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Macro-Economic Factors affecting Mutual funds in India& Basis for Evaluating Mutual fund Performance

Amit Gera

PGDM 2006-2008 Batch

Alliance Business School

Bangalore

Abstract

A mutual fund is a form of collective investment that pools money from investors and invests themoney in stocks, bonds, short-term money-market instruments, and/or other securities. The portfoliomanager trades the fund's underlying securities, realizing a gain or loss, and collects the dividend orinterest income. The investment proceeds are then passed on to the individual investors.The rationale behind a mutual fund is that there are large number of investors who lack the time andor the skills to manage their money. Hence professional fund managers, acting on behalf of the MutualFund, manage the investments (investor's money) for their benefit in return for a management fee.The organization that manages the investment is called the Asset Management Company (AMC). Thusa Mutual Fund is the most suitable investment for the common man as it offers an opportunity to investin a diversified, professionally managed basket of securities at a relatively low cost.There are certain criteria on the basis of which the performance of a mutual fund can be assessed suchas NAV, portfolio turnover, risk and return as well as various expense ratios like Sharpe ratio, BetaRatio, etc. This article also aims to give an insight on the futuristic outlook of the Mutual Funds in India.New Funds are coming in the market such as Gold Funds, Real Estate Funds etc. The various newtrends in the field are explored to understand diversified growth and opportunities that are prevalentand that could be the probable future of Mutual Funds.

Introduction

The most important factor shaping in today's global economy is the process of globalization. Indiancompanies are moving in search of low-cast markets, technology is driving growth in production andcompetition is becoming more intense. A second factor is the fastest growth in private capital flows,mainly short-term flows by banks and financial institutions, portfolio flows by mutual funds and pensionfunds and foreign direct investment into India. A third factor is the increasing share of India and otheremerging market economies in world trade.The outburst in communication technology has led to greater integration of Indian financial markets

across the world. The impact of these changes could be felt from the extremely buoyant activity inIndian stock markets. A number of foreign financial service providers have entered into the Indianfinancial market like Morgan Stanley, Templeton, and Goldman Sachs. Currently FII investment is at $6.5 Billion compared to $ 2 Billion in 2001. The stock market is booming with Sensex hovering around16000-17000. SEBI has put in place appropriate guidelines and controls to regulate the markets intune with the changing environment and attendant risks. All this is happening because of largeamounts of investment in the country

People often invest in various asset classes to:*

To beat Inflation

To fund future needs

To meet contingencies

To maintain same standard of living after retirementAll these factors matters a lot to the investors and the mutual fund route is one way through whichpeople can meet these needs.

What Is a Mutual Fund?

SEBI (Mutual Fund) Regulations 1993 defines Mutual Fund as "a fund established in the form of a trustby a sponsor to raise money by the trustees through the sale of units to the public under one or moreschemes for investing securities in accordance with these regulations".In common terms, a mutual fund is a portfolio of stocks, bonds, or other securities that is collectivelyowned by hundreds or thousands of investors and managed by a professional investment company.The unit holders are people who have similar investment goals. Each fund has specific investmentcriteria, which are spelt out in its prospectus, the official booklet that describes the mutual fund.Investors then know what they are getting and can match their objective to that of a fund. The pooledmoney has more buying power than one investor alone, so that a fund can own hundreds of differentsecurities. Thus, its success is not dependent on how just one or two companies perform but onperformance of several stocks which fund is holding.A mutual fund makes money in several ways:

By earning dividends or interest on the investments it owns

By selling securities that have appreciated in value.Investors make money in the form of dividends and interest that are passed on to them and theincrease (or decrease) in the fund's value. The mutual fund manager keeps constant watch on financialmarkets and adjusts the portfolio to achieve the highest returns. By owning part of a fund, the hardwork of selecting and monitoring stocks and bonds is done for investors. The majority of mutual fundsavailable are open-ended funds. Open-ended funds can have an unlimited number of investors ormoney in the fund. These funds are always open to accept money from investors and to return themoney back to investors. This gives the investor the flexibility to enter into the scheme or to exit fromthe scheme or to exit from the scheme as and when required as per their needs. Managers of closed-end funds, on the other hand, decide upfront how many shares they will issue and when they will sellthem. The only way to purchase shares in a closed-end fund, once the original shares have been sold,is to buy them from a current investor. Occasionally, open-end funds can and do close to newinvestors, often because of high cash inflows that cannot be invested in a timely manner. They do notbecome closed-end funds, however, because current shareholders can still buy additional shares from

the fund company. When investors purchase a mutual fund, they own a piece of an investmentportfolio. They share in the gains, losses, and expenses in proportion to the amount they have investedin the fund. At the close of every trading day, a mutual fund company tallies the value of all thesecurities in its portfolio and deducts its expenses (e.g., management fees, administrative expenses,and advertising costs). The balance is divided by the number of shares owned by shareholders to arriveat the value of one unit of the mutual fund. The net asset value or NAV is the price that fund pays youper unit when you sell. For a majority of people, mutual funds are a major part of their investmentportfolio-unless they have a lot of money and ample time to devote to investing in individual securities.

Why Mutual Funds not Individual Securities?

People prefer mutual fund and not individual securities because first, a great deal of time and expertiseis required to analyze a company—its prospects for earnings growth, its performance over the shortand long term in comparison to its competitors, its debt level and creditworthiness, its new products inthe pipeline, and technological changes looming that might harm or improve business. Second,purchasing individual securities involves higher transaction costs. Even when you use a discountbroker, the commissions you pay to buy and sell are not cheap. Third, owning individual stocks meansyou are less likely to have proper diversification. To diversify a stock portfolio, you need to own at least10 to 20 different companies in different industries, which could cost very much. For the same priceyou might pay for 100 shares of one security, you can buy units in a fund that owns 100 securities.Diversification lowers your investment risk—if one or two stocks plunge, others may gain in value,offsetting the loss.

How Mutual Fund Works

In India, SEBI (Mutual Fund) Regulations, 1996 regulates the structure of mutual funds. Mutual fundsin India are constituted in the form of a Public Trust created under The Indian Trusts Act, 1882. As perthese regulations, mutual funds should have the following three-tier structure:

Sponsor

Trust / Trustee

Asset Management Company

Types of mutual fund schemes

StructureBy Investment Objective

Open-end Funds Growth FundsClosed-end Funds Income FundsInterval Funds Balanced Funds

Macroeconomic Factors Affecting Mutual Fund Industry in India

The macroeconomic factors are the major determinant of the growth of an economy. Analyzing themacroeconomic factors gives an idea of the current economy position and a projection of the future of the economy based on which we decide the future of a particular industry. The various macroeconomicfactors responsible for mutual fund industry in India are as follow:

Population

India's population is young, with 54% under the age of 25 and 80% under 45 and the percentage of