Basics of mutual funds
The article mentioned below, is for the investors who have not yet started investing in mutual funds, but willing to explore the opportunity and also for those who want to clear their basics for what is mutual fund and how best it can serve as an investment tool.
Before we move to explain what is mutual fund, it’s very important to know the area in which mutual funds works, the basic understanding of stocks and bonds.
Stocks represent shares of ownership in a public company. Examples of public companies include Reliance, ONGC and Infosys. Stocks are considered to be the most common owned investment traded on the market.
Bonds are basically the money which you lend to the government or a company, and in return you can receive interest on your invested amount, which is back over predetermined amounts of time. Bonds are considered to be the most common lending investment traded on the market. There are many other types of investments other than stocks and bonds (including annuities, real estate, and precious metals), but the majority of mutual funds invest in stocks and/or bonds. TOP
Working of Mutual Fund
To protect the interest of the investors, SEBI formulates policies and regulates the mutual funds. It notified regulations in 1993 (fully revised in 1996) and issues guidelines from time to time. MF either promoted by public or by private sector entities including one promoted by foreign entities is governed by these Regulations. SEBI approved Asset Management Company (AMC) manages the funds by making investments in various types of securities. Custodian, registered with SEBI, holds the
. The Association of Mutual Funds in India (AMFI) reassures the investors in units of mutual funds that the mutual funds function within the strict regulatory framework. etc). mentioned below. Its objective is to increase public awareness of the mutual fund industry. The key feature of open-end schemes is liquidity. Investors can conveniently buy and sell units at Net Asset Value ("NAV") related prices. you are buying units or portions of the mutual fund and thus on investing becomes a shareholder or unit holder of the fund. TOP
Types of Mutual Funds Schemes in India
Wide variety of Mutual Fund Schemes exists to cater to the needs such as financial position. According to SEBI Regulations. transparency etc. then international. Close . One can invest directly in the scheme at the time of the initial issue. Being a collection of many stocks. Interval Schemes: Interval Schemes are that scheme. These do not have a fixed maturity. The market price at the stock exchanges could vary from the net asset value (NAV) of the scheme on account of demand and supply situation. The mutual fund will have a fund manager who is responsible for investing the gathered money into specific securities (stocks or bonds).growth companies. TOP
What is a Mutual Fund?
A mutual fund is just the connecting bridge or a financial intermediary that allows a group of investors to pool their money together with a predetermined investment objective. Beyond that. Alternatively some close-ended schemes provide an additional option of selling the units directly to the Mutual Fund through periodic repurchase at the schemes NAV. It could take you weeks to buy all these investments.Ended Schemes: An open-end fund is one that is available for subscription all through the year.securities of various schemes of the fund in its custody. low-grade corporate bonds.e. then adding bonds.
Overview of existing schemes existed in mutual fund category: BY STRUCTURE
1. Investors can transact (buy or sell) the units of the scheme on the stock exchanges where they are listed. but if you purchased a few mutual funds you could be done in a few hours because mutual funds automatically diversify in a predetermined category of investments (i. Open . It is easier to think of mutual funds in categories. disclosure. thus mutual funds has Variety of flavors. risk tolerance and return expectations etc. TOP
Diversification is nothing but spreading out your money across available or different types of investments.
AMFI also is engaged in upgrading professional standards and in promoting best industry practices in diverse areas such as valuation.
The most basic level of diversification is to buy multiple stocks rather than just one stock. Depending on the structure of the scheme there are two exit options available to an investor after the initial offer period closes. There are over hundreds of mutual funds scheme to choose from. 2. expectations of unitholder and other market factors. however one cannot buy units and can only sell units during the liquidity window.
. The units may be traded on the stock exchange or may be open for sale or redemption during pre-determined intervals at NAV related prices. thus by pooling money together in a mutual fund. investors can purchase stocks or bonds with much lower trading costs than if they tried to do it on their own. an investors can go for picking a mutual fund might be easy.Ended Schemes: These schemes have a pre-specified maturity period. When you invest in a mutual fund. which combines the features of open-ended and close-ended schemes.
Mutual funds are considered as one of the best available investments as compare to others they are very cost efficient and also easy to invest in. you can diversify even more by purchasing different kinds of stocks. SEBI Regulations ensure that at least one of the two exit routes is provided to the investor. 3. two thirds of the directors of Trustee Company or board of trustees must be independent. By choosing to diversify respective investment holdings reduces risk tremendously up to certain extent. emerging or mid size companies. Mutual funds are set up to buy many stocks. and so on. by minimizing risk & maximizing returns. But the biggest advantage to mutual funds is diversification.
convenience and liquidity. these funds ensure low risk and provide stable income to the investors. Government authorities. Debt funds: The objective of these Funds is to invest in debt papers.The risk return trade-off indicates that if investor is willing to take higher risk then correspondingly he can expect higher returns and vise versa if he pertains to lower risk instruments. Debt funds are further classified as:
Gilt Funds: Invest their corpus in securities issued by Government. as Mutual funds provide professional management. This is because the money that is pooled in are not invested only in debts funds which are less riskier but are also invested in the stock markets which involves a higher risk but can expect higher returns. That doesn’t mean mutual fund investments risk free. The Equity Funds are sub-classified depending upon their investment objective. diversification.
Overview of existing schemes existed in mutual fund category: BY NATURE
1. But as he moves ahead to invest in capital protected funds and the profit-bonds that give out more return which is slightly higher as compared to the bank deposits but the risk involved also increases in the same proportion. Hedge fund involves a very high risk since it is mostly traded in the derivatives market which is considered very volatile. thus Equity funds rank high on the risk-return matrix. Equity fund: These funds invest a maximum part of their corpus into equities holdings. The structure of the fund may vary different for different schemes and the fund manager’s outlook on different stocks. private companies. as follows:
Diversified Equity Funds Mid-Cap Funds Sector Specific Funds Tax Savings Funds (ELSS)
Equity investments are meant for a longer time horizon. which provide moderate return with minimal risk. if an investors opt for bank FD. By investing in debt instruments.
2. For example.
Thus investors choose mutual funds as their primary means of investing. which would be satisfied by lower returns. banks and financial institutions are some of the major issuers of debt papers. These Funds carry zero Default risk but
. popularly known as Government of India debt papers.
The portfolio of these schemes will consist of only those stocks that constitute the index.
Liquid Funds: Also known as Money Market Schemes.
MIPs: Invests maximum of their total corpus in debt instruments while they take minimum exposure in equities.
Income Schemes:Income Schemes are also known as debt schemes. certificates of deposit. Investors need to keep a watch on the performance of those sectors/industries and must exit at an appropriate time. Each category of funds is backed by an investment philosophy. These schemes are safer as they invest in papers backed by Government.88 of the Income Tax Act. These schemes normally invest a major part of their fund in equities and are willing to bear short-term decline in value for possible future appreciation. Under Sec. These funds primarily invest in short term papers like Certificate of Deposits (CDs) and Commercial Papers (CPs). Further the mutual funds can be broadly classified on the basis of investment parameter viz.
Short Term Plans (STPs): Meant for investment horizon for three to six months. are a mix of both equity and debt funds. etc. These scheme ranks slightly high on the risk-return matrix when compared with other debt schemes.
Index schemes attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE 50. which are in line with pre-defined investment objective of the scheme. Software. CPs and CDs. The investor can align his own investment needs with the funds objective and invest accordingly. Balanced funds: As the name suggest they. Capital appreciation in such schemes may be limited. such as treasury bills. Some portion of the corpus is also invested in corporate debentures. Equity part provides growth and the debt part provides stability in returns.
Tax Saving Schemes:
Tax-saving schemes offer tax rebates to the investors under tax laws prescribed from time to time. TOP
Types of returns
There are three ways. The percentage of each stock to the total holding will be identical to the stocks index weightage. It gets benefit of both equity and debt market. They invest in both equities and fixed income securities. commercial paper and inter-bank call money. corporate debentures and Government securities. in the proportion indicated in their offer documents (normally 50:50). the returns from such schemes would be more or less equivalent to those of the Index. they are more risky compared to diversified funds.
Money Market Schemes: Money Market Schemes aim to provide easy liquidity.
Income Funds: Invest a major portion into various debt instruments such as bonds. These funds provides easy liquidity and preservation of capital. These schemes aim to provide investors with the best of both the worlds. e. Petroleum stocks. Fast Moving Consumer Goods (FMCG). These schemes generally invest in fixed income securities such as bonds and corporate debentures. These funds are meant for short-term cash management of corporate houses and are meant for an investment horizon of 1day to 3 months. contributions made to any Equity Linked Savings Scheme (ELSS) are eligible for rebate. And hence. The aim of these schemes is to provide capital appreciation over medium to long term. The aim of these schemes is to provide regular and steady income to investors. While these funds may give higher returns. where the total returns provided by mutual funds can be enjoyed by investors:
Balanced Schemes: Balanced Schemes aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes rank low on risk-return matrix and are considered to be the safest amongst all categories of mutual funds.g. The returns in these funds are dependent on the performance of the respective sectors/industries.
Sector Specific Schemes:
These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. These schemes generally invest in safer.are associated with Interest Rate risk. inter-bank call money market. short-term instruments. preservation of capital and moderate income. Pharmaceuticals.
3. which is pre-defined in the objectives of the fund.
By investment objective:
Growth Schemes: Growth Schemes are also known as equity schemes. These schemes invest in both shares and fixed income securities. These schemes invest in short-term instruments like Treasury Bills.
when a fund manager sells a security. Most funds also pass on these gains to investors in a distribution. Liquidity .Just like an individual stock.
2. The industry witnessed a compounded annual growth rate of 31. fund managers don't consider your personal tax situation. the investors risk is spread out and minimized up to certain extent. The figure for March 2011 is the quarterly average for the first calendar quarter as the regulator stopped providing monthly average asset under management (AAUM) from September 2010 onwards.
If the fund sells securities that have increased in price. The mutual fund industries are thus charging extra cost under layers of jargon. Economies of Scale .Some funds doesn’t perform in neither the market.Mutual fund buy and sell large amounts of securities at a time. where SIP start with just Rs. Funds will also usually give you a choice either to receive a check for distributions or to reinvest the earnings and get more shares. Investors purchase funds because they do not have the time or the expertise to manage their own portfolio. and help to bring down the average cost of the unit for their investors. When money pours into funds that have had strong success.Investments in mutual fund is considered to be easy. mutual fund also allows investors to liquidate their holdings as and when they want. for picking up stocks.
3. is generally from the entry & exit load which they charge from an investors. Most AMC also have automatic purchase plans whereby as little as Rs. Mutual fund industry in India came with the concept of Mutual Fund in the year 1963 at the initiative of the Government of India and Reserve Bank of India. Professional Management . thus many investors debate over whether or not the so-called professionals are any better than mutual fund or investor him self. It might have been more advantageous for the individual to defer the capital gains liability ////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////
Investments in Mutual Fund
Mutual Funds are a popular investment tool for investors because it offers a convenient and cost-effective way to invest in the financial markets. You can then sell your mutual fund shares for a profit.when making decisions about your money.The basic advantage of funds is that. at the time of purchase. high returns from a few investments often don't make much difference on the overall return. A mutual fund is considered to be relatively less expensive way to make and monitor their investments.50 per month basis. Diversification . A fund pays out nearly all income it receives over the year to fund owners in the form of a distribution.
3. Professional Management. a capitalgain tax is triggered. Dilution is also the result of a successful fund getting too big. The growth was slow initially but it accelerated from the year 1987 when non-UTI players entered the industry.
2. For example. thus help to reducing transaction costs.
Advantages of Investing Mutual Funds: 1. the fund's shares increase in price. compare to other available instruments in the market. one must keep in mind about the Pros and cons of investments in mutual fund. Costs – The biggest source of AMC income. Dilution . The idea behind diversification is to invest in a large number of assets so that a loss in any particular investment is minimized by gains in others. 2000.
Disadvantages of Investing Mutual Funds: 1. by well qualified professional.
Income is earned from dividends on stocks and interest on bonds.
If fund holdings increase in price but are not sold by the fund manager.
4. Simplicity . and the minimum investment is small.Purchasing units in a mutual fund instead of buying individual stocks or bonds.25% from March 2003 to March 2011. the manager often has trouble finding a good investment for all the new money. the fund has a capital gain. as their management is not dynamic enough to explore the available opportunity in the market.Because funds have small holdings across different companies.
Pros & cons of investing in mutual funds:
For investments in mutual fund. they are professional managed. Taxes . which affects how profitable the individual is from the sale.
Wide varieties of Mutual Fund Schemes exist to cater to the needs such as financial position. liquidity. risk tolerance and return expectations etc. These securities are often referred to as holdings and all of the fund's holdings make up the portfolio.Mutual Funds are right way to invest into because it provides affordability. It also allows investor to systematically invest in equities and debt markets through Systematic Investment Plan. before it can collect funds from the public. Through this mode investor can take exposure with as little as Rs. The table below gives an overview into the existing types of schemes in the Industry. which regulates securities markets. It offers an opportunity to invest in a diversified. tax benefits. and professional management and most importantly it helps in maximizing returns by effectively utilizing hard earned money. Five hundred and by investing regularly for a longer period can benefit from cost averaging and can built a large corpus to meet future commitments. When one invest in a mutual fund.
. mentioned in the fund's prospectus.
Mutual fund is required to be registered with Securities and Exchange Board of India (SEBI). The assets in a mutual fund's portfolio are managed by a professional Fund Manager(s) who decides which securities to buy and sell based on the fund's investment objective. short-term money-market instruments. It acts like a company that pools money from investors and invests the same in stocks. professionally managed basket of securities. which means investors own a percentage of the fund's entire portfolio in ratio of its holding. other securities or assets and some combination of these investments. the investor is actually buying shares in the fund.
. since it is a corporation formed under a separate Act of Parliament.. exit load) the scheme and its impact on overall return. Analysis of the Fund House and the experience of the Fund Manger. Comparison of scheme with its benchmark and how has the scheme performed especially in a volatile environment. and distributes the profits. In other words.If any new investor is looking to invest for the future in equities will usually face two options .
Who is the Regulatory Body for Mutual Funds?
Securities Exchange Board of India (SEBI) is the regulatory body for all the mutual funds mentioned above. However Mutual Funds help to reduce risk through diversification and professional management. All the mutual funds must get registered with SEBI.
Which was the First Mutual Fund to be set up in India?
Unit Trust of India is the first Mutual Fund set up under a separate act. and started its operations in 1964 with the issue of units under the scheme US64.com. Sortino. Analysis of the fund corpus and how it has changed across the time period. Last but not the least an investor can refer to certain investment ratios such as Sharpe. an individual as per his investment objective needs to know the various criteria to choose the fund. lack of which may increase his risk exposure. in equity shares. which can be
Performance analysis of the scheme for a considerable long period taking into account historical returns and portfolio. Call money markets etc. However understanding the differences between them is essential as both carry inherent advantages and risks. In this active form of investment an individual must have sound knowledge.
1. Alpha etc. The only exception is the UTI. UTI Act in 1963. Treynor. The experience and expertise of Fund managers in selecting securities and timing their purchases and sales help them to build a diversified portfolio that minimizes risk and maximizes returns. Government securities.e.mutual funds or individual stocks. The information regarding the ratio and their interpretation can be taken fromwww.
What is a Mutual Fund?
A Mutual Fund is a body corporate registered with the Securities and Exchange Board of India (SEBI) that pools up the money from individual / corporate investors and invests the same on behalf of the investors /unit holders. Comparison of charges deducted by Asset Management Companies across the category where an investor wishes to make investment. after understanding the basics of mutual fund and its various schemes. experience and adequate time. a mutual fund allows an investor to indirectly take a position in a basket of assets. to judge the risk-return analysis of the scheme. Any individual investing in common stock of a company has to bear the responsibility of managing his portfolio on his own and also bear the price risk. The price at which one can exit (i.
the company specific risks are largely eliminated due to professional fund management.
Can mutual funds assumed to be risk-free investments?
6. which states that an investor can reduce his total risk by holding a portfolio of assets instead of only one asset.
What is a Systematic Investment Plan and how does it operate?
A systematic investment plan is one where an investor contributes a fixed amount every month and at the prevailing NAV the units are credited to his account. the returns on competing funds.
Why should one choose to invest in a mutual fund?
For retail investor who does not have the time and expertise to analyze and invest in stocks and bonds. An application form has to be filled up giving all the particulars along with the cheque or Demand Draft for the amount to be invested.
What are the types risks involved in investing in mutual funds?
A very important risk involved in mutual fund investments is the market risk.
9. (4) AMCs and Trustees of a MF should be two separate and distinct legal entities. mutual funds have access to crucial corporate information which individual investors cannot access.
What is the investor’s exit route in case of a closed-ended fund?
According to Sebi regulations. By creating a portfolio of a variety of assets. (4) Being institutions with good bargaining power in markets. A dividend plan entails a regular payment of dividend to the investors. the only difference being that due to professional management of funds the controllable risks are substantially reduced. To get more details about the different funds and their features please visit our mutual fund glossary. (8) MFs should distribute minimum of 90% of their profits among the investors. In case of closed-ended funds.
How do mutual funds diversify their risks?
According to basis financial theory. most of the equity funds will also experience a downturn.
What are the benefits of s Systematic Investment Plan?
A systematic investment plan (SIP) offers 2 major benefits to an investor:
What are the parameters on which a Mutual Fund scheme should be evaluated?
Performance indicators like total returns given by the fund on different schemes.
What are open-ended and closed-ended mutual funds?
In an open-ended mutual fund there are no limits on the total size of the corpus.
11. When the market is in doldrums. (7) All MF schemes should be registered with SEBI. They should also have their Board of Directors. mutual funds offer a viable investment alternative. Income fund. (2) MFs need to set up a Board of Trustees and Trustee Companies. This is because by holding all your money in just one asset. SEBI has the following broad guidelines pertaining to mutual funds : (1) MFs should be formed as a Trust under Indian Trust Act and should be operated by Asset Management Companies (AMCs). (5) The AMC or any of its companies cannot act as managers for any other fund. this risk is substantially reduced. Mutual fund investments are not totally risk free.5 crore.
What are the different types of funds offered by fund house?
Currently there exist balanced funds.
14. Sector funds etc.
8. the total size of the corpus is limited by the size of the initial offer. disclosure norms and advertising code for mutual funds. all closed-ended funds have to be necessarily listed on a recognized stock exchange. (9) There are other guidelines also that govern investment strategy. A reinvestment plan is a plan where these dividends are reinvested in the scheme itself.
How investors invest in Mutual Funds?
One can invest by approaching a registered broker of Mutual funds or the respective offices of the Mutual funds in that particular town/city. investing in mutual funds contains the same risk as investing in the markets.
12. the objective of the fund and the promoter’s image are some of the key factors to be considered while taking an investment decision regarding mutual funds.4.
13. Thus the secondary market provides an exit route in case of closed-ended funds. But generally there are 3 broad categories. However. Investors are permitted to enter and exit the open-ended mutual fund at any point of time at a price that is linked to the net asset value (NAV).
15. (3) The net worth of the AMCs should be at least Rs. This is because: (1) Mutual Funds provide the benefit of cheap access to expensive stocks (2) Mutual funds diversify the risk of the investor by investing in a basket of assets (3) A team of professional fund managers manages them with in-depth research inputs from investment analysts. Today many funds are offering this facility. Growth funds. A growth plan is one where no dividends are declared and the investor only gains through capital appreciation in the NAV of the fund.
What are the broad guidelines issued for a MF?
SEBI is the regulatory authority of MFs.
What are the different types of plans that mutual fund offers?
That depends on the strategy of the concerned scheme. (6) AMCs have to get the approval of SEBI for its Articles and Memorandum of Association. In fact. the entire fortunes of your portfolio depend on this one asset.
If the capital gains earned by you during a financial year are invested in specified mutual funds then such capital gains are exempt from capital gains tax under Section 54EA and Section 54EB of the Income Tax Act. all financial assets.
. Income from mutual funds in the form of dividends is entirely exempt from income tax provided the fund in question is a equity/growth fund where more than 50% of the portfolio is invested in equities. pooling them and investing the funds.(1) It avoids lump sum investment at one point of time (2) In a scenario of falling prices. units of a mutual fund gifted by unitholders are no longer chargeable to Gift Tax.
Do mutual fund investments attract wealth tax?
No. In such cases 20% of your contribution will qualify for rebate under Section 88 of the Income Tax Act. tax benefits are available under Section 88 of the Income Tax Act. Under the Wealth Tax Act.
If I gift mutual fund units. it reduces your overall cost of acquisition by a process of rupee-cost averaging. (5) 75% of the unit holders can pass a resolution to wind-up the scheme. the target investors are different.
Do investments in mutual funds offer tax benefit on capital gains?
Yes. (4) 75% of the unit holders with the prior approval of SEBI can terminate AMC of the fund.
What are my major rights as a unit holder in a mutual fund?
Some important rights are mentioned below: (1) Unit holders have a proportionate right in the beneficial ownership of the assets of the scheme and to the dividend declared.
Is investor eligible for rebate on income tax by investing in a MF?
Yes in case of certain specific Equity Linked Saving Schemes.
Is dividend earned from mutual funds exempt from income tax?
Yes. With effect from 1st October 1998.
22. (3) They are entitled to receive redemption cheques within 10 working days from the date of redemption.
21. does it attract gift tax?
No. This means that (3) at lower prices you end up getting more units for the same investment.
What is the difference between mutual funds and portfolio management schemes?
While the concept remains the same of collecting money from investors.
20. (2) They are entitled to receive dividend warrants within 42 days of the date of declaration of the dividend. In the case of portfolio management the target investors are high networth investors while in case of mutual funds the target investors are the retail investors. including mutual fund units are exempt totally from Wealth Tax. In such cases the fund prospectuses explicitly states that it is a tax saving fund.