Rs 45+ Rs 1.0125 = Rs 46.0125

The investor will be allotted 108.666 units. (5000 / 46.0125).


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SEBI Regulations

SEBI regulations impose a limit on the maximum load that a fund can charge. An open ended fund can charge a maximum load of 7%. A closed end fund can charge a maximum load of 5%. The redemption price cannot be less than 93% of the purchase price.
If the NAV is Rs 10, the maximum purchase price can be Rs10.70. The minimum redemption price can be Rs 9.30.

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Expenses
Only scheme-specific expenses can be charged to the fund. These expenses are:
Investment management fees Marketing and selling expenses Fees of custodians Fees of registrar and transfer agents Audit fees Trustee fees Costs relating to investor communication Costs of statutory advertisements

Expenses incurred on AMC offices, staff salaries and technology are borne by AMC and not charged to the scheme.
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Limits to Expenses
The limits for expenses charged to the fund are as per the following slabs:
2.5% on the first Rs100 crore of net assets 2.25% on the next Rs300 crore of net assets 2% on the next Rs300 crore of net assets 1.75% on the balance net assets

The net assets in the above limit are taken as weekly average net assets. Debt funds are required to charge 0.25% lower in each of the above slabs. Fund of funds can charge a maximum of 0.75% only as recurring expenses.
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Investment Management Fees

The limits on investment management fees are as follows:


1.25% on the first Rs. 100 crore of net assets 1% on the remaining net assets over and above Rs.100 crore.

Example A fund has net assets of Rs 800 crore. What is the limit on the investment management fees that the AMC can charge to the fund?
For the first 100cr @ 1.25% = 1.25 crore On the balance 700cr @ 1% = 7 crore

Total fees that the AMC can charge = 8.25 crore


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Accounting Policies

Mutual funds can distribute dividends only out of realized profits. Dividends, bonus and rights should be recognized on the ex-date. Average cost must be used to determine the holding cost of the securities. Investments must be accounted on the transaction date, not on the settlement date. Scheme-wise annual reports have to be drawn according to SEBI approved format

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Valuation Policies

Uniform policies of valuation are set by AMFI and approved by SEBI. Valuation policies to be disclosed to investors in the offer document. The fair value of a security is the closing price at the markets on the valuation date, in case of liquid securities. In the case of illiquid securities, a valuation methodology is adopted to arrive at the fair value. Valuation of the mutual fund portfolio is done on every business day.
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Valuation of Equity Shares


Equity shares are valued at the last traded price on the stock exchange where they are principally traded. If not traded, the closing price of the previous trading date can be taken.
Not be more than 30 days before the valuation date.

A thinly traded share is defined as one where, in the preceding 30 days:


The traded value is less than Rs 5 lakh, and The traded volume is less than 50,000 shares

Thinly traded shares can be valued at the last traded price or at fair valuation approved by the trustees.
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Valuation of Debt Securities


Closing price can be taken if it is not over 15 days old. A debt security is thinly traded, if its traded value in the previous one month is less than Rs.5 crore. Fair valuation for debt securities is done based on the yield provided by Crisil and used uniformly across the industry.
Government securities are valued using the Crisil gilt valuer. Corporate securities are valued using the Crisil bond valuer.

If a corporate security is not of investment grade (credit rating below BBB) it is valued at a discount of 25% on its face value. Money market securities with days to maturity not exceeding one year, are not marked to market.
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Illiquid Securities
An illiquid security is defined as one that is thinly traded, non-traded or unlisted. If a security is illiquid, it cannot be accurately valued. Such securities cannot exceed:
15% of net assets in an open-ended scheme. 20% of net assets in a closed end scheme.

Mutual funds cannot


transfer illiquid securities between schemes purchase illiquid securities from sponsors or associate companies.

Mutual funds disclose on a half-yearly basis:


the holding of illiquid securities, scheme-wise in amount and as a percentage of net assets.

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Taxation

A mutual fund is exempted from income tax under Section 10(23D) of the Income Tax Act. Mutual funds distribute income as dividend, or allow the appreciation to accumulate.
They offer dividend and growth options to investors.

Mutual fund dividends are exempt from tax, in the hands of the investors as per Section 10(35) of the IT Act.
There is no tax deduction at source (TDS) on mutual fund dividends.

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Taxation of Dividends

Dividends are subject to dividend distribution tax (DDT)


for equity-oriented schemes holding less than 65% in equity

DDT is payable at the rate of


12.5% for investments by individuals and Hindu undivided families (HUFs) 20% for investments by all other categories 25% for all categories in a liquid scheme

DDT has to be paid directly by the fund, before distribution of the dividend to the investor.
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Taxation of Capital Gains


Capital gain or loss realised:
Within 12 months is called short-term capital gain or loss. After 12 months is called long-term capital gain or loss.

For an equity oriented fund,


STCG is taxable at 15% LTCG is exempted from tax

For non-equity oriented funds


STCG is taxable at the marginal rate of tax of the investor and LTCG is taxable at 10% without indexation or 20% with indexation.

Securities transactions tax (STT) is payable at 0.25% by investors on redeeming units of an equity-oriented fund.
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Chapter 7 Investor Services

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Investor Information

The investor provides information to the mutual fund at the time of investment
Mandatory information to be provided as required by Sebi

The application form is used to buy units


Available along with the KIM Instructions for filling up application is available in the KIM & Offer Document

The completed application from has to be submitted at the AMCs office or ISC
Distributors assist in filling up and submitting application forms
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Documents for Investing

The Offer document and KIM describes the investment process to be followed by each category of investors Individual investors have to provide PAN details with the applications
Maximum of three joint holders are allowed in a mutual fund

Institutional investors must be permitted by their charter to invest in mutual funds


Approval of the governing body must accompany the application form signed by the authorized signatories

NRIs and FIIs have been given blanket permission to invest by RBI
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Payment Instruments

The application form for buying units of a mutual fund must be accompanied by a payment instrument
Minimum investment in a scheme

The accepted payment instruments are mentioned in the offer document/KIM of the scheme
Cheques and Demand drafts Instruments not accepted as valid

Source of investment for NRI/FII investment is important


NRO, NRE, FCNR accounts & FIRC Repatriation of redemption proceeds
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Investor Folio and Account Statement

The information provided in the application form is captured under a folio created
Consolidation of holdings Creation of multiple folios Use of transaction slips for additional purchase

The proof of investment in a mutual fund is the account statement


Gives details of financial and non-financial transactions

Mutual funds allow investors to use a common application form to invest in different schemes of the fund house
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Redemption of Investment
Investors can specify their redemption request in units or amount
Partial redemption and full redemption

The redemption request has to signed by the holders according to their mode of holding
Authorized signatories to sign for institutional investors

The redemption proceeds are paid into the bank account of the first holder
Mandatory to provide bank account details in the application form Repatriation of NRI redemption will depend upon source of funds The redemption proceeds have to be paid within 10 working days

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Investment Options-I

Investment options help investors invest and structure returns according to their specific requirements Automatic Reinvestment Plans
Dividend re-invested and not paid-out Gives compounding benefits

Systematic Investment Plans


Periodic investment of fixed amounts Allows rupee cost averaging

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Investment Options-II

Systematic Transfer Plans


Allows periodic transfer of funds between schemes Transaction is done at applicable NAV Loads and taxes apply

Systematic Withdrawal Plans


Is used by investors who want regular income Reduces the units standing to the credit of the investor Loads and taxes apply

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Facilities Offered by Mutual Funds

On-line transactions with the mutual funds Cheque- writing facility


Third party cheques cannot be written

Pledging of units
Units under lien cannot be redeemed

Nomination facility
Can be modified by the investor

Periodic information to the investor on performance, portfolio and markets


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Chapter 8 Investment management

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Investment Portfolio of a Mutual Fund

The portfolio of a mutual fund is a collection of securities and financial instruments


Selection of securities depends upon the investment objective of the fund

Equity and debt are the two broad categories of securities used to create a fund portfolio
Dynamics of the markets and strategies used by fund managers Types of instruments Sebis regulations govern the investments made by a fund
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Types of Equity Instruments

Ordinary Equity Shares


Implies ownership No guarantee of principal or income Capital appreciation is the primary attraction

Preference Shares
Dividend paid at fixed rates May be cumulative and participating No voting rights

Equity Warrants
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Categorization of Equity Instruments- I

Based on market capitalization


Number of shares X Current market price Large, mid and small cap shares Varying risk return profile of and suitability of each category The objective of the fund would decide the selection of stocks Separate indices track each category

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Categorization of Equity Instruments- II

Categorization based on earnings


Relationship between earnings and market price

The ratio of the market price to earnings per shares is the P/E ratio
Indicates the markets willingness to pay for the earning potential High for growing companies Positively related to the market price of the shares

The ratio of dividend per share to the market price is the dividend yield of a share
Inversely related to the market price of the share
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Categorization of Equity Instruments- III

Growth stocks
Earnings grow at faster than average rates and are ploughed back Have high P/E ratios and low dividend yields

Value stocks
Undervalued shares with low P/E and high dividend yields Potential to earn profits when such shares find favor with markets

Cyclical stocks
Earnings are linked to economic cycles Have low P/E and high dividend yield
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Equity Fund Management Strategies

Passive fund management style


Strategy of investing in an indexs shares in the same proportion No stock selection or portfolio rebalancing except when the index changes Costs of investments is kept low

Active fund management style


Aims at bettering the index return through active stock selection and portfolio rebalancing Higher fund management cost
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Equity Fund Management Tools

Fundamental analysis
Research into qualitative and quantitative factors that affect the performance of the company Economy-industry-company analysis

Technical analysis
Use of price data to identify future price movement patterns

Quantitative analysis
Use of mathematical decision making models for fund management

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Equity Fund Management Functions

Fund Managers
Take decisions on style, allocation and stock selection

Security Analysts
Track companies in which the fund has invested and potential opportunities Use fund management tools like fundamental and technical analysis

Security Dealers
Members of the stock exchange Execute buy and sell orders for the fund
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Features of Debt Instruments

Debt instruments represent a loan


Can be bought from issuer or in the secondary markets

Par value is the principal amount borrowed which is repaid on redemption Coupon is the rate of interest payable on the par value Maturity is the term of borrowing
Call and put option modify the maturity

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Classification of Debt Instruments

Based on issuer
Differ in terms of credit quality

Based on tenor
Instruments with less than one year to maturity are called money market instruments Long-term borrowings are issued for up to 30 years

Based on interest payments


Fixed and floating rates of interest Zero coupon and deep discount bonds
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Money Market Instruments

Certificate of Deposits
Unsecured borrowings of banks

Commercial papers
Credit rated paper to meet working capital requirements of companies

Treasury bills
Issued by the government for tenors of 91,182 and 364 days

Call and Notice markets & Repos


Borrowings for overnight to 14 days CBLOs are securitized repos with liquidity
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Long-Term Debt Instruments

Corporate Debentures are secured credit rated instruments


Listed on stock exchanges if publicly issued Usually privately placed May be fixed or floating rate bonds May be issued as convertible debentures

Government securities are issued by RBI through auctions


Issued for maturities between 1 to 30 years

Bonds issued by FIs are unsecured borrowings


May have tax concessions
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Debt Fund Portfolio

A debt funds portfolio depends upon its investment objective


Liquid funds invest in money market securities Income funds invest in a combination of long-term debt securities Gilt funds invest only in government securities Dynamic bond funds actively manage the maturity of the portfolio FMPs invest in securities with maturities that match the tenor of the fund

Mutual funds do not give loans

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Bond Yield Measures

Current yield of a bond is the coupon as a percentage of current market price If we bought a 8% bond at Rs. 110, the current yield is = (8/110)*100 = 7.27% The YTM is the rate at which present value of future cash flows equals the current market price Given price, YTM can be calculated through iteration Given YTM, price can be computed, using the YTM rate to discount the future cash flows.
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Risks in Debt Securities

Interest rate risk is the increase or decrease in the price of bonds with a change in rates Credit risk is the risk of default in meeting obligations of interest and repayment
Government securities are not credit rated The credit risk of other bonds are measured by credit rating Credit spread is the excess interest paid by other borrowers over what the government is paying for the same tenor Higher the credit rating, lower is the spread
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Risks in Debt Securities

Reinvestment risk
The risk of reinvestment of interest income at lower rates Affects total income

Liquidity risk
The risk of not being able to sell the bond close to its value

Inflation Risk
The reduction in the value of fixed payments

Call risk
The redemption by the issuer of a high interest debt prior to maturity
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Managing Interest Rate Risk

The sensitivity of the price of a bond to changes in interest rates is measured by a number called duration
Interest rate risk is different across bonds Duration is not equal to the tenor of the bond

If duration is 3 years, and interest changes by 1%, price of the bond will change in the opposite direction, by 3%

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Debt Fund Management Strategies

Buy and hold


Portfolio exposed to interest rate risk

Duration management
increase duration if rates are expected to fall decrease duration if rates are expected to rise

Credit selection
invest in low grade bonds that are likely to be upgraded

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Investment in Derivatives

Derivatives derive their value from an underlying security


Futures Options Swaps

Derivatives are used to rebalance or hedge their portfolios Sebis regulations require mutual funds to inform the investors before using derivatives
Explain the benefits in the offer document with simple examples

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Investment Regulations

A mutual funds investment is governed by Sebis regulations which aim at


A minimum level of diversification Protecting the investors interests

A mutual fund can


Invest only in marketable securities Investment only on delivery basis Mutual funds can borrow up to 20% of net assets for a period not exceeding 6 months
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Investment Restrictions
A mutual fund under all its schemes, cannot hold more than 10% of the paid-up capital of a company Not more than 10% of its NAV in a single company
Exceptions: Index Funds and Sectoral funds

Debt instruments with investment grade rating of a single issuer cannot exceed 15% of the net assets
Can be extended to 20%, with the approval of the trustees

Investment in unlisted shares cannot exceed


5% of net assets for an open-ended scheme 10% of net assets for a close-ended scheme

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Investment in Group Companies

A mutual fund scheme cannot invest in unlisted securities of the sponsor or an associate or group company of the sponsor A mutual fund scheme cannot invest in privately placed securities of the sponsor or its associates Investment by a scheme in listed securities of the sponsor or associate companies cannot exceed 25% of the net assets of the scheme

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Inter-Scheme Transfers

Inter-scheme transfers happen on a delivery basis, at market prices Such transfers should not result in significantly altering the investment objectives of the schemes involved Such transfer should not be of illiquid securities, as defined in the valuation norms One scheme can invest in another scheme, up to 5% of its net assets
No management fee is payable on these investments

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Chapter 9 Return, Risk, Performance and Fund Selection

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Returns From Mutual Funds

The components of the returns from a mutual fund investment are


Dividends Capital Gains

Dividends are paid out to investors who choose the dividend option Capital gains is the difference between the acquisition price and sale price of units
Realized when units are sold

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Methods of Return Calculation

The methods of calculating returns from mutual funds are


Change in NAV method Total Return Method Return on Investment method Compounded annual growth rate method (CAGR)

The suitable method of calculating returns depends on the investment objective of the investor The performance data published by mutual funds use the CAGR method for the growth option of a scheme
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Change in NAV Method

Calculates the return between two dates Example:


NAV of a fund was Rs. 23.45 at the beginning of a year NAV of the fund was Rs. 27.65 at the end of the year

Percentage change in NAV = (27.65 23.45)/23.45 *100 = 17.91% This method considers only the change in NAV between two dates
Dividend paid, if any, is not considered
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Total Return Method


Calculates the return by considering both dividend and capital appreciation. Example
Investor bought units of a mutual fund scheme at a price of Rs.12.45 per unit He redeems the investment a year later, at Rs. 15.475 per unit During the year, he also receives dividend at 7%

The rate of return on his investment can be computed as = ((15.475 12.45) + 0.70)/12.45 x 100 = (3.725/12.45) x 100 = 29.92% Does not consider the re-investment of dividend
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Return on Investment (RoI) Method

The RoI is calculated using the formula


(Value of holdings at the end of the period - value of holdings at the beginning of the period)/ value of holdings at the beginning of the period x 100 Value of holdings at the beginning of the period = number of units at the beginning x begin NAV Value of holdings end of the period = (number of units held at the beginning + number of units re-invested) x end NAV Number of units re-invested = dividends/ex dividend NAV

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RoI Method - Example

An investor buys 100 units of a fund at Rs. 10.5 on January 1, 2007. On June 30, 2007, he receives dividends at the rate of 10%. The ex-dividend NAV was Rs. 10.25. On December 31, 2007, the funds NAV was Rs. 12.25.
The begin period value of the investment is = 10.5 x 100 = Rs. 1050 Number of units reinvested = 100/10.25 = 9.756 units End period value of investment = 109.756 x 12.25 = Rs. 1344.51 The return on investment =(1344.51-1050)/1050 x 100 = 28.05%
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Compounded Annual Growth Rate

CAGR is the rate at which investment has grown from begin point to the end point, on an annual compounding basis
V0(1+r)n = V1 r =((V1/V0)1/n)-1

Where
V0 is the value at the start V` is the value at the end n is the holding period in years r is the CAGR
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Expense and Income Ratios

Expense ratio is calculated as


Total expenses/Average net assets X 100 It is a measure of efficiency of the fund Important in the evaluation of debt and liquid funds Fund size and account size has an impact on the expense ratios

Income ratio is calculated as


Net investment income/Average net assets Useful for evaluating income-oriented funds

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Turnover Ratio

Portfolio turnover ratio is calculated as


Value of assets purchased or sold/Net Assets x 100 Measures the trading activity in the portfolio A turnover rate of 200% means the portfolio was turned over twice

A high portfolio turnover ration implies higher transaction costs


All costs related to trading are called transaction costs

Transaction costs have to evaluated in the light of the type of scheme and investment objective

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Portfolio Characteristics

Size of the fund


A larger fund enjoys benefits of scale, a smaller fund is more agile

Cash holdings of a fund


A high cash holding may impair performance in a rising market but protect downside in a falling market

Funds hold some cash for redemption needs


Deploying funds collected in an NFO may take time

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Comparison of Mutual Fund Performance

The performance of mutual is compared to


A benchmark Peer group average Other financial products

The market index is used as a benchmark


Choice depends on the investment objective of the fund

The performance of a fund has to be compared with other similar funds to be relevant

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Benchmark Comparison

Market benchmarks are independent portfolios that are not managed by any fund manager A funds chosen benchmark has to be mentioned in the offer document
Has to reflect the portfolio and investment objective of the fund Can be changed with approval of the trustees

Mutual fund performance is measured relative to the benchmark


Investors look for absolute returns

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Peer Group Comparison

The factors to be considered while selecting funds for peer group comparison are:
They should invest in the same asset class Investment pattern must be similar The funds must have comparable investment objective The size and quality of assets must be comparable

Funds are ranked by grouping similar funds

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Regulations for Return Computation


Returns should be calculated using the NAV of the growth option
Load should not be included

Returns have to be computed for 1,3,5,10 years and since inception Returns for periods less than one year have to be absolute returns
Liquid fund returns alone can be annualized for periods of less than 1 yr

Returns for periods more than on year has to calculated using CAGR Returns have to be disclosed for the fund and benchmark

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Chapter 9 Return, Risk, Performance and Fund Selection

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Returns From Mutual Funds

The components of the returns from a mutual fund investment are


Dividends Capital Gains

Dividends are paid out to investors who choose the dividend option Capital gains is the difference between the acquisition price and sale price of units
Realized when units are sold

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Methods of Return Calculation

The methods of calculating returns from mutual funds are


Change in NAV method Total return Method Return on investment method Compounded annual growth rate method (CAGR)

The suitable method of calculating returns depends on the investment objective of the investor The performance data published by mutual funds use the CAGR method for the growth option of a scheme
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Change in NAV Method

Calculates the return between two dates Example:


NAV of a fund was Rs. 23.45 at the beginning of a year NAV of the fund was Rs. 27.65 at the end of the year

Percentage change in NAV = (27.65 23.45)/23.45 *100 = 17.91% This method considers only the change in NAV between two dates
Dividend paid, if any, is not considered
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Total Return Method


Calculates the return by considering both dividend and capital appreciation. Example
Investor bought units of a mutual fund scheme at a price of Rs.12.45 per unit He redeems the investment a year later, at Rs. 15.475 per unit During the year, he also receives dividend at 7%

The rate of return on his investment can be computed as = ((15.475 12.45) + 0.70)/12.45 x 100 = (3.725/12.45) x 100 = 29.92% Does not consider the re-investment of dividend
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Return on Investment (RoI) Method

The RoI is calculated using the formula


(Value of holdings at the end of the period - value of holdings at the beginning of the period)/ value of holdings at the beginning of the period x 100 Value of holdings at the beginning of the period = number of units at the beginning x begin NAV Value of holdings end of the period = (number of units held at the beginning + number of units re-invested) x end NAV Number of units re-invested = dividends/ex dividend NAV

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RoI Method - Example

An investor buys 100 units of a fund at Rs. 10.5 on January 1, 2007. On June 30, 2007, he receives dividends at the rate of 10%. The ex-dividend NAV was Rs. 10.25. On December 31, 2007, the funds NAV was Rs. 12.25.
The begin period value of the investment is = 10.5 x 100 = Rs. 1050 Number of units reinvested = 100/10.25 = 9.756 units End period value of investment = 109.756 x 12.25 = Rs. 1344.51 The return on investment =(1344.51-1050)/1050 x 100 = 28.05%
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Compounded Annual Growth Rate

CAGR is the rate at which investment has grown from begin point to the end point, on an annual compounding basis
V0(1+r)n = V1 r =((V1/V0)1/n)-1

Where
V0 is the value at the start V` is the value at the end n is the holding period in years r is the CAGR
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Expense and Income Ratios

Expense ratio is calculated as


Total expenses/Average net assets x 100 It is a measure of efficiency of the fund Important in the evaluation of debt and liquid funds Fund size and account size has an impact on the expense ratios

Income ratio is calculated as


Net investment income/Average net assets Useful for evaluating income-oriented funds

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Turnover Ratio

Portfolio turnover ratio is calculated as


Value of assets purchased or sold/Net Assets x 100 Measures the trading activity in the portfolio A turnover rate of 200% means the portfolio was turned over twice

A high portfolio turnover ratio implies higher transaction costs


All costs related to trading are called transaction costs

Transaction costs have to be evaluated in the light of the type of scheme and investment objective

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Portfolio Characteristics

Size of the fund


A larger fund enjoys benefits of scale, a smaller fund is more agile

Cash holdings of a fund


A high cash holding may impair performance in a rising market but protect downside in a falling market

Funds hold some cash for redemption needs


Deploying funds collected in an NFO may take time

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Comparison of Mutual Fund Performance

The performance of mutual is compared to


A benchmark Peer group average Other financial products

The market index is used as a benchmark


Choice depends on the investment objective of the fund

The performance of a fund has to be compared with other similar funds to be relevant

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Benchmark Comparison

Market benchmarks are independent portfolios that are not managed by any fund manager A funds chosen benchmark has to be mentioned in the offer document
Has to reflect the portfolio and investment objective of the fund Can be changed with approval of the trustees

Mutual fund performance is measured relative to the benchmark


Investors look for absolute returns

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Peer Group Comparison

The factors to be considered while selecting funds for peer group comparison are:
They should invest in the same asset class Investment pattern must be similar The funds must have comparable investment objective The size and quality of assets must be comparable

Funds are ranked by grouping similar funds

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Regulations for Return Computation


Returns should be calculated using the NAV of the growth option
Load should not be included

Returns have to be computed for 1,3,5,10 years and since inception Returns for periods less than one year have to be absolute returns
Liquid fund returns alone can be annualized for periods of less than one year

Returns for periods more than one year has to calculated using CAGR Returns have to be disclosed for the fund and benchmark

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Risk in Mutual Fund Investment

Risk arises when actual returns are different from expected returns
Historical average is a good proxy for expected return

Risk in equity funds depends upon the portfolio characteristics, strategy and fund managers ability
Maybe company specific or market risk Equity investing is profitable over the long-term

Risk in debt funds arises due to interest rate and credit risks

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Measures of Risk

Standard deviation measures the fluctuation of actual return around the mean
Preferred because it is a measure of total return Drawback is that it uses past performance data

Beta measures the sensitivity of a funds return to changes in the market index
Funds with high beta are more volatile Measures only market risk

Ex-marks or R-squared measures the extent to which the fluctuation in returns can be explained by market movements
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Other Measures of Risk

Risk Adjusted Return considers risk premium in relation to the risk of the fund
Sharpe ratio & Treynor ratio

Alpha is the excess return generated by a fund over what is justified by its risk measured by beta The P/E ratio of a fund can be used to gauge its risk Interest rate risk and credit risk are the main risks in a debt fund
Average maturity and duration measures interest rate risk Credit rating and NPAs measure credit risk
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Equity Fund Selection

Fund category
Suitability to investor objective

Investment style
Growth vs Value

Age of the fund


Experience and consistency preferred to new fund

Fund management experience Size of the fund


Larger funds have lower costs

Performance and risk


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Equity Fund Portfolio Evaluation

Percentage holding in cash Concentration in portfolio Market capitalisation of the fund Portfolio turnover Risk Statistics
Beta Ex-Marks Gross dividend yield Funds with low beta, high ex-marks and high gross dividend yield is preferable
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Selection of Debt Funds

Total return rather than YTM is important Expense very important


High expense ratios lead to yield sacrifice

Credit quality
Better the rating of the holdings, safer the fund

Average maturity
Higher average maturity means higher duration and interest rate risk

Tax implication have to be considered while selecting options

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Selection of Liquid Funds

Relative yield of the fund is important


Trade-off between yield and credit quality

Protection of principal invested


NAV fluctuation limited due to low duration and low levels of interest rate risk.

Credit quality of portfolio Low expense ratio Investor composition and size of the fund

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Selection of Balanced Funds

Evaluation and selection criteria would depend upon the funds equity or debt orientation
Returns ,risk , cost will depend on this orientation

Portfolio will have lower ex-marks and beta


Average maturity of the debt component indicates the risk

Portfolio balance should be maintained in line with investment objectives


Tax status will depend upon the portfolio composition

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