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CONCEPT OF MUTUAL FUND INVESTOR EARN FROM MUTUAL FUND ADVANTAGES OF MUTUAL FUND DISADVANTAGES OF MUTUAL FUND FREQUENTIY USED TERM
2 3 4
TYPES OF MUTUAL FUND SCHEMES ORGANIZATION OF A MUTUAL FUND FUND MANAGEMENT STYLE & STRUCTURING OF PORTFOLIO INDIVIDUAL SCHEME ANALYSIS – THEMATIC FUNDS
15 30 33 49 49 69 91 106 126 137
– INDEX FUNDS – EQUITY LINKED SAVING SCHEMES – DIVERSIFIED EQUITY FUNDS
– DEBT FUNDS CONSLUSION BIBLIOGRAPHY
Ch. 1- Introduction
The one investment vehicle that has truly come of age in India in the past decade is mutual funds. Today, the mutual fund industry in the country manages around Rs 329,162 crore (As of Dec, 2006) of assets, a large part of which comes from retail investors. And this amount is invested not just in equities, but also in the entire gamut of debt instruments. Mutual funds have emerged as a proxy for investing in avenues that are out of reach of most retail investors, particularly government securities and money market instruments. Specialization is the order of the day, be it with regard to a scheme’s investment objective or its targeted investment universe. Given the plethora of options on hand and the hard-sell adopted by mutual funds vying for a piece of your savings, finding the right scheme can sometimes seem a bit daunting. Mind you, it’s not just about going with the fund that gives you the highest returns. It’s also about managing risk–finding funds that suit your risk appetite and investment needs. So, how can you, the retail investor, create wealth for yourself by investing through mutual funds? To answer that, we need to get down to brass tacks–what exactly is a mutual fund? Very simply, a mutual fund is an investment vehicle that pools in the monies of several investors, and collectively invests this amount in either the equity market or the debt market, or both, depending upon the fund’s objective. This means you can access either the equity or the debt market, or both, without investing directly in equity or debt
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Concept of a Mutual Fund
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. 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. Thus a Mutual Fund is the most suitable investment for the common man as it offers an opportunity to invest in a diversified, professionally managed basket of securities at a relatively low cost. The flow chart below describes broadly the working of a mutual fund:-
Savings form an important part of the economy of any nation. With savings invested in various options available to the people, the money acts as the driver for growth of the country. Indian
financial scene too presents multiple avenues to the investors. Though certainly not the best or deepest of markets in the world, it has ignited the growth rate in mutual fund industry to provide reasonable options for an ordinary man to invest his savings. Investment goals vary from person to person. While somebody wants security, others might give more weightage to returns alone. Somebody else might want to plan for his child’s education while somebody might be saving for the proverbial rainy day or even life after retirement. With objectives defying any range, it is obvious that the products required will vary as well.
Investors earn from a Mutual Fund in three ways:
1. Income is earned from dividends declared by mutual fund schemes from time to time. 2. If the fund sells securities that have increased in price, the fund has a capital gain. This is reflected in the price of each unit. When investors sell these units at prices higher than their purchase price, they stand to make a gain. 3. If fund holdings increase in price but are not sold by the fund manager, the fund's unit price increases. You can then sell your mutual fund units for a profit. This is tantamount to a valuation gain. Though still at a nascent stage, Indian MF industry offers a plethora of schemes and serves broadly all type of investors. The range of products includes equity funds, debt, liquid, gilt and balanced funds. There are also funds meant exclusively for young and old, small and large investors. Moreover, the setup of a legal structure, which has enough teeth to safeguard investors’ interest, ensures that the investors are not cheated out of their hard-earned money. All in all, benefits provided by them cut across the boundaries of investor category and thus create for them, a universal appeal. Investors of all categories could choose to invest on their own in multiple options but opt for mutual funds for the sole reason that all benefits come in a package.
Advantages of Mutual Funds
1. Professional Management Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. This risk of default by
any company that one has chosen to invest in, can be minimized by investing in mutual funds as the fund managers analyze the companies’ financials more minutely than an individual can do as they have the expertise to do so. They can manage the maturity of their portfolio by investing in instruments of varied maturity profiles. 2. Diversification Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own. 3. Convenient Administration Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient. 4. Return Potential Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities. Apart from liquidity, these funds have also provided very good post-tax returns on year to year basis. Even historically, we find that some of the debt funds have generated superior returns at relatively low level of risks. On an average debt funds have posted returns over 10 percent over one-year horizon. The best performing funds have given returns of around 14 percent in the last one-year period. In nutshell we can say that these funds have delivered more than what one expects of debt avenues such as post office schemes or bank fixed deposits. Though they are charged with a dividend distribution tax on dividend payout at 12.5 percent (plus a surcharge of 10 percent), the net income received is still tax free in the hands of investor and is generally much more than all other avenues, on a post tax basis. 5. Low Costs Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors. 6. Liquidity In open-end schemes, the investor gets the money back promptly at net asset value related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the
prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the Mutual Fund. Since there is no penalty on pre-mature withdrawal, as in the cases of fixed deposits, debt funds provide enough liquidity. Moreover, mutual funds are better placed to absorb the fluctuations in the prices of the securities as a result of interest rate variation and one can benefits from any such price movement. 7. Transparency Investors get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook. 8. Flexibility Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans; you can systematically invest or withdraw funds according to your needs and convenience. 9. Affordability A single person cannot invest in multiple high-priced stocks for the sole reason that his pockets are not likely to be deep enough. This limits him from diversifying his portfolio as well as benefiting from multiple investments. Here again, investing through MF route enables an investor to invest in many good stocks and reap benefits even through a small investment. Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy. 10. Choice of Schemes Mutual Funds offer a family of schemes to suit your varying needs over a lifetime. 11. Well Regulated All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI. 12. Tax Benefits Last but not the least, mutual funds offer significant tax advantages. Dividends distributed by them are tax-free in the hands of the investor. They also give you the advantages of capital gains taxation. If you hold units beyond one year, you get the benefits of indexation. Simply put, indexation benefits increase your purchase cost by a certain portion, depending upon the yearly
cost-inflation index (which is calculated to account for rising inflation), thereby reducing the gap between your actual purchase cost and selling price. This reduces your tax liability. What’s more, tax-saving schemes and pension schemes give you the added advantage of benefits under Section 88. You can avail of a 20 per cent tax exemption on an investment of up to Rs 10,000 in the scheme in a year Disadvantages of mutual funds Mutual funds are good investment vehicles to navigate the complex and unpredictable world of investments. However, even mutual funds have some inherent drawbacks. Understand these before you commit your money to a mutual fund. 1. No assured returns and no protection of capital If you are planning to go with a mutual fund, this must be your mantra: mutual funds do not offer assured returns and carry risk. For instance, unlike bank deposits, your investment in a mutual fund can fall in value. In addition, mutual funds are not insured or guaranteed by any government body (unlike a bank deposit, where up to Rs 1 lakh per bank is insured by the Deposit and Credit Insurance Corporation, a subsidiary of the Reserve Bank of India). There are strict norms for any fund that assures returns and it is now compulsory for funds to establish that they have resources to back such assurances. This is because most closed-end funds that assured returns in the earlynineties failed to stick to their assurances made at the time of launch, resulting in losses to investors. A scheme cannot make any guarantee of return, without stating the name of the guarantor, and disclosing the net worth of the guarantor. The past performance of the assured return schemes should also be given. 2. Restrictive gains Diversification helps, if risk minimisation is your objective. However, the lack of investment focus also means you gain less than if you had invested directly in a single security. Assume, Reliance appreciated 50 per cent. A direct investment in the stock would appreciate by 50 per cent. But your investment in the mutual fund, which had invested 10 per cent of its corpus in Reliance, will see only a 5 per cent appreciation. 3. Taxes During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its sales, you will pay taxes on the income you receive, even if you reinvest the money you made.
4. Management risk When you invest in a mutual fund, you depend on the fund's manager to make the right decisions regarding the fund's portfolio. If the manager does not perform as well as you had hoped, you might not make as much money on your investment as you expected. Of course, if you invest in Index Funds, you forego management risk, because these funds do not employ managers. History of Mutual Funds in India 1963 1964 1987 1993 1996 2003 Establishment of Unit Trust of India Unit Scheme 1964 launched Entry of non-UTI, Public Sector mutual funds Entry of private sector funds First Mutual Fund regulations came into being Substitution of prevalent rules by SEBI (Mutual Funds) Regulations 1996 UTI bifurcated into two separate entities – 2004 Specified Undertaking of Unit Trust of India
– UTI Mutual Fund Existence of 421 schemes, managing assets worth Rs. 153108
Frequently used terms
Net Asset Value (NAV)
Net Asset Value is the market value of the assets of the scheme minus its liabilities. The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date.
Is the price you pay when you invest in a scheme. Also called Offer Price. It may include a sales load.
Is the price at which a close-ended scheme repurchases its units and it may include a backend load. This is also called Bid Price.
Is the price at which open-ended schemes repurchase their units and close-ended schemes redeem their units on maturity. Such prices are NAV related.
Is a charge collected by a scheme when it sells the units. Also called, ‘Front-end’ load. Schemes that do not charge a load are called ‘No Load’ schemes.
Repurchase or ‘Back-end’Load
Is a charge collected by a scheme when it buys back the units from the unitholders.
Ch. 2- Types of mutual fund schemes
A wide variety of Mutual Fund Schemes exist to cater to the needs such as financial position, risk tolerance and return expectations etc. The table below gives an overview into the existing types of schemes in the Industry.
a) open-ended schemes b) close-ended schemes c) interval schemes
By investment objective:
a) growth schemes b) income schemes c) Balanced schemes d) money market schemes
a) Tax saving schemes b) special schemes c) index schemes d) sector specific schemes
a) Open-ended schemes Open-ended or open mutual funds are much more common than closed-ended funds and meet the true definition of a mutual fund – a financial intermediary that allows a group of investors to
pool their money together to meet an investment objective– to make money! An individual or team of professional money managers manage the pooled assets and choose investments, which create the fund’s portfolio. They are established by a fund sponsor, usually a mutual fund company, and valued by the fund company or an outside agent. This means that the fund’s portfolio is valued at "fair market" value, which is the closing market value for listed public securities. An open-ended fund can be freely sold and repurchased by investors. • Buying and Selling:
Open funds sell and redeem shares at any time directly to shareh
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