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MUTUAL FUNDS

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A mutual fund is an investment company that sells shares and uses the proceeds to manage a portfolio of securities.

The money thus collected is then invested in capital market instruments such as shares, debentures and other securities.

The income earned through these investments and the capital appreciation realized are shared by its unit holders in proportion to the number of units owned by them.

It is a common pool of money into which investors place their contributions that are to be invested in different types of securities in accordance with the stated objective.

MUTUAL FUNDS

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BENEFITS OF MUTUAL FUNDS

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Liquidity Denomination Intermediation Diversification Cost Advantage Managerial expertise Professional Management Convenient Administration Return Potential Transparency Flexibility Choice of schemes Tax benefits Well regulated

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Disadvantages of mutual funds

Costs Control Not in the Hands of an Investor

No Customized Portfolios

Difficulty in Selecting a Suitable Fund Scheme

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History of Mutual Fund

The concept of mutual fund by UTI in the year 1963. Though the growth was slow, but it accelerated from the year 1987 when non-UTI players entered the industry.

The mutual fund industry can be broadly put into four phases according to the development of the sector.

First Phase - 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament.

The first scheme launched by UTI was Unit Scheme 1964.

In 1978 UTI was de-linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative control in place of RBI.

At the end of 1988 UTI had Rs.6,700 crores of assets under management.

Second Phase - 1987-1993 (Entry of Public Sector Funds)

SBI Mutual Fund was the first followed by Canbank Mutual Fund (Dec 1987)

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Punjab National Bank Mutual Fund (Aug 1989), Indian Bank Mutual Fund (Nov1989).

Bank of India (Jun 1990), LIC in 1989 and GIC in 1990.

Bank of Baroda Mutual Fund (Oct 1992).

The end of 1993 marked Rs.47,004 as assets under management.

Third Phase - 1993-2003 (Entry of Private Sector Funds)

A new era started in the Indian mutual fund industry, With the entry of private sector funds in 1993

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The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996

At the end of January 2003, there were 33 mutual funds with total assets of Rs. 1,21,805 crore.

The Unit Trust of India with Rs.44,541 crore (Asset value)

Fourth Phase - since February 2003

This phase had bitter experience for UTI. It was bifurcated into two separate entities. One is the Specified Undertaking of the Unit Trust of India with AUM of Rs.29,835 crores (as on January 2003).
The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and functions under the Mutual Fund Regulations.

With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs.76,000 crores of AUM and with the setting up of a UTI Mutual Fund

Classification of mutual funds

Open-end Funds | Closed-end Funds
Open-end Funds:Funds that can sell and purchase units at any point in time are classified as Open-end Funds. The
fund size (corpus) of an open-end fund is variable (keeps changing) because of continuous selling (to investors) and repurchases (from the investors) by the fund. An open-end fund is not required to keep selling new units to the investors at all times but is required to always repurchase, when an investor wants to sell his units. The NAV of an open-end fund is calculated every day.

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Closed-end Funds:Funds that can sell a fixed number of units only during the New Fund Offer (NFO) period are known as Closed-end Funds. The corpus of a Closed-end Fund remains unchanged at all times. After the closure of the offer, buying and redemption of units by the investors directly from the Funds is not allowed. However, to protect the interests of the investors, SEBI provides investors with two avenues to liquidate their positions:
1.

Closed-end Funds are listed on the stock exchanges where investors can buy/sell units from/to each other. The trading is generally done at a discount to the NAV of the scheme. The NAV of a closed-end fund is computed on a weekly basis (updated every Thursday). Closed-end Funds may also offer "buy-back of units" to the unit holders. In this case, the corpus of the Fund and its outstanding units do get changed.

2.

Load Funds | No-load Funds

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Load Funds

Mutual Funds incur various expenses on marketing, distribution, advertising, portfolio churning, fund manager's salary etc. Many funds recover these expenses from the investors in the form of load. These funds are known as Load Funds. A load fund may impose following types of loads on the investors:
1.

Entry Load - Also known as Front-end load, it refers to the load charged to an investor at the time of his entry into a scheme. Entry load is deducted from the investor's contribution amount to the fund.
Exit Load - Also known as Back-end load, these charges are imposed on an investor when he redeems his units (exits from the scheme). Exit load is deducted from the redemption proceeds to an outgoing investor. Deferred Load - Deferred load is charged to the scheme over a period of time. Contingent Deferred Sales Charge (CDSC) - In some schemes, the percentage of exit load reduces as the investor stays longer with the fund. This type of load is known as Contingent Deferred Sales Charge.

2.

3.

4.

No-load Funds
All those funds that do not charge any of the above mentioned loads are known as No-load Funds.

Mutual fund types

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Types of Funds

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Existing Funds

Open-ended funds (OEF) & Closed ended funds (CEF)

Growth, income & Hybrid Equity, Debt and Balance Load & No-Load Guaranteed & Non- Guaranteed Capital Protection Oriented

New Generation Mutual Funds

Fund of Fund
Real Estate fund Asset allocation fund Exchange Traded Fund

Commodity fund Derivative Fund Tax-exempt & Non tax-exempt Fund.

Types of mutual funds

1. Equity funds

Equity funds are considered to be the more risky funds as compared to other fund types, but they also provide higher returns than other funds. It is advisable that an investor looking to invest in an equity fund should invest for long term i.e. for 3 years or more. There are different types of equity funds each falling into different risk bracket. In the order of decreasing risk level, there are following types of equity funds: a) b) c) Growth funds Index funds Specialty funds

Types of Equity funds

Aggressive Growth / Capital Appreciation Funds - In Aggressive Growth Funds, fund managers aspire for maximum capital appreciation and invest in less researched shares of speculative nature. Because of these speculative investments Aggressive Growth Funds become more volatile and thus, are prone to higher risk than other equity funds. Growth funds - Growth Funds also invest for capital appreciation (with time horizon of 3 to 5 years) but they are different from Aggressive Growth Funds in the sense that they invest in companies that are expected to outperform the market in the future. Without entirely adopting speculative strategies, Growth Funds invest in those companies that are expected to post above average earnings in the future. Index funds - Index Funds have the objective to match the performance of a specific stock market index. The portfolio of these funds comprises of the same companies that form the index and is constituted in the same proportion as the index. Equity index funds that follow broad indices (like S&P CNX Nifty, Sensex) are less risky than equity index funds that follow narrow sectoral indices (like BSEBANKEX or CNX Bank Index etc). Narrow indices are less diversified and therefore, are more risky. Specialty funds - Specialty Funds have stated criteria for investments and their portfolio comprises of only those companies that meet their criteria. Criteria for some specialty funds could be to invest / not to invest in particular regions / companies. Specialty funds are concentrated and thus, are comparatively riskier than diversified funds.

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2.

Hybrid funds

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Hybrid funds are those funds whose portfolio includes a blend of equities, debts and money market securities. Hybrid funds have an equal proportion of debt and equity in their portfolio. There are following types of hybrid funds in India: Growth & Income funds - Funds that combine features of growth funds and income funds are known as Growth-and-Income Funds. These funds invest in companies having potential for capital appreciation and those known for issuing high dividends. The level of risks involved in these funds is lower than growth funds and higher than income funds. Asset allocation funds - Mutual funds may invest in financial assets like equity, debt, money market or non-financial (physical) assets like real estate, commodities etc.. Asset allocation funds adopt a variable asset allocation strategy that allows fund managers to switch over from one asset class to another at any time depending upon their outlook for specific markets. Balanced Fund- Investment in more than one asset class Debt and Equity in various proportions. Primary objective : hybrid ( regular income as well as capital appreciation).

3.

Debt Funds

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Funds that invest in medium to long-term debt instruments issued by private companies, banks, financial institutions, governments and other entities belonging to various sectors (like infrastructure companies etc.) are known as Debt / Income Funds. Debt funds are low risk profile funds that seek to generate fixed current income (and not capital appreciation) to investors. In order to ensure regular income to investors, debt (or income) funds distribute large fraction of their surplus to investors. Although debt securities are generally less risky than equities, they are subject to credit risk (risk of default) by the issuer at the time of interest or principal payment. To minimize the risk of default, debt funds usually invest in securities from issuers who are rated by credit rating agencies and are considered to be of "Investment Grade". Debt funds that target high returns are more risky.

High yield Debt Funds

The risk of default is present in all debt funds, and therefore, debt funds generally try to minimize the risk of default by investing in securities issued by only those borrowers who are considered to be of "investment grade". But, High Yield Debt Funds adopt a different strategy and prefer securities issued by those issuers who are considered to be of "below investment grade". The motive behind adopting this sort of risky strategy is to earn higher interest returns from these issuers. These funds are more volatile and bear higher default risk, although they may earn at times higher returns for investors.

4.

Money market funds

Money market / liquid funds invest in short-term (maturing within one year) interest bearing debt instruments. These securities are highly liquid and provide safety of investment, thus making money market / liquid funds the safest investment option when compared with other mutual fund types. However, even money market / liquid funds are exposed to the interest rate risk. The typical investment options for liquid funds include Treasury Bills (issued by governments), Commercial papers (issued by companies) and Certificates of Deposit (issued by banks).

Multifund Funds
A multifund mutual funds portfolio managers invest in a portfolio of different mutual funds. A multifund mutual fund achieves even more diversification than a typical mutual fund, because it contains several mutual funds. However, investors incur two types of management expenses:
a)

The expenses of managing each individual mutual fund The expenses of managing multifund mutual fund

b)

Funds of Funds
Invest in other schemes of same or other mutual funds Is consider like a debt scheme for TAX purpose 2 Advantages - Since FOF is a mutual fund scheme, no tax on income generated from buying and selling securities. - allows fund managers to re balance portfolio freely. - investors need not to decide when to sell units and execute Transactions. - convince to investors.

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Commodity Fund
Specialize in investing in different commodities directly or through shares of commodity companies or through commodity future contracts.

Example Gold Funds.

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Specialty Funds
Specialty funds focus on a group of companies sharing a particular characteristic.

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SIP ( Systematic Investment Plan)

A Systematic Investment Plan (SIP) is a vehicle offered by Mutual funds to help you save regularly. It is just like a recurring deposit with the Post office or Bank where you put in a small amount every month. The difference here is that the amount is invested in a mutual fund. The minimum amount to be invested can be as small as Rs 500 and the frequency of investment is usually monthly or quarterly. Eg. An investors opts for SIP from HDFC mutual fund (AMC) in HDFC top 200 ( SIP Scheme) for a monthly SIP of Rs. 1000 for three years.

What is NET ASSET VALUE ?

The Term Net Asset Value (NAV) is used by investment companies to measure net assets. It is calculated by subtracting liabilities from the value of a fund's securities and other items of value and dividing this by the number of outstanding shares. Net asset value is popularly used in newspaper Mutual fund tables to designate the price per share for the fund. The value of a collective investment fund based on the market price of securities held in its portfolio. Units in open ended funds are valued using this measure. Closed ended investment trusts have a net asset value but have a separate market value. NAV per share is calculated by dividing this figure by the number of ordinary shares. Investments trusts can trade at net asset value or their price can be at a premium or discount to NAV.

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Value or purchase price of a share of stock in a mutual fund. NAV is calculated each day by taking the closing market value of all securities owned plus all other assets such as cash, subtracting all liabilities, then dividing the result (total net assets) by the total number of shares outstanding.

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Calculation of NAV
Suppose the Mutual fund has the following assets and liabilities:

Stock
Bonds Cash

$20,000
$10,000 $500

Liabilities $ 300 Outstanding shares 10,000

Styles of investment

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Value investing

It is the most conservative of the mutual fund styles. Value investing is fairly well defined by the investing philosophies of Dodd and Graham, who are considered to be the fathers of value investing. The essence of Dodd and Graham's teachings involve analyzing securities with the intent of finding some gems that are priced well below their intrinsic value, then buying and holding those securities until their price is in line with their intrinsic value. In general, such companies are out of favor with the market for some reason but are not what one would consider "distressed. Growth investing is the moderate form of the mutual fund styles. Growth investors also strive to buy low and sell high, but they're willing to pay intrinsic value for the securities of companies that are in the growth stage of their life cycle or are poised to grow at a relatively rapid rate, thus providing an acceptable riskadjusted return on investment (ROI). They will hold these companies' securities as long as they remain in the growth stage and there are no negative changes in the companies' fundamentals. But the possibility of negative developments in the companies' fundamentals poses a serious risk. If such changes are not foreseen by the funds' analysts, stock prices can fall before the funds' have time to unwind their positions in the faltering companies and the funds will suffer losses.

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Momentum investing is more a strategy than a mutual fund style, and it's an aggressive strategy. Momentum investors buy securities, usually stock, that are experiencing rapidly rising prices, i.e., they appear to have a lot of momentum. Quite often these securities will be rising in price mainly because they're "hot" and people are buying because other people are buying, rather than because of some change in the companies' fundamentals that justifies their rising prices, and the momentum usually drives prices well beyond intrinsic value.

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Evaluating fund performance

Sharpes Performance

In this model, performance of a fund is evaluated on the basis of Sharpe Ratio, which is a ratio of returns generated by the fund over and above risk free rate of return and the total risk associated with it. According to Sharpe, it is the total risk of the fund that the investors are concerned about. So, the model evaluates funds on the basis of reward per unit of total risk. Symbolically, it can be written as: Sharpe Index (Si) = (Ri - Rf) / Si Where, Si = standard deviation of the fund. Ri = Portfolios actual return during a specified time period Rf = Risk-free rate of return during the same period

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Treynors perform

Treynor (1965) was the first researcher developing a composite measure of portfolio performance. This Index is a ratio of return generated by the fund over and above risk free rate of return (generally taken to be the return on securities backed by the government, as there is no credit risk associated), during a given period and systematic risk associated with it (beta). Treynor's Index (Ti) = (Ri - Rf) / Bi. Where: Ti = Treynors performance index Ri = Portfolios actual return during a specified time period Rf = Risk-free rate of return during the same period p = beta of the portfolio

Actual performance of Indian Mutual Funds