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)
Phase IV 1996: Investor friendly regulatory measures have been taken both by SEBI to protect the investor, and by the government to enhance investors returns through tax benefits.
Reduction/Diversification of Risks: The potential losses are also shared with other investors.
Reduction of transaction costs: The investor has the benefit of economies of scale; the funds pay lesser costs because of larger volumes and it is passed on to the investors. Wide Choice to suit risk-return profile: Investors can chose the fund based on their risk tolerance and expected returns.
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.
Moderate
Low
Low
No
Moderate
Moderate
Moderate
Moderate
Yes
Moderate
Moderate
High
Low
Yes
Moderate
Moderate
High
Low
Yes
Moderate
Moderate
Moderate
High
Yes
High
A bank deposit is guaranteed by the bank for repayment of principal and interest whereas a debt fund has no contractual guarantee for repayment of principal or interest.
In bank deposits, the investor has to assess the risk in terms of credit ratings of the bank which gives an indication of the financial soundness of the bank. However, a debt fund is not rated by any agency. The investor has to assess the risk on the portfolio held by the fund. Bank deposits are not totally free from risk and generally give lower returns. A conservative debt fund can give higher returns than a bank deposit, even though there is no contractual guarantee as in a deposit.
Mutual Funds aim to strike a balance between risk and return and give the best of both to the investor.
Fund Structure
Fund Sponsor
Trustees
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: The mutual fund shall ensure that the re-purchase price is not lower than 93% of the NAV. The sale price is not higher than 107% of the NAV. Repurchase price of closed end scheme shall not be lower than 95% of the NAV. The difference between the repurchase price and the sale price of the units shall not exceed 7% of the sale price.
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:
1.25% of the first Rs.100 crores of weekly average net assets outstanding in the accounting year. 1% weekly average net assets in excess of Rs. 100 crores. A no load scheme can charge an additional management fee up to 1% of weekly average net assets outstanding in the accounting year.
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.
Use long-term performance data The longer the period covered by fund performance data, the more reliable would be the conclusions about the funds record.
Compare the Same Time Periods - it is imperative to use the performance data over the same periods of time as returns over different periods vary due to different market conditions.
Returns since Inception -SEBI requires returns to be compared since the inception of a scheme using Rs. 10 as the base amount. - Adjustments have to be made in case loads are paid.
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.
Active Equity Funds: - Using appropriate market index. - The appropriate index to be used to evaluate a broad-based equity fund should be decided on the basis of the size and the composition of the funds portfolio. - If the fund has a large portfolio, a broader market index like BSE 100 or 200 or NSE 100 may be used to benchmark rather than S&P NIFTY or BSE 30. - An actively managed fund expects to beat the index. Sector Funds: - Benchmark will be the relative Sectoral Index. - An investor in Infotech or Pharma Sector funds can expect the same return as the relative sectoral indices. In other words, the choice of a correct equity index as a benchmark also depends upon the investment objective of the fund. For example, a small cap fund has to be compared with a small cap index.
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. Money Market Funds: - Money market funds due to their short term nature are benchmarked against the government funds of appropriate maturities. - J.P.Morgans T-Bill index is used by analysts. - NSEs mibid/mibor rates that reflect interbank call money money market interest rates can also be used as a benchmark.
Even when two funds of similar characteristics are compared, their returns must be calculated on the following comparable basis: Compare the returns over the same period only. Only annualised compound returns are comparable, I.e. data must be available for long enough periods. Only after-tax returns of two different schemes should be compared.
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
sources for MF performance data and evaluation. Newsletters: Many MFs, banks and non-banking firms catering to retail investors publish their own newsletters. Prospectus: SEBI regulations requires sponsors to disclose performance data relating to schemes being managed by them.
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
Check whether rupee cost averaging method will prove beneficial to Mrs. Sudhakar.
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!