Professional Documents
Culture Documents
6.mutual Funds
6.mutual Funds
Investor Perspective
Basics of Investments:
Risk Aversion
Risk Management
Mutual Funds
Mutual Funds
A mutual fund 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.
An equity fund would buy equity assets ordinary
shares, preference shares, warrants etc.
A bond fund would buy debt instruments such as
debenture bonds, or government securities/money
market securities.
A balanced fund will have a mix of equity assets and debt
instruments.
Mutual Fund shareholder or a unit holder is a part owner
of the funds asset.
Mutual Funds
Operations Flow Chart
(Reference: amfiindia.com)
Closed-end Fund
One time sale of fixed number of units.
Investors are not allowed to buy or redeem the units directly from the
funds. Some funds offer repurchase after a fixed period. For example,
UTI MIP offers a repurchase after 3 years.
Listed on stock exchange and investors can buy or sell units through
the exchange.
Units maybe traded at a discount or premium to NAV based on
investors perception about the funds future performance and other
market factors.
Gilt Funds
Invest in Gilts which are government securities with medium to
long term maturities, typically over one year.
Gilt funds invest in government paper called dated securities.
Virtually zero risk of default as it is backed by the Government.
It is most sensitive to market interest rates. The price falls when
the interest rates goes up and vice-versa.
Debt Funds
Debt Funds/Income Funds
Invest in debt instruments issued not only by government, but
also by private companies, banks and financial institutions and
other entities such as infrastructure companies/utilities.
Target low risk and stable income for the investor.
Have higher price fluctuation as compared to money market funds
due to interest rate fluctuation.
Have a higher risk of default by borrowers as compared to Gilt
funds.
Debt funds can be categorized further based on their risk profiles.
Carry both credit risk and interest rate risks.
Equity Funds
Equity Funds:
Invest a major portion of their corpus in equity shares issued by
companies, acquired directly in initial public offering or through
secondary market and keep a part in cash to take care of
redemptions.
Risk is higher than debt funds but offer very high growth potential
for the capital.
Equity funds can be further categorized based on their investment
strategy.
Equity funds must have a long-term objective.
Hybrid Funds
Balanced Funds:
Has a portfolio comprising of debt instruments, convertible
securities, preference and equity shares.
Almost equal proportion of debt/money market securities and
equities. Normally funds maintain a Equity-Debt ratio of 55:45 or
60:40.
Objective is to gain income, moderate capital appreciation and
preservation of capital.
Ideal for investors with a conservative and long-term orientation.
Return
Safety
Liquidity
Tax
Benefit
Convenience
Bank
Deposit
Low
High
High
No
High
Equity
Instruments
High
Low
High or
Low
No
Moderate
Debentures
Moderate
Moderate
Low
No
Low
Fixed
Deposits by
Companies
Moderate
Low
Low
No
Moderate
Bonds
Moderate
Moderate
Moderate
Yes
Moderate
Return
Safety
Liquidity
Tax
Benefit
Convenience
RBI Relief
Bonds
Moderate
High
Low
Yes
Moderate
PPF
Moderate
High
Low
Yes
Moderate
National
Saving
Certificate
Moderate
High
Low
Yes
Moderate
National
Saving
Scheme
Moderate
High
Low
Yes
Moderate
Monthly
Income
Scheme
Moderate
High
Low
Yes
Moderate
Return
Safety
Liquidity
Tax
Benefit
Convenience
Life
Insurance
Moderate
High
Low
Yes
Moderate
Mutual
Funds
(Open-end)
Moderate
Moderate
High
No
High
Mutual
Funds
(Closedend)
Moderate
Moderate
High
Yes
High
Fund Structure
Fund Sponsor
Trustees
Asset Management
Company
Depository
Agent
Custodian
Fund Sponsor
The Fund Sponsor
Any person or corporate body that establishes the Fund
and registers it with SEBI.
Form a Trust and appoint a Board of Trustees.
Appoints Custodian and Asset Management Company
either directly or through Trust, in accordance with SEBI
regulations.
SEBI regulations also define that a sponsor must contribute
at least 40% to the net worth of the asset management
company.
Trustees
Trustees
Created through a document called the Trust Deed that is
executed by the Fund Sponsor and registered with SEBI.
The Trust-the mutual fund may be managed by a Board of
Trustees- a body of individuals or a Trust Company- a
corporate body.
Protector of unit holders interests.
2/3 of the trustees shall be independent persons and
shall not be associated with the sponsors.
Trustees
Rights of Trustees:
Approve each of the schemes floated by the AMC.
The right to request any necessary information from the
AMC.
May take corrective action if they believe that the
conduct of the fund's business is not in accordance with
SEBI Regulations.
Have the right to dismiss the AMC,
Ensure that, any shortfall in net worth of the AMC is
made up.
Trustees
Obligations of the Trustees:
Enter into an investment management agreement with the
AMC.
Ensure that the fund's transactions are in accordance with
the Trust Deed.
Furnish to SEBI on a half-yearly basis, a report on the
fund's activities
Ensure that no change in the fundamental attributes of any
scheme or the trust or any other change which would affect
the interest of unit holders is happens without informing the
unit holders.
Review the investor complaints received and the redressal
of the same by the AMC.
Distribution Channels
Distribution Channels
Mutual Funds are primary vehicles for large collective investments,
working on the principle of pooling funds.
A substantial portion of the investments happen at the retail level.
Agents and distributors are a vital link between the mutual funds and
investors.
Agents
- Is a broker between the fund and the investor and acts on behalf of the
principal.
- He is not exclusive to the fund and also sells other financial services.
This in a way helps him to act as a financial advisor.
Distribution Companies
- Is a company which sells mutual funds on behalf of the fund.
- It has several employees or sub-broker under it.
- It manages distribution for several funds and receives commission for its
services.
Distribution Channels
Banks and NBFCs
- Several banks, particularly private and foreign banks are
involved in a fund distribution by providing similar services like
that of distribution companies.
- They work on commission basis.
Direct Marketing
- Mutual funds sell their own products through their sales
officers and employees of the AMC.
- This channel is normally used to mobilise funds from high
net worth individuals and institutional investors.
Sales Practices
Agent Commissions
- No rules prescribed for governing the maximum or
minimum commissions payable by a fund to its agents.
- As per SEBI regulations, 1996 all initial expenses
including brokerage charges paid to agents cannot
exceed 6% of resources raised under the scheme.
- Excess distribution charges have to be borne by the AMC.
- A no-load fund is authorised to charge the schemes with the
commissions paid to agents as part of the regular
management and marketing expenses allowed by SEBI.
Accounting
Calculating Net Asset Value
Unit Capital is the investors subscriptions. In mutual funds it
is not treated as a liability.
Investments made on behalf of the investors are reflected on
the assets side of the balance sheet.
There are liabilities of short-term nature.
Funds Net Asset = Asset Liabilities
Net Asset Value = Net Assets of the scheme / No. of
Outstanding Units
i.e
NAV = (Market value of investments + Receivables + Other
Accrued Income + Other assets Accrued Expenses Other
Payables Other liabilities) / ( No. of Units Outstanding as at
the NAV date)
Accounting
The factors affecting the NAV are as following:
Capital Gains or Losses on the sale or purchase of the
Investment securities.
Dividend and income earned on the assets.
Capital Appreciation in the underlying value of the stocks
held in the portfolio.
Other assets and liabilities.
Number of units sold or purchased.
Accounting
SEBI regulations for NAV
The day on which NAV is calculated by a fund is called
valuation date.
NAV of all schemes must be calculated and published
at least weekly.
This is applicable to both open-end and closed-end fund.
Some closed end funds (Monthly Income Schemes) that
are not listed on stock exchange may publish it monthlyquarterly.
Accounting
SEBI Guidelines for Pricing of Units:
Accounting
Since investments held by a mutual fund in its portfolio are to
be marked to the market, the NAV includes two components:
a) Realized gains or losses.
b) Unrealized gains or losses.
As per SEBI guidelines, unrealized appreciation cannot be
distributed by a fund, whereas the realized gain can be
distributed.
Accounting
Investment Management Fees and Advisory Fees:
Accounting
Total expenses charged by the AMC to a scheme,
excluding issue or redemption expenses but including
investment management and advisory fees have
following limits:
2.5% - On the first Rs. 100 crores of average weekly
net assets
2.25% - On the next Rs. 300 crores of average weekly
net assets
2% - On the next Rs. 300 crores of average weekly net
assets
75% - On the balance of average weekly net assets
For bond funds, the above percentages are required to
be lower by 0.25%
Taxation
Taxation in the Hands of the Fund
Income earned by any mutual fund registered with SEBI or set up by a
public sector bank/Financial Institution or authorised by RBI is exempt
from tax.
Income distributed to unit holders by a closed-end or debt fund has to
pay a distribution tax of 10% plus surcharge of 1% I.e. a tax of 11%.
This tax is also applicable to distributions made by open-end funds
which have less than 50% allocation to equity.
The Impact on the Fund and the Investor
Due to the tax payment by the fund, the NAV and the value of the
investors investment will come down.
The tax bears no relationship to the investors tax bracket.
This tax makes the income schemes less attractive than growth
schemes.
The fund cannot avoid tax even if the investor chooses to reinvest the
distribution back into the fund.
Taxation
Taxation in the Hands of the Investor
Tax Rebate available on Subscriptions to Mutual Funds (In accordance
with Section 88 of Income Tax Act)
Investments up to Rs. 60,000 in units of any specified mutual fund
qualifies for tax rebate to the extent of 20% of such investment.
In case of Infrastructure Bonds, investments up to Rs. 70,000 is eligible
for 20% tax rebate.
Total investment eligible for tax rebate cannot exceed Rs. 60,000.
Investment up to Rs. 10,000 in an equity linked saving scheme (ELSS)
qualifies for tax rebate of 20%.
Taxation
Taxation in the Hands of the Investor
Dividend Tax : The tax paid by the investor on receiving dividends from a
mutual fund. There is no dividend tax to be paid at the investors end.
There is no dividend tax deduction from NAV in all funds which are openend and with over 50% allocation of investment to equities.
Tax of 10.2% is deducted from the NAV by the fund in the following
cases:
- All closed end funds including equity.
- All open end funds with less than 50% allocation in equity.
Taxation
Taxation in the Hands of the Investor
Capital Gains on Sale of Units: Capital Gains tax is charged when
something is sold at profit. If the investor sells his units and earns Capital
Gains, the investor is subject to the Capital Gains Tax.
If the units are held for less than 12 months, they will be treated as short
term capital gain. Otherwise,t hey are called long term capital gains.
For short term, capital gains = Sale consideration (Cost of Acquisition +
Cost of Improvements + Cost of Transfer)
The tax charged depends on the income bracket of the investor.
For long term capital gains, the investor gets the benefit of Indexation by
which his purchase price is marked up by an inflation index.
Cost of acquisition or improvement = actual cost of acquisition or
improvement * cost of inflation index for year of transfer/cost of inflation
index for year of acquisition or improvement.
The tax charged is either 10% or (20% - rate of inflation).
Debt Funds
Diversified Debt Funds:
Invests in all available types of debt securities, issued by entities
across all industries and sectors.
Derives benefit of risk reduction through risk diversification.
Focused Debt Funds:
Have a narrow focus with less diversification in its investments.
Include Sector, Specialized and Offshore debt funds.
Have a higher risk as compared to diversified debt funds.
High Yield Debt Funds:
Invest in debt instruments that are not backed by tangible assets
and considered below investment grade.
May earn higher returns though at the cost of higher risk.
Debt Funds
Assured Return Funds- An Indian Variant:
Assured Return or Guaranteed Monthly Income Plans are
essentially Debt/Income funds.
Returns are indicated in advance for all the future years of the
closed-end funds.
Any shortfall is borne by the sponsors or managers.
Market regulator, SEBI has been discouraging fund managers
from offering assured return schemes. If offered, explicit guarantee
is required from a guarantor whose name is specified in advance in
the offer document of the scheme.
Equity Funds
Aggressive Growth Funds
Objective is to earn very high returns for the investor.
Target is maximum capital appreciation.
Invest in less researched or speculative shares and may adopt
speculative investment strategies.
High volatility and risk as compared to other funds.
Growth Funds:
Objective is capital appreciation over a long time, 7 - 10 years
span.
Invest in companies whose earnings are expected to rise at an
above average rate.
These companies will be considered to have growth potential, but
not entirely unproven and speculative.
Less volatile than aggressive growth funds.
Equity Funds
Specialty Funds
Thematic funds that have a theme for investments.
Narrow portfolio orientation and invest only in companies that meet
pre-defined criteria.
Diversification is limited to one type of investment.
More volatile than diversified funds.
Specialty funds are further sub-categorized based on their
investments.
Diversified Equity Funds:
Invest only in equities except for a very small portion in liquid
money market securities.
It is not focused on any one or few sectors or shares.
Reduce the sector or stock specific risks through diversification.
Lower risks than growth funds.
Equity Funds
Equity Linked Savings Schemes - an Indian Variant:
Investment in these schemes entitles the investor to claim an income
tax rebate.
Usually has a lock-in period of 3 years before the end of which funds
cannot be withdrawn.
There are no specific restrictions on the investment objectives for the
fund managers.
Generally, such funds would be Diversified Equity Funds.
Equity Income Funds:
Objective is to give high level of current income along with some steady
capital appreciation.
Invest in shares of companies with high dividend yields and do not
fluctuate as much as other shares. Ex - Power/Utility sector.
Less volatile and risky than other equity funds.
Equity Funds
Equity Index Funds:
The objective is to match the performance of the stock market by
tracking an index that represents the overall market.
Invests in shares that constitute the index and in the same proportion.
Sensitive to overall market risk.
Example: UTI Nifty Fund
Value Funds:
Invest in fundamentally sound companies whose shares are currently
under-priced in the market.
Have lower risk as compared to Growth Funds and take a long term
approach.
Often invested in cyclical industries.
Example: Templeton India Growth fund that has shares of
Cement/Aluminum and other cyclical industries.
Hybrid Funds
Growth & Income Funds:
Strike a balance between capital appreciation and income for the
investor.
Portfolio is a mix between companies with good dividend paying
records and those with potential for capital appreciation.
Less risky than growth funds but more risky than income funds.
Asset Allocation Funds:
Follow variable asset allocation policy.
Move in an out of an asset class (equity, debt, money market or
even non-financial assets)
Asset allocation funds that follow more stable allocation policies are
like balanced funds.
Asset allocation funds that follow more flexible allocation policies
are like aggressive growth or speculative funds.
Investment Plans
Automatic Re-investment Plans
Allows the investor to re-invest in additional units the amount of dividends
or other distributions made by the fund instead of receiving it in cash.
Investment takes place at ex-dividend NAV.
The investors reap the benefit of compounding his investments.
Automatic Investment Plans
Allows the investor to invest a fixed sum periodically. Enables him to
save in a disciplined and phased manner.
Such funds help in rupee cost averaging.
Mode of investment could be through direct debit to investors salary or
bank account.
Voluntary Accumulation Plan, a modified version of AIP allows the
investor flexibility in terms of amount and frequency of investment.
Investment Plans
Systematic Withdrawal Plans
Allow systematic withdrawals from his fund investment on a periodic
basis.
The investor must withdraw a specific minimum amount and also
maintain a minimum balance in his fund account.
The amount withdrawn is treated as redemption of units at the applicable
NAV as specified in the Offer Document.
SWPs are different from MIPs. SWPs allows investors to get back the
principal amount invested while MIPs will only pay the income part on
regular basis.
Systematic Transfer Plans
Allow the investor to transfer on a periodic basis from one scheme to
another within the same fund family.
A transfer will be treated as redemption of units from one scheme and
investment of units in another scheme.
Such redemption and investment will be at applicable NAV as mentioned
in the Offer Document.
Different Performance
Measures
No, percentage NAV change cannot give a correct picture as it does not
take into account the interim dividends paid. The correct measure here is
Total Return Method.
Total Return Method
- It takes into account the dividends paid in the interim period and is
suitable for all types of funds.
- It must be interpreted in the light of market conditions and investment
objective of the fund.
- Its limitation is that it ignores the fact that distributed dividends also get
reinvested if received during the year.
Total Return is:
[(Distributions + Change in NAV)/NAV at the beginning of the period]* 100
Different Performance
Measures
Return on Investment or Total Return with Dividends Reinvested at
NAV
-The shortcoming of Total return is overcome by computing the Total
Return with reinvestment of dividends in the fund at the NAV on the date
of distribution.
- Is a measure of cumulative wealth accumulation and is the same as
ROI.
- Appropriate for measuring performance of accumulation plans,
monthly/quarterly income income schemes debt funds that distribute
interim dividends.
ROI or Total Return with Reinvestment is:
{(Units Held + div/ex-dNAV) * endNAV begin NAV} /begin NAV * 100
Different Performance
Measures
Cumulative Aggregate vs. Average Annualised Returns
- Absolute NAVs do not give a complete picture. Consistent performance
with respect to Total Return and compounded annual return is of
importance.
- Childrens Gift Fund and Rajalakshmi of UTI are based on cumulative
returns.
- When Cumulative Returns are received at the end of a long period,
Annualised Average Compound Rate of Return must be calculated from
the cumulative figure.
- Comparisons between two such schemes is possible only after the
Cumulative Returns are converted into Average Annualised Returns.
Formula for conversion:
A = P*(1+R/100)N where P = principal invested, A = Maturity value of the
investment, N = Period of investment in years, R = annualised compound
rate in percentage.
Expense Ratio
The Expense Ratio
- Indicator of funds efficiency and cost effectiveness.
- It is defined as the ratio of total expenses to average net assets of the
fund.
- Past and estimated expense figures and ratios are disclosed in the Offer
Document.
- Fluctuations in the ratio across periods require that an average over
three to five years be used to judge a funds performance. Also it should
be evaluated in the light of the fund size, average account size and
portfolio composition.
- Funds with small corpus size will have higher expense ratio.
- If a funds income levels or returns are small say a debt fund with 10%
return, expense ratio becomes important and difference of even 0.5%
between two funds can make lot of difference.
Income Ratio
The Income Ratio
- Defined as its net investment income divided by its net assets for the
period.
- Useful for measuring income oriented funds, particularly debt funds and
not suitable for funds looking for capital appreciation.
- Cannot be used in isolation, but only with expense ratio and total return.
Cash Holdings
-A large cash holding allows the fund to strengthen its position
in preferred securities without liquidating others.
- Allows cushion against decline in market prices of shares or
bonds.
Benchmarking
Importance of Benchmarking
- A funds performance can be judged in relation to investors expectations.
- However, it is important for the investor to define his expectations in
relation to certain guideposts.
- These guideposts or indicators of performance can be thought of as
benchmarks against which a funds performance ought to be measured.
- For instance, BSE-30 will be a benchmark for diversified equity fund and
BSE IT index for tech funds.
While an advisor needs to look at the absolute measures of
performance, he needs to select the right benchmark to evaluate a
funds performance, so that he can compare the measured
performance figures against the selected benchmark.
Benchmarking
Basis for choosing an Appropriate Performance Benchmark
The appropriate benchmark has to be selected by reference to:
1. The Asset Class it invests in. Thus, an equity fund has to be judged by
from an appropriate benchmark from the equity market and so on.
2. The funds stated Investment Objective.
There are three types of benchmarks that can be used to evaluate a
funds performance:
1. Relative to the market as a whole.
2. Relative to other mutual funds.
3. Relative to other comparable financial products or investments
options open to the investor.
Debt Funds:
- Using appropriate debt market index.
- A broad based bond fund or debt fund should be benchmarked with
broad based debt index whereas a narrower Government Securities
Fund, only the Government Sector sub-segment of the broad based
index has to be used.
- Closed-end funds with clear maturity can be compared with bank
deposits.
- I-SECs I-BEX is most commonly used by some analysts.
Benchmarking relative to
other MFs
Benchmarking relative
to other MFs
Expense Ratio
- Expense ratios effect funds performance.
Tracking MF Performance
To track fund performance, the first step is to find the relevant information
on NAV, expenses, cash flow, appropriate indices etc. The common
sources of information are:
funds financial performance which are indicators for expense ratios and
total return. It also includes a listing of the funds portfolio holdings at
market value, statement of revenue and expenses, unrealized
appreciation/depreciation at year end and changes in net assets.
Tracking MF Performance
Fund Tracking agencies like Credence and Value Research are
Power of Compounding
Investing for Long Term the power of compounding
- Invest for the long term and let your money grow on a compound basis.
- Higher the frequency of compounding, greater the growth of capital.
- An advisor must enable the investor to understand the benefits of
compounding.
Example:
If MR. Kapoor invests Rs. 1000 @ 10% interest rate for 10 years and the
amount is compounded annually, this is how the money grows:
Interest generated in the first year would be Rs. 80 (1,000*.08)
Interest generated in the second year would be 86.4 [(1,000+ 80)*.08]
instead of 80
Interest in the third year would be 93[(1000 + 80+ 86.4) * .08)
And so on till the interest keeps growing each year, resulting in a total of
Rs. 2,600 at the end of 10
Amount
Invested
NAV
January
1000
R. 10/-
February
1000
Rs. 8/-
March
1000
Rs. 12.50
Amount
Invested
NAV
Units
Purchased
January
1000
R. 10/-
100
February
1000
Rs. 8/-
125
March
1000
Rs. 12.50
80
Average cost per unit under the plan = 3000/305 = Rs. 9.84
Average NAV = (10 + 8 + 12.50)/3 = Rs. 10.17
Average of the three NAVs is higher than the figure achieved
through rupee-cost averaging.
So, we can say that rupee-cost-averaging is beneficial to
Investors.
Thank You!