MUTUAL FUNDS - Basics

                                                                 MUTUAL FUNDS

 

Mutual Fund MF :-

A common pool of money in to which investors taken place their contributions to be invested in accordance with a stated objective. Mutual funds are the most appropriate investment opportunity for small investors. Investing in mutual funds is a good alternative to direct investing. Mutual funds help in the growth of Capital markets by investing in capital market instruments on behalf of investors. All gains and losses of funds are shared by the investors. Investing in Mutual funds are subject to tax implications. Mutual fund structure in India is laid down under the securities and Exchange Board of India SEBI (MF) Regulations Act, 1996.

 

Valuation of Mutual funds :-

The valuation of Mutual fund can be done based on the unit price i.e. Net Asset Value NAV. The NAV is a market value of a unit price in the scheme of the Mutual fund.

NAV = Net Assets of the scheme / Number of units outstanding on the valuation date

Net assets can be calculated as below :-

 

Description	Amount	Amount
Market value of investments		XXXX
receivables		XXXX
Other accrued income		XXXX
other assets		XXXX
		XXXXX
Less :
Accrued expenses	XXX
Other payables	XXX
Other liabilities	XXX
		XXXX
Net Asset Value NAV		XXXXX

 

Here,

Example of other assets is dividend announced by a company, yet to be received.

Example of other liabilities is Management fee or custodian fee which is payable to AMC.

Value date is the day on which NAV is calculated

 

Advantages of Mutual funds :-

(a) Reduction or diversification of risk of portfolio,

(b) Professional management,

(c) Safety of regulated environment,

(d) Liquidity,

(e) Convenience and flexibility.

 

Limitations of Mutual funds :-

(a) It is difficult to managing a portfolio of funds,

(b) No control over costs,

(c) No tailor made portfolios .

 

Classification of Mutual funds :-

1. Open-ended fund :-

In the open-ended fund, the units are available for purchase or sale at all times (except when there is a lock-in period) at NAV based prices. Stock exchange will not be there in the open-ended fund. Fresh subscriptions may not be available. Unit capital is variable in open-ended funds.

 

2. Closed-end fund :-

In this category, Mutual funds get listed on stock exchange, and available at a discount or premium to NAV. Units can be redeemed on maturity date. Unit capital is constant. These units having buy back option.

 

3. Load funds :-

‘Load’ is onetime fee payable by the investors for open-ended schemes. The load can be charged at entry level, or over the period, or exit level of the scheme. If load charged at entry level, it is called as “Entry load”. If load charged over the over the period of time, it is called as “Deferred load”. If load is charged at the time of exit from the scheme, it is called as “Exit load”. Load is charged to recover initial issue expenses including marketing and selling expenses, Advertisement costs, Brokerage, etc.

 

4. No load funds :-

The ‘fund’ which makes no charge i.e. Entry, or Deferred, or Exit, is known as ‘No Load’. In this category, the initial issue expenses are absorbed by the Asset Management Company (AMC). The investors can buy or sell units only at NAV prices in this category.

 

5. Tax exempted funds :-

Any income received by the Mutual fund, Dividend, Long Term Capital Gain (LTCG), and open-ended equity oriented Mutual funds are tax-exempted.

 

6. Taxable funds :-

Short Term Capital Gain (STCG) held for a period of less than one year is taxable fund.

 

Types of Mutual funds :-

1. Money Market Mutual Fund (MMMF):-

These are debt securities in short term nature of less than one year of maturity, such as treasury bills, Commercial paper, Certificate of Deposits, etc. Lowest risk, low returns, high liquidity, and safety of principal are the features of this type of Mutual funds.

 

2. Gilt funds :-

Dated securities with long term in nature i.e. more than one year of maturity are belongs to this type. These funds also low risk and return, but more risk and return than money market funds.

 

3. Debt Funds :-

Debt funds are also termed as Income funds. These funds are corporate bonds, government securities, Debt instruments issued by Govt. Private companies, Banks, Financial institutions, etc. investors can get regular income will be generated through investing in these funds. Debt funds can be sub divided in to following types.

(a) Diversified debt funds i.e. all available types of debt securities issued by entities across all industries and sectors,

(b) Focused debt fund i.e. debt funds have a narrower focus with less diversification, which are having more risk than diversified debt funds. Municipal bonds are example of this type of funds.

(c) High yield Debt funds i.e. debt instruments that are considered below investment grade determined by credit rating agencies. These are having high interest rate risk as well as higher returns.

(d) assured return funds i.e. guaranteed monthly income funds which are having lowest risk within debt funds category.

 

4. Equity funds :-

These are invested in equity and equity related instruments. These can be divided in to below :-

(a) Aggressive growth funds which are invested in less researched and speculative shares. More volatile risk and high returns can be possible through invest in this category.

(b) Growth funds i.e. which are invested in companies whose earnings are expected to raise at above average. These are having less volatile risk.

(c) Speciality funds I.e. those which can be meet their predefined criteria. More volatile risk than diversified funds. These funds again sub divided in to following types :-

(i) Sector funds i.e. which are invested in only one sector of the market.

(ii) foreign securities funds i.e. invested in equities within one or more foreign countries there by achieving diversification across countries borders.

(iii) Mid cap or small cap funds i.e. which are invested in shares of companies with relatively lower market capitalization than that of big, blue chip companies.

(d) Equity Linked Savings Scheme (ELSS) i.e. investors should clearly look for where the fund management proposes to invest, and accordingly judge the level of risk involved. The ELSS is also known as “Diversified Equity Fund”.

(e) Equity Index fund i.e. the fund which tracks the performance of a specific stock market index.

(f) Value fund i.e. the fund which seek out fundamentally sound companies whose shares are currently under priced in the market.

(g)Equity income fund i.e. the fund which can be invest in shares of companies with high dividend yields. The Equity income fund is also called as “Dividend yield fund”.

 

5. Hybrid funds :-

The funds which are relatively balance holding of debt and equity securities in their portfolio. These can be classified as following :-

(a) Balanced funds i.e. the fund has a portfolio comprising debt instruments, convertible securities, equity and preference shares. These funds having the objectives of income, moderate capital appreciation, long term orientation, seek to provide regular income, etc.

(b) Growth and Income funds i.e. the funds which are less than pure growth funds and greater than income funds. These funds having an objective of seek to strike a balance between capital appreciation, income for the investors, and seek to provide high dividend and capital appreciation.

(c) asset allocation funds i.e. the funds which are invested in different types of assets or sectors. This type of funds are high riskier.

 

6. Commodity funds :-

The funds which are invested in different types of commodities such as good grains, edible oils, etc. are called as Commodity funds.

 

7. Real estate funds :-

The funds which are invested in the stocks of Real estate companies are termed as real estate funds.

 

8. exchange Traded Funds (ETFs) :-

ETFs are combination of best features of open-ended and closed-end structures. These funds are treated on the exchanges, its unit prices are determined in the market place, and will keep changing from time to time. Unit price varies during the day, as per market movements. ETFs are purchase and sell through market makers by giving a bid and ask prices. ETFs are less costly as no commission payable to intermediaries. These funds are more efficient in terms of tracking the index performance.

 

9. Fund of funds (FOF) :-

An FOF invests in other mutual funds schemes of the AMC or other AMCs. It does not invest directly in capital market. These funds are having higher expenses and greater diversification.

 

Components of Mutual fund :-

Mutual Fund structure is a three tier structure as following :-

1. The Sponsor :-

The ‘sponsor’ is any person who acting alone or in combination with another body corporate, establishes Mutual fund. Sponsor will form a trust, executes trust deed, and appoints the board of trustees and Asset Management Company AMC. Sponsor contributes minimum 40% of net worth of AMC to trust.

 

2. Trustees :-

The trust, the Mutual fund may be managed by a Board of trustees i.e. a body of individuals, or a trust company, or a corporate body. Most of the funds in India are managed by Board of trustees. At least two-third of the trustees must be independent. Trustees appointed by the Sponsor with SEBI approval. Trustees have a main responsibility towards unit holders. The investments in Mutual Funds are held by the trustees. Trustees oversee the functioning of AMC.

 

3. Asset Management Company :-

The role of the AMC is to act as the investment manager of the fund. Minimum net worth of INR 10 crores for AMC. At least 50% of directors of AMC to be independent. AMC is the fund manager for managing Mutual fund assets. AMC charges Asset management fee subject to ceiling prescribed by SEBI.

 

Rik type – Mutual fund :-

S.No	Name of the Fund	Risk involved
1	Money Market / Liquid Funds	Low
2	Government securities funds	Low
3	income funds	Moderate
4	balanced funds	Moderate
5	Growth / Income funds	Moderate
6	short term bond funds	Moderate
7	index funds	Moderate
8	Aggressive growth funds	High
9	International funds	High
10	sector funds	High
11	Specialised funds	High
12	High yield bond funds	High
13	Commodity funds	High

 Note :- Generally, more risky, higher the returns will be generated.

Evaluating financial products :-

S.No	Product	Safety	Liquidity	Return	Volatility
1	Equity	Low	High / Low	High to Moderate	High
2	FI bonds	High	Moderate	Moderate to High	Moderate
3	Debentures	Moderate	Low	Moderate to Low	Moderate
4	Corp. FD	Low	Low	Moderate	Low
5	Bank Deposits	High	High	Low to High	Low
6	PPF	High	Moderate	Moderate	Low
7	Life Insurance	High	Low	Low to Moderate	Low
8	Gold	High	Moderate	Moderate to Low	Moderate
9	Real estate	Moderate	Low	High to Low	High
10	Mutual Fund	High	High	High	Moderate

Investor’s perspective :-

S.No	Product	Investment objective	Risk tolerance	Time horizon
1	Equity	Capital appreciation	High	Long term
2	FI bonds	Income	Low	Mid - Long
3	Debentures	Income	Income	Mid - Long
4	Corp. FD	Income	Income	Medium term
5	Bank Deposits	Income	Low	Flex - All terms
6	PPF	Income	Low	Long term
7	Life Insurance	Risk cover	Low	Long term
8	Gold	Inflation hedge	Low	Long term
9	Real estate	Inflation hedge	Low	Long term
10	Mutual Fund	Cap.  Gwt.  Inc.	High - Moderate - Low	Flex - All terms

 

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