NOTES ON MUTUAL FUNDS

Mutual funds are gaining popularity among the investors with every passing day. A huge number of people in
India, including youth, are showing interest in mutual fund investments these days. The reason contributing to
the popularity of this smart investment tool is the hoard of advantages that it offers to the investors during and
after the investment period. Mutual funds are in the form of Trust (usually called Asset Management Company)
that manages the pool of money collected from various investors for investment in various classes of assets to
achieve certain financial goals. We can say that Mutual Fund is trusts which pool the savings of large number of
investors and then reinvests those funds for earning profits and then distribute the dividend among the investors.
In return for such services, Asset Management Companies charge small fees. Every Mutual Fund / launches
different schemes, each with a specific objective. Investors who share the same objectives invests in that
particular Scheme. Each Mutual Fund Scheme is managed by a Fund Manager with the help of his team of
professionals.

Types of Mutual Funds

Mutual Funds can be classified into various categories under the following heads:

ACCORDING TO TYPE OF INVESTMENTS:

While launching a new scheme, every Mutual Fund is supposed to declare in the prospectus the kind of
instruments in which it will make investments of the funds collected under that scheme. Thus, the various kinds
of Mutual Fund schemes as categorized according to the type of investments are as follows:
(A) Equity Funds / Schemes: These funds primarily invest in the equities or shares of various companies.
Since, they tend to reap high returns, they are generally considered to be high risk.
(B) Debt Funds / Schemes (Also Called Income Funds): These funds invest in multiple debt instruments
including fixed income assets, debentures, and government bonds. They are considered to be safe funds
because, despite the market fluctuations, their returns are set.
(C) Diversified Funds / Schemes (Also Called Balanced Funds): Also referred to as hybrid funds, they
usually invest in different asset classes, irrespective of the proportion of debts and equities involved. This
ensures that the risks and returns remain in sync, thus striking a perfect balance.
(D) Gilt Funds / Schemes: Gilt funds are a form of mutual fund that invests only in government-issued bonds
and securities (g-secs). They vary in maturity and are considered a risk-free investment as the money
invested is in the government's safe hands. Medium and long-term government securities are chosen for
investment, and since the Reserve Bank of India (RBI) decides the interest on the same, it is considered an
option for low-risk investment.
(E) Money Market Funds / Schemes: These funds invest in short-term liquid instruments like Treasury bills.
They are considered to be risk-free as the returns, though moderate, are almost immediate.
(F) Sector Specific Funds: Just as the name suggests, sectoral funds make investments in well-defined market
sectors like infrastructure, real estate or finance. The returns on these funds are entirely dependent upon the
performance of that specific sector.
(G) Index Funds: To simply put it, index funds are equivalent to buying shares from listed exchanges like BSE
or NSE. The returns vary with the movement of the index and are thus subject to market swings.

ACCORDING TO THE INVESTMENT OBJECTIVE

The other most important criteria to classify Mutual Funds is based on the investment objectives of the
investor. On these grounds, mutual funds can be categorized as follows:

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(A) Income Funds- The basic aim of the income funds is to provide you with both, a regular income and long-
term capital growth. This is why they enable investors to place their money in fixed income instruments like
bonds and debentures.
(B) Growth Funds- The fundamental objective of growth funds is to provide capital growth or
appreciation. They tend to invest in schemes where the possibility of the principal amount growing is high.
This makes them risky but capable of generating good returns.
(C) Liquid Funds- The sole purpose of liquid funds is to provide a cover of liquidity to the investor. With
this as the goal, they invest in short-term investment instruments like treasury-bills or government bonds.
They are safer as compared to growth funds but can only generate moderate returns.
Apart from the various types of mutual funds mentioned above, investors in India can also invest in Global or
international funds. These are the funds which promote investment in assets located outside the home country.
Although they can augment the diversity of your portfolio, they can also prove to be unsafe as they are subject
to several political and economic risks, beyond the control of the investor.

ACCORDING TO THE TIME OF CLOSURE OF THE SCHEME:

While launching new schemes, Mutual Funds also declare whether this will be an open ended scheme (i.e. there
is no specific date when the scheme will be closed) or there is a closing date when finally the scheme will be
wind up. Thus, according to the time of closure schemes are classified as follows:-
(A) Open Ended Schemes
(B) Close Ended Schemes
Open ended funds are allowed to issue and redeem units any time during the life of the scheme, but close ended
funds cannot issue new units except in case of bonus or rights issue. Therefore, unit capital of open ended funds
can fluctuate on daily basis (as new investors may purchase fresh units), but that is not the case for close ended
schemes. In other words we can say that new investors can join the scheme by directly applying to the mutual
fund at applicable net asset value related prices in case of open ended schemes but not in case of close ended
schemes. In case of close ended schemes, new investors can buy the units only from secondary markets.
ACCORDING TO TAX INCENTIVE SCHEMES:
Mutual Funds are also allowed to float some tax saving schemes. Therefore, sometimes the schemes are
classified according to this also:-
(a) TAX SAVING FUNDS
(b) NOT TAX SAVING FUNDS / OTHER FUNDS

ACCORDING TO THE TIME OF PAYOUT:

Sometimes Mutual Fund schemes are classified according to the periodicity of the pay outs (i.e. dividend
etc.).The categories are as follows:-
(a) Dividend Paying Schemes
(b) Reinvestment Schemes

Functions of Investment Companies

An investment company is a financial services firm that holds securities of other companies purely for
investment purposes. Investment companies come in different forms: exchange-traded funds, mutual funds,
money-market funds, and index funds. Investment companies collect funds from institutional and retail
investors, and are entrusted with making investments in financial instruments according to the strategies that
were previously agreed with the investors.

 Collect Investments

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Investment companies collect funds by issuing and selling shares to investors. There are basically two types of
investment companies: close-end and open-end companies. Close-end companies issue a limited amount of
shares that can then be traded in the secondary market--on a stock exchange--whereas open-end company funds,
e.g. mutual funds, issue new shares every time an investor wants to buy its stocks.

 Invest in Financial Instruments

Investment companies invest in financial instruments according to the strategy of which that they made
investors aware. There are a wide range of strategies and financial instruments that investment companies use,
offering investors different exposures to risks. Investment companies invest in equities (stocks), fixed-income
(bonds), currencies, commodities and other assets.

 Pay out the Profits

The profits and losses that an investment company makes are shared among its shareholders. Depending on the
type: close-end or open-end--and the structure of the investment company, investors can redeem their shares for
cash from the company, sell the shares to another firm or individual, or receive capital distributions when assets
held by the investment company are sold.

Classification of Investment companies

Unit Investment Trusts (UITs)

A unit investment trust, or UIT, is a company established under an indenture or similar agreement. It has the
following characteristics:
 The management of the trust is supervised by a trustee.
 Unit investment trusts sell a fixed number of shares to unit holders, who receive a proportionate share of
net income from the underlying trust.
 The UIT security is redeemable and represents an undivided interest in a specific portfolio of securities.
 The portfolio is merely supervised, not managed, as it remains fixed for the life of the trust. In other
words, there is no day-to-day management of the portfolio.

Face Amount Certificates

A face amount certificate company issues debt certificates at a predetermined rate of interest. Additional
characteristics include:
 Certificate holders may redeem their certificates for a fixed amount on a specified date, or for a specific
surrender value, before maturity.
 Certificates can be purchased either in periodic installments or all at once with a lump-sum payment.
 Face amount certificate companies are almost nonexistent today.

Management Investment Companies

The most common type of Investment Company is the management investment company, which actively
manages a portfolio of securities to achieve its investment objective. There are two types of management
investment company: closed-end and open-end. The primary differences between the two come down to where
investors buy and sell their shares -in the primary or secondary markets -and the type of securities they sell.
o Closed-End Investment Companies: A closed-end investment company issues shares in a one-time
public offering. It does not continually offer new shares, nor does it redeem its shares like an open-end
investment company. Once shares are issued, an investor may purchase them on the open market and
sell them in the same way. The market value of the closed-end fund's shares will be based on supply and

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 demand, much like other securities. Instead of selling at net asset value, the shares can sell at a premium
or at a discount to the net asset value.
o Open-End Investment Companies: Open-end investment companies, also known as mutual funds,
continuously issue new shares. These shares may only be purchased from the investment company and
sold back to the investment company. Mutual funds are discussed in more detail in the Variable
Contracts section.

Advantages of investing in Mutual Funds:

Investing in mutual funds turns out to be a very lucrative investment option for investors who wisely plan and
execute the investment strategies in sync with their investment objective. Even though mutual funds carry some
associated risk, the risks can be easily mitigated by making smart investment decisions. While you may be well
aware of some of the common mutual fund benefits, there are a few lesser-known advantages that you mightn’t
know about. It is pivotal to know all the benefits offered by mutual funds prior to investing in order to derive
the maximum benefit from your investment. Here is the list of all the benefits that mutual funds offer to the
investors:
 Smart investment option
When you invest in an investment tool which invests in one specific sector there is a risk of losing money in
one go. If the industry where you have invested fails, then you might lose all your money. However, this is
not the case with mutual fund investments. When you invest in a mutual fund the associated risk is relatively
low as most of the mutual fund schemes spread the investment in multiple assets and sectors for reducing the
risk. Hence, if any one of the sectors faces a loss then the gains from the other sectors will compensate the
amount that you have lost. This risk mitigation benefit makes mutual fund investments a smart investment
option compared to other investments.
 Low-cost investment
This is a very interesting feature of mutual funds. Since mutual funds get money from multiple investors, the
asset management services provided by the company come at a comparatively low cost or charge since the
amount is equally divided between all the investors.
 Well-regulated funds
Mutual fund investments are regulated by the Securities and Exchange Board of India (SEBI). SEBI has laid
down certain rules and regulations which all the mutual fund providers in the country have to follow. All the
investments made in the funds have to be according to the SEBI guidelines. This ensures that the investment
works in favour of both investors and providers without any unfair treatment. Being monitored and
supervised by an authorized body like SEBI, the investments under mutual funds are safe and well-regulated.
 Professionally managed
Investing in mutual funds is easy. These funds are professionally managed by expert and experienced fund
managers who have extensive experience in managing funds. Hence, even beginners who don't have any
knowledge about the market can invest in such funds with the help of expert managers. Since experienced
professionals manage all activities related to these funds you can be assured that your money will be invested
in safe places. Not only that, an entire team of experts will take care of your investment, design your
portfolio, strategies on your behalf, and will guide you through every step of investment.
 Multiple investment options
Investors get a variety of investment options while investing in a mutual fund. Not only can they choose
funds as per their investment objective but they can also pick funds based on the amount of returns they want
to derive. For instance, if you want to receive returns in a short period of time, you should ideally invest in
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 short-term funds but when you have some future expenses to meet, investing in long-term funds will be ideal
to serve your purpose. Mutual funds also offer the option of having a regular income flow throughout the
tenure in the form of dividend payout facility. If your investment objective is to grow your capital throughout
the investment tenure you can choose the growth option and for earning a regular income you have to go for
the dividend facility.
 Lump sum investment or in installments
Mutual fund investments offer investment options for people who don't have a large amount of money to
invest at a go. Suppose you are very young or just don't have sufficient money to invest in mutual funds in
one shot, in both the cases you can still invest in mutual funds by opting for the SIP investment option. A SIP
is a Systematic Investment Plan which allows the investors to invest in mutual funds in installments (EMIs).
When you invest in a SIP there will not be much pressure on your finances. Contrarily, if you have a large
amount of money you can invest a lump sum amount.
 Low investment requirement
Since mutual funds offer SIP investment facility, the investors can start investing in these funds with as little
as Rs.500 every month. When you opt for the Systematic Investment Plan (SIP) under a scheme you don't
have to invest thousands of rupees in the fund in one go. Instead, you can start your investment with a
minimum of Rs.500 by opting for an SIP. Later, if you have a lump sum amount and feel the need to increase
the invested amount you can invest more money in your fund.
 Diversification of risk
Though mutual fund investments are subject to market risks, the advantage is that the associated risk can be
diversified. It is completely up to the risk appetite of the investor to decide how much risk he/she is ready to
take. While a high-risk fund tends to offer higher returns, the chances of loss in these are equally high. So, if
you are not willing to take a huge risk you have the option to choose low or medium-risk funds. A medium-
risk fund tends to balance the risk and give out a medium return and a low-risk fund has lower risks and gives
the lowest returns. Thus, based on your risk-taking ability you can diversify the risk by choosing a suitable
fund matching your requirement.
 Growth-oriented investment
Since most of the mutual funds invest in the growth-oriented equity market, the investors get a chance to
benefit from the growing Indian economy. Though investments in equity and equity-related securities of
companies are prone to certain risks, the chances of generating returns from such funds are considerably
higher. Moreover, such a fund invests in the stocks and bonds of high-grade companies the investors can do
their individual research and then invest in the desired stocks on their own without any involvement of the
intermediary.
 Easy liquidity options
When making investments in mutual funds, an investor gets options for liquidity as well. Being an investor
you will have the flexibility to choose between regular funds and tax-saving funds which are different from
each other in terms of liquidity. While in a regular plan you can liquidate your income a few months after
making the investment, in a tax-saver fund, the principal, as well as the dividend, can be withdrawn only after
the completion of a 3-year lock-in period. As a result of the higher lock-in period in a tax-saver scheme, you
can plan your future finances in a better way while generating high capital growth by the end of the
investment tenure.
 Ease of purchase and redemption
The units of a mutual fund scheme can be easily purchased and redeemed at the pertinent NAV prices on all
the working days. Except for the mutual funds which are locked for a certain period of time, like ELSS, the
units of the open-ended mutual funds can be purchased or redeemed on any of the business days unless
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 specified otherwise by the fund house. Since there is no restriction on the liquidation of the units, the
subscribers have easy access to their invested money.
 Flexibility of switching funds
Mutual funds come with an option of fund switching. This means the investors can switch between schemes
or between funds to avail better terms and/or better returns from their investment. However, in most of the
cases, the fund switching option is available only between schemes of the same fund and not between the
funds offered by a particular company.
 Easy to track funds
It is not an easy task to regularly review the mutual fund investment portfolios as the fund units are purchased
and liquidated by the subscribers on a regular basis. This is why the mutual fund companies provide clear
statements of all investments thus making it easy for investors to keep a track of their investment. You can
ask for the statement from the executives or can download it from the official website of the fund house that
you have invested in.
 Tax-saving advantages
A mutual fund investment also provides tax-saving benefits to investors. If you invest your money in mutual
funds such as equity-linked savings schemes (ELSS) then you will be eligible to get tax-deduction benefits
under Section 80C of the Income Tax Act, 1961. As per the Income Tax Act, a mutual fund investor is
permitted to have tax deduction benefits up to the amount of Rs.1,50,000. Hence, when you invest in such
tax-saving schemes you will get the benefit of not paying income tax for the amount of money that you have
invested in the mutual fund scheme. In this way, such investments will bring down your taxable income.
Mutual funds are relatively more tax-efficient than other types of investments. Long-term capital gain tax on equity
mutual fund is zero, which means, if you sell your investment one year after purchase, you don’t have to pay tax.
For debt funds, long-term capital gains apply when you hold them for 3 years.
Some important features of tax-saving funds are: It is a surrogate route to the direct stock market, the minimum
investment is Rs 500 per month, It has a lock-in-period of only 3-years and the returns are tax-free as well.
So, these are some of the advantages of investing in mutual funds. Mutual funds are indeed better than other
investment options since most of the benefits are exclusive and help the investors gain high returns with less
risk. However, since mutual funds are subject to market risks, choose funds that are suitable according to your
risk appetite and take guidance of the experts before investing.

How to Select Mutual Funds: Mutual Funds are of different types – this allows investors to invest in particular types of
funds, depending on their goals. Here are some examples:

1. To park money for an extremely short term, invest in liquid funds like Kotak Money Market Scheme
2. To invest money for a short-term duration like 1 to 3 years, invest in Ultra Short Term Funds (example
– Franklin India Low Duration Fund) or Short Term Funds (example – HDFC Short Term Debt Fund)
3. For long-term investing, investment is to be made in equity funds. In equity funds, one can choose from high-risk
funds like mid cap and small cap funds to relatively less risky funds, like large-cap and diversified funds.
Investors who want to adopt a middle approach can choose balanced funds. Example – HDFC Balanced Fund.
4. Unlike other investments like real estate or stocks, mutual funds allows to start as small as Rs 500. One can start
with mutual funds with as low as Rs 500 or Rs 1000. Some funds, like Reliance Small Cap  Fund allows investor
to start with just Rs 100.
5. Automated Investment: Mutual funds are largely beneficial because one can invest with less money. The
Systematic Investment Plan or SIP is an excellent example wherein the money gets automatically debited from
your account. You can choose a fund that suits your investing goal.
6. If you have more knowledge about certain industries or sectors, but don’t have enough expertise to know which
company to invest in, you can make use of sector mutual funds. By doing so, you are ensuring your money gets
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 invested in a certain industry without having to research which company to invest in. Sector mutual funds stick to
investing primarily in a certain sector only. Some common types of sector mutual funds are mining funds, energy
funds, automobile funds, etc.
7. Mutual funds also give the flexibility to invest through SIP or lump sum.

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