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Mutual Funds

Mutual Funds

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Published by: Mangesh Jadhav on Jul 31, 2012
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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.



BENEFITS OF MUTUAL FUNDS  8/1 Liquidity Denomination Intermediation Diversification Cost Advantage Managerial expertise Professional Management Convenient Administration Return Potential Transparency Flexibility Choice of schemes Tax benefits Well regulated             .

8/1 Disadvantages of mutual funds  Costs Control Not in the Hands of an Investor  No Customized Portfolios  Difficulty in Selecting a Suitable Fund Scheme .

.8/1 History of Mutual Fund • The concept of mutual fund by UTI in the year 1963. Though the growth was slow. • The mutual fund industry can be broadly put into four phases according to the development of the sector. but it accelerated from the year 1987 when non-UTI players entered the industry.

• The first scheme launched by UTI was Unit Scheme 1964.700 crores of assets under management. .1964-87 • Unit Trust of India (UTI) was established on 1963 by an Act of Parliament.First Phase . • 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.6. • At the end of 1988 UTI had Rs.

Second Phase . • The end of 1993 marked Rs. LIC in 1989 and GIC in 1990. • Bank of India (Jun 1990).47. Indian Bank Mutual Fund (Nov1989).004 as assets under management. • Bank of Baroda Mutual Fund (Oct 1992). .1987-1993 (Entry of Public Sector Funds) • SBI Mutual Fund was the first followed by Canbank Mutual Fund (Dec 1987) 8/1 • Punjab National Bank Mutual Fund (Aug 1989).

1993-2003 (Entry of Private Sector Funds) • A new era started in the Indian mutual fund industry.21. • The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund Regulations in 1996 • At the end of January 2003.805 crore. 1.44. there were 33 mutual funds with total assets of Rs.Third Phase .541 crore (Asset value) . With the entry of private sector funds in 1993 8/1 • The erstwhile Kothari Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993. • The Unit Trust of India with Rs.

sponsored by SBI.835 crores (as on January 2003). BOB and LIC. • The second is the UTI Mutual Fund Ltd. One is the Specified Undertaking of the Unit Trust of India with AUM of Rs.76. It was bifurcated into two separate entities.29. • With the bifurcation of the erstwhile UTI which had in March 2000 more than Rs.Fourth Phase .since February 2003 • This phase had bitter experience for UTI. It is registered with SEBI and functions under the Mutual Fund Regulations. PNB.000 crores of AUM and with the setting up of a UTI Mutual Fund .

The NAV of an open-end fund is calculated every day. Closed-end Funds are listed on the stock exchanges where investors can buy/sell units from/to each other. An open-end fund is not required to keep selling new units to the investors at all times but is required to always repurchase. to protect the interests of the investors. The NAV of a closed-end fund is computed on a weekly basis (updated every Thursday). The trading is generally done at a discount to the NAV of the scheme. the corpus of the Fund and its outstanding units do get changed. 2. when an investor wants to sell his units. However. SEBI provides investors with two avenues to liquidate their positions: 1. Closed-end Funds may also offer "buy-back of units" to the unit holders.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 corpus of a Closed-end Fund remains unchanged at all times. In this case. buying and redemption of units by the investors directly from the Funds is not allowed. After the closure of the offer. . 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. 8/1 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.

Entry Load . portfolio churning. 2. the percentage of exit load reduces as the investor stays longer with the fund. Deferred Load . distribution.Also known as Back-end load. Exit load is deducted from the redemption proceeds to an outgoing investor. it refers to the load charged to an investor at the time of his entry into a scheme. advertising. 4. These funds are known as Load Funds. Many funds recover these expenses from the investors in the form of load. fund manager's salary etc. . Entry load is deducted from the investor's contribution amount to the fund. these charges are imposed on an investor when he redeems his units (exits from the scheme). Exit Load .Deferred load is charged to the scheme over a period of time. 3.Load Funds | No-load Funds  8/1 Load Funds Mutual Funds incur various expenses on marketing.In some schemes. A load fund may impose following types of loads on the investors: 1. This type of load is known as Contingent Deferred Sales Charge.Also known as Front-end load.  No-load Funds All those funds that do not charge any of the above mentioned loads are known as No-load Funds. Contingent Deferred Sales Charge (CDSC) .

Mutual fund types 8/1 .

income & Hybrid Equity.Types of Funds  8/1 Existing Funds Open-ended funds (OEF) & Closed ended funds (CEF) Growth. . 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. there are following types of equity funds: a) b) c) Growth funds Index funds Specialty funds . but they also provide higher returns than other funds. Equity funds Equity funds are considered to be the more risky funds as compared to other fund types. for 3 years or more.e. In the order of decreasing risk level. It is advisable that an investor looking to invest in an equity fund should invest for long term i. There are different types of equity funds each falling into different risk bracket.

In Aggressive Growth Funds. Because of these speculative investments Aggressive Growth Funds become more volatile and thus. are comparatively riskier than diversified funds. fund managers aspire for maximum capital appreciation and invest in less researched shares of speculative nature. Criteria for some specialty funds could be to invest / not to invest in particular regions / companies. Specialty funds are concentrated and thus. The portfolio of these funds comprises of the same companies that form the index and is constituted in the same proportion as the index.Index Funds have the objective to match the performance of a specific stock market index.Specialty Funds have stated criteria for investments and their portfolio comprises of only those companies that meet their criteria. Growth funds . Specialty funds . 8/1 . Index funds . Narrow indices are less diversified and therefore. Growth Funds invest in those companies that are expected to post above average earnings in the future. Sensex) are less risky than equity index funds that follow narrow sectoral indices (like BSEBANKEX or CNX Bank Index etc). Equity index funds that follow broad indices (like S&P CNX Nifty. are prone to higher risk than other equity funds.Types of Equity funds Aggressive Growth / Capital Appreciation Funds . Without entirely adopting speculative strategies.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. are more risky.

These funds invest in companies having potential for capital appreciation and those known for issuing high dividends. 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 . . Primary objective : hybrid ( regular income as well as capital appreciation). debt. The level of risks involved in these funds is lower than growth funds and higher than income funds.. Balanced Fund.Funds that combine features of growth funds and income funds are known as Growth-and-Income Funds.Investment in more than one asset class Debt and Equity in various proportions. 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. Asset allocation funds . debts and money market securities. Hybrid funds 8/1 Hybrid funds are those funds whose portfolio includes a blend of equities.Mutual funds may invest in financial assets like equity.2. commodities etc. money market or non-financial (physical) assets like real estate.

banks. Debt Funds 8/1 Funds that invest in medium to long-term debt instruments issued by private companies. The motive behind adopting this sort of risky strategy is to earn higher interest returns from these issuers. governments and other entities belonging to various sectors (like infrastructure companies etc. although they may earn at times higher returns for investors. Debt funds are low risk profile funds that seek to generate fixed current income (and not capital appreciation) to investors. 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".3. To minimize the risk of default. they are subject to credit risk (risk of default) by the issuer at the time of interest or principal payment. In order to ensure regular income to investors. Debt funds that target high returns are more risky. financial institutions.) are known as Debt / Income Funds. High yield Debt Funds The risk of default is present in all debt funds. debt (or income) funds distribute large fraction of their surplus to investors. and therefore. These funds are more volatile and bear higher default risk. debt funds usually invest in securities from issuers who are rated by credit rating agencies and are considered to be of "Investment Grade". But. Although debt securities are generally less risky than equities. High Yield Debt Funds adopt a different strategy and prefer securities issued by those issuers who are considered to be of "below investment grade". .

Multifund Funds A multifund mutual fund’s portfolio managers invest in a portfolio of different mutual funds. thus making money market / liquid funds the safest investment option when compared with other mutual fund types. Commercial papers (issued by companies) and Certificates of Deposit (issued by banks). These securities are highly liquid and provide safety of investment. However. even money market / liquid funds are exposed to the interest rate risk. investors incur two types of management expenses: a) The expenses of managing each individual mutual fund The expenses of managing multifund mutual fund b) . A multifund mutual fund achieves even more diversification than a typical mutual fund. The typical investment options for liquid funds include Treasury Bills (issued by governments). However. because it contains several mutual funds. Money market funds Money market / liquid funds invest in short-term (maturing within one year) interest bearing debt instruments.4.

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

8/1 Commodity Fund Specialize in investing in different commodities directly or through shares of commodity companies or through commodity future contracts. . Example Gold Funds.

.8/1 Specialty Funds • Specialty funds focus on a group of companies sharing a particular characteristic.

The difference here is that the amount is invested in a mutual fund. 1000 for three years.8/1 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 minimum amount to be invested can be as small as Rs 500 and the frequency of investment is usually monthly or quarterly. An investors opts for SIP from HDFC mutual fund (AMC) in HDFC top 200 ( SIP Scheme) for a monthly SIP of Rs. Eg.

Net asset value is popularly used in newspaper Mutual fund tables to designate the price per share for the fund. 8/1 Value or purchase price of a share of stock in a mutual fund.What is NET ASSET VALUE ? The Term Net Asset Value (NAV) is used by investment companies to measure net assets. subtracting all liabilities. Units in open ended funds are valued using this measure. NAV per share is calculated by dividing this figure by the number of ordinary shares. The value of a collective investment fund based on the market price of securities held in its portfolio. 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. . Closed ended investment trusts have a net asset value but have a separate market value. Investments trusts can trade at net asset value or their price can be at a premium or discount to NAV. NAV is calculated each day by taking the closing market value of all securities owned plus all other assets such as cash. then dividing the result (total net assets) by the total number of shares outstanding.

8/1 Calculation of NAV • Suppose the Mutual fund has the following assets and liabilities: Stock Bonds Cash $20.000 $500 Liabilities $ 300 Outstanding shares 10.000 .000 $10.

But the possibility of negative developments in the companies' fundamentals poses a serious risk. If such changes are not foreseen by the funds' analysts. 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.Styles of investment  8/1 Value investing It is the most conservative of the mutual fund styles. 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). . stock prices can fall before the funds' have time to unwind their positions in the faltering companies and the funds will suffer losses. Value investing is fairly well defined by the investing philosophies of Dodd and Graham. such companies are out of favor with the market for some reason but are not what one would consider "distressed. then buying and holding those securities until their price is in line with their intrinsic value. 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. Growth investors also strive to buy low and sell high.“ Growth investing is the moderate form of the mutual fund styles. who are considered to be the fathers of value investing. In general.

. and the momentum usually drives prices well beyond intrinsic value. i. that are experiencing rapidly rising prices. and it's an aggressive strategy. they appear to have a lot of momentum. Momentum investors buy securities. .e. rather than because of some change in the companies' fundamentals that justifies their rising prices. Quite often these securities will be rising in price mainly because they're "hot" and people are buying because other people are buying.8/1  Momentum investing is more a strategy than a mutual fund style. usually stock.

it can be written as: Sharpe Index (Si) = (Ri .8/1 Evaluating fund performance  Sharpe’s Performance In this model. Si = standard deviation of the fund. performance of a fund is evaluated on the basis of Sharpe Ratio.Rf) / Si Where. According to Sharpe. Ri = Portfolio’s actual return during a specified time period Rf = Risk-free rate of return during the same period . 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. Symbolically. So. the model evaluates funds on the basis of reward per unit of total risk. it is the total risk of the fund that the investors are concerned about.

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).Rf) / Bi.8/1  Treynor’s perform Treynor (1965) was the first researcher developing a composite measure of portfolio performance. Treynor's Index (Ti) = (Ri . Where: Ti = Treynor’s performance index Ri = Portfolio’s actual return during a specified time period Rf = Risk-free rate of return during the same period βp = beta of the portfolio .

Actual performance of Indian Mutual Funds .

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