INDEX 1 2 3 4 5 6 7 8 9 10 11 12 UNDERSTANDING MUTUAL FUNDS HISTORY OF MUTUAL FUNDS TYPES OF MUTUAL FUNDS ADVANTAGES OF MUTUAL FUNDS DISADVANTAGES OF MUTUAL FUNDS IMPORTANCE OF MUTUAL FUNDS NET ASSET VALUE CLASSES OF MUTUAL FUNDS HOW MUTUAL FUND WORKS INVESTORS RIGHTS AND FACILITIES CASE STUDY BIBLIOGRAPHY 6 9 13 21 23 24 26 28 30 31 33 37
UNDERSTANDING MUTUAL FUND
Mutual fund is a trust that pools money from a group of investors (sharing common financial goals) and invest the money thus collected into asset classes that match the stated investment objectives of the scheme. Since the stated investment objectives of a mutual fund scheme generally form the basis for an investor's decision to contribute money to the pool, a mutual fund can not deviate from its stated objectives at any point of time. DEFINITION : The securities and exchange board of India regulations.1993 defines a mutual fund as “a fund established in the form of a trust by a sponsor, to raise monies by the trustees through the sale of units to the public, under one or more schemes, for investing in securities in accordance with these regulations”. Every Mutual Fund is managed by a fund manager, who using his investment management skills and necessary research works ensures much better return than what an investor can manage on his own. The capital appreciation and other incomes earned from these investments are passed on to the investors (also known as unit holders) in proportion of the number of units they own.
When an investor subscribes for the units of a mutual fund, he becomes part owner of the assets of the fund in the same proportion as his contribution amount put up with the corpus (the total amount of the fund). Mutual Fund investor is also known as a mutual fund shareholder or a unit holder. Any change in the value of the investments made into capital market instruments (such as shares, debentures etc) is reflected in the Net Asset Value (NAV) of the scheme. NAV is defined as the market value of the Mutual Fund scheme's assets net of its liabilities. NAV of a scheme is calculated by dividing the market value of scheme's assets by the total number of units issued to the investors.
For example: A. If the market value of the assets of a fund is Rs. 100,000 B. The total number of units issued to the investors is equal to 10,000. C. Then the NAV of this scheme = (A)/(B), i.e. 100,000/10,000 or 10.00 D. Now if an investor 'X' owns 5 units of this scheme E. Then his total contribution to the fund is Rs. 50 (i.e. Number of units held multiplied by the NAV of the scheme)
HISTORY OF MUTUAL FUND
The Evolution The formation of Unit Trust of India marked the evolution of the Indian mutual fund industry in the year 1963. The primary objective at that time was to attract the small investors and it was made possible through the collective efforts of the Government of India and the Reserve Bank of India. The history of mutual fund industry in India can be better understood divided into following phases: Phase 1. Establishment and Growth of Unit Trust of India - 1964-87
Unit Trust of India enjoyed complete monopoly when it was established in the year 1963 by an act of Parliament. UTI was set up by the Reserve Bank of India and it continued to operate under the regulatory control of the RBI until the two were de-linked in 1978 and the entire control was transferred in the hands of Industrial Development Bank of India (IDBI). UTI launched its first scheme in 1964, named as Unit Scheme 1964 (US-64), which attracted the largest number of investors in any single investment scheme over the years. UTI launched more innovative schemes in 1970s and 80s to suit the needs of different investors. It launched ULIP in 1971, six more schemes between 1981-84, Children's Gift Growth Fund and India Fund (India's first offshore fund) in 1986, Mastershare (Inida's first equity diversified scheme) in 1987 and Monthly Income Schemes (offering assured returns) during 1990s. By the end of 1987, UTI's assets under management grew ten times to Rs 6700 crores. Phase II. Entry of Public Sector Funds - 1987-1993
The Indian mutual fund industry witnessed a number of public sector players entering the market in the year 1987. In November 1987, SBI Mutual Fund from the State Bank of India became the first non-UTI mutual fund in India. SBI Mutual Fund was later followed by Canbank Mutual Fund, LIC Mutual Fund, Indian Bank Mutual Fund, Bank of India Mutual Fund, GIC Mutual Fund and PNB Mutual Fund. By 1993, the assets under management of the industry increased seven times to Rs. 47,004 crores. However, UTI remained to be the leader with about 80% market share.
A mou nt Mobi lised 11,05 7 1,964 13,02 1
Assets Under Manage ment
Mobilisa tion as % of gross Domesti c Savings 5.2% 0.9% 6.1%
UTI Public Sector Total
38,247 8,757 47,004
Phase III. Emergence of Private Secor Funds - 1993-96
The permission given to private sector funds including foreign fund management companies (most of them entering through joint ventures with Indian promoters) to enter the mutal fund industry in 1993, provided a wide range of choice to investors and more competition in the industry. Private funds introduced innovative products, investment
8 techniques and investor-servicing technology. By 1994-95, about 11 private sector funds had launched their schemes. Phase IV. Growth and SEBI Regulation - 1996-2004
The mutual fund industry witnessed robust growth and stricter regulation from the SEBI after the year 1996. The mobilisation of funds and the number of players operating in the industry reached new heights as investors started showing more interest in mutual funds. Invetors' interests were safeguarded by SEBI and the Government offered tax benefits to the investors in order to encourage them. SEBI (Mutual Funds) Regulations, 1996 was introduced by SEBI that set uniform standards for all mutual funds in India. The Union Budget in 1999 exempted all dividend incomes in the hands of investors from income tax. Various Investor Awareness Programmes were launched during this phase, both by SEBI and AMFI, with an objective to educate investors and make them informed about the mutual fund industry. In February 2003, the UTI Act was repealed and UTI was stripped of its Special legal status as a trust formed by an Act of Parliament. The primary objective behind this was to bring all mutual fund players on the same level. UTI was re-organised into two parts: 1. The Specified Undertaking, 2. The UTI Mutual Fund Presently Unit Trust of India operates under the name of UTI Mutual Fund and its past schemes (like US-64, Assured Return Schemes) are being gradually wound up. However, UTI Mutual Fund is still the largest player in the industry. ASSETS UNDER MANAGEMENT (RS. CRORES) U T I P UBL IC SEC TOR PRIV ATE SECT OR TO TA L
Phase V. Growth and Consolidation - 2004 Onwards The industry has also witnessed several mergers and acquisitions recently, examples of which are acquisition of schemes of Alliance Mutual Fund by Birla Sun Life, Sun F&C Mutual Fund and PNB Mutual Fund by Principal Mutual Fund. Simultaneously, more international mutal fund players have entered India like Fidelity, Franklin Templeton Mutual Fund etc. There were 29 funds as at the end of March 2006. This is a continuing phase of growth of the industry through consolidation and entry of new international and private sector players.
TYPES OF MUTUAL FUNDS
Mutual funds schemes can broadly be classified into many types as given below: General Classification of Mutual Funds
1) Open-ended fund. Funds that can sell and purchase units at any point of time are classified as Open-end Funds. It is just the opposite of close ended funds. Under this scheme, the size of the fund and the period of the fund is not pre-determined. The investors are free to buy and sell any number of units at any point of time. In other words your subscription will be accepted at any time of the year as open-ended funds are generally not listed on stock exchanges. The NAV of an open-end fund is calculated every day.
The main objective of this fund is income generation. The investors get dividend, rights or bonuses as rewards for their investment. Units can be redeemed at at any point by the investor.
11 For instance, the unit scheme (1964) of the unit trust of India is an open ended one, both in terms of period and target amount. Anybody can buy this unit at any time and sell it also at any time at his discretion.
2) Close-ended funds. Funds that can sell a fixed number of units only during the New Fund Offer (NFO) period are known as Closed-end Funds. Under this scheme, the corpus (size ) of the fund and its duration are prefixed. In other words, the corpus of the fund and the number of units are determined in advance and have a fixed number of shares and are open for subscription during a specified period for a fixed period of time - for example, five years. Once the subscription reaches the pre-determined level, the entry of investors is closed; they cannot purchase any more units.After the expiry of the fixed period, the entire corpus is disinvested and the proceeds are distributed to the various unit holders in proportion to their holding. Closed-end Funds are listed on the stock exchanges where investors can buy/sell units from/to each other. The trading is generally done at a discount to the NAV of the scheme. The NAV of a closed-end fund is computed on a weekly basis (updated every Thursday). The main objective of this fund is capital appreciation. 3) Load Funds Mutual Funds incur various expenses on marketing, distribution, advertising, portfolio churning, fund manager's salary etc. Many funds recover these expenses from the investors in the form of load. These funds are known as Load Funds. A load fund may impose following types of loads on the investors:
Entry Load - Also known as Front-end load, it refers to the load charged to an investor at the time of his entry into a scheme. Entry load is deducted from the investor's contribution amount to the fund.
Exit Load - Also known as Back-end load, these charges are imposed on an investor when he redeems his units (exits from the scheme). Exit load is deducted from the redemption proceeds to an outgoing investor.
Deferred Load - Deferred load is charged to the scheme over a period of time. Contingent Deferred Sales Charge (CDSC) - In some schemes, the percentage of exit load reduces as the investor stays longer with the fund. This type of load is known as Contingent Deferred Sales Charge.
4) No-load Funds All those funds that do not charge any of the above mentioned loads are known as No-load Funds. Mutual fund accept amounts in multiples of rs.1,000 (sometimes rs.50). so, if an investor wants to invest rs.1,000 in a fund whose NAV is rs.19.52 per unit,entry load 0.5%, then he will pay 19.52 + (0.5% x 19.52)=19.52 + 0.0976=19.62rs. per unit and he will get (1,000/19.62)= 50.97 units. It may be noted that number of units issued could be odd fractions; the amount invested has to be round multiple of a thousand. After say one year, this investor would like to liquidate his investment by selling units back to AMC, and at that time NAV is rs. 23.21 per unit and exit load is 1%. Then he will get [23.21 –(1%x23.21)] =rs.22.98 per unit totaling to 22.98 x 50.97 = 1,171.29 rupees. His appreciation of value is from rs.1,000 to rs. 1,171.29 i.e; 17.13% per annum.
5) Tax-exempt Funds Funds that invest in securities free from tax are known as Tax-exempt Funds. All open-end equity oriented funds are exempt from distribution tax (tax for distributing income to investors). Long term capital gains and dividend income in the hands of investors are tax-free.
13 6) Non-Tax-exempt Funds Funds that invest in taxable securities are known as Non-Tax-exempt Funds. In India, all funds, except open-end equity oriented funds are liable to pay tax on distribution income. Profits arising out of sale of units by an investor within 12 months of purchase are categorized as short-term capital gains, which are taxable. Sale of units of an equity oriented fund is subject to Securities Transaction Tax (STT). STT is deducted from the redemption proceeds to an investor. BROAD MUTUAL FUND TYPES 1) Growth funds. Growth schemes predominantly invest in equity and equity linked instruments and derivatives. These funds concentrates mainly on long run gains i.e; capital appreciation rather than regular income. These obviously are high risk, high return investment. They includes ; (a) Index funds Corpus is invested in those stocks which are part of stock market index composition, such as BSE Sensex or NIFTY. It is invested in the same proportion in theses stocks as their weight in index. So, as index moves, funds NAV moves. These are easy to track and easy to understand. No script specific knowledge or sector study is required. As market goes up, NAV is high. For an investor its pretty simple to understand and decide on investment time (b) Sector funds Equity funds that invest in a particular sector/industry of the market are known as Sector Funds. The exposure of these funds is limited to a particular sector (say Information Technology, Auto, Banking, Pharmaceuticals or Fast Moving Consumer Goods) which is why they are more risky than equity funds that invest in
14 multiple sectors. These schemes invest in stocks of a specific industry.pharma sector und, bank fund, infrastructure fund, lifestyle industry fund,mid-cap, blue-chip fund are such examples. Investors, who believe in growth of a particular industry to be more than average (index), can choose these schemes.
(c) Opportunity fund These schemes target to encash opportunities arising out of certain happening or actions in stock market. IPO’s are oversubscribed and hence many small investors miss the bus as they get refund of money instead of allocation of shares. Most shared of the day of listing are traded at a price higher than issue price. Hence these are gains from IPO listings. The main objective of this scheme is to encash these gains from listings. (d) Equity linked saving scheme (ELSS) According to the new income tax act section 80C investments in ELSS are subject to 100% tax rebate on investments up to maximum rs.100,000 from a financial year. ELSS is an equity diversified scheme and has a lock in period of three years. ELSS invests more than 80 percent of their money in equity and related instruments. Pension schemes launched by the mutual funds also offer tax benefits. 2) Income funds. Funds that invest in medium to long-term debt instruments issued by private companies, banks, financial institutions, governments and other entities belonging to various sectors (like infrastructure companies etc.) are known as Debt / Income Funds. The fund aims at generating and distributing regular income to the members. Debt funds are low risk profile funds that seek to generate fixed current income (and not capital appreciation) to investors. Based on different investment objectives, there can be following types of debt funds:
Gilt edge fund
Also known as Government Securities in India, Gilt Funds invest in government papers having medium to long term maturity period issued by the central or the state government. These investments have little credit risk (risk of default) and provide safety of principal to the investors. (b) Money Market Mutual funds (MMMFs) Money market funds typically invest in highly liquid and safe securities like commercial paper, certificate of deposits, treasury bills,etc. these instruments are called money market instruments. (c) Liquid fund Liquid funds invest in short-term (maturing within one year) interest bearing
debt instruments. These securities are highly liquid and provide safety of investment, thus making liquid funds the safest investment option when compared with other mutual fund types. The typical investment options for liquid funds include Treasury Bills (issued by governments), Commercial papers (issued by companies) and Certificates of Deposit (issued by banks). 3) Balanced fund. The portfolio of balanced funds include assets like debt securities, convertible securities, and equity and preference shares held in a relatively equal proportion. Balanced shemes work on proper mix of debt and equity instruments. Usually mix is 60%:40% or 50%:50%. The objectives of balanced funds are to reward investors with a regular income, moderate capital appreciation and at the same time minimizing the risk of capital erosion. Balanced funds are appropriate for conservative investors having a long term investment horizon.
16 (a) Dynamic asset allocation fund. Mutual funds may invest in financial assets like equity, debt, money market or non-financial (physical) assets like real estate, commodities etc.. fund managers may switch over to equity if they expect equity market to provide good returns and switch over to debt if they expect debt market to provide better returns. It should be noted that switching over from one asset class to another is a decision taken by the fund manager on the basis of his own judgment and understanding of specific markets, and therefore, the success of these funds depends upon the skill of a fund manager in anticipating market trends. These schemes do not target any fixed proprtaionate allocation between equity and debt. It could be 0% to 100% equity and remaining 100% to 0% debt instrument. The proportion is decided by the fund managers team as per the market conditions and their analysis. (b) Monthly Income plans ( MIPs) MIPs invest a portion of their assets in equities (ranging from 10% to 25% of assets ) and the balance in debt securities. The main objective is to generate regular income through investments in fixed income securities to provide periodical income distribution to the unit holders. (c.) Fund of Funds Mutual funds that do not invest in financial or physical assets, but do invest in other mutual fund schemes offered by different AMCs, are known as Fund of Funds. Fund of Funds maintain a portfolio comprising of units of other mutual fund schemes, just like conventional mutual funds maintain a portfolio comprising of equity/debt/money market instruments or non financial assets. Fund of Funds provide investors with an added advantage of diversifying into different mutual fund schemes with even a small amount of investment, which further helps in diversification of risks.
NON FINANCIAL ASSETS SCHEMES Following schemes would soon see the Indian market; 1) Gold Exchange Traded Fund scheme It is a mutual fund scheme that invests primarily in gold or gold related instruments. Gold related instrument means such instrument have gold as underlying, as may be specified by SEBI from time to time. In case of a gold exchange traded fund scheme, the assets of the scheme being gold or gold related instruments may be kept in custody of a bank which is registered as a custodian with SEBI. The funds of any such scheme should be invested only in gold or gold related instruments in accordance with its investment objective, except to the extent necessary to meet the liquidity requirements for honoring repurchases or redemptions, as disclosed in the offer document; and pending deployment of funds, the mutual fund may invest such funds in short fund deposits of scheduled commercial banks. This is as per notification issued by SEBI, in January 2006. 2) Real Estate Mutual Fund SEBI approved these schemes in June 2006. These funds would initially be close ended schemes. Their units would be compulsorily listed on the stock exchanges. Apart from real estate properties in India, the schemes can invest in mortgage(housing lease)backed securities and equity shares/bonds/debentures of listed and unlisted companies dealing in properties and undertake property development. The funds would be required to appoint a custodian who has been granted a certificate registration to carry on the business of custodian of securities by the board.
ADVANTAGES OF MUTUAL FUND
1) Portfolio Diversification Mutual Funds invest in a well-diversified portfolio of securities which enables investor to hold a diversified investment portfolio (whether the amount of investment is big or small). 2) Professional Management Fund manager undergoes through various research works and has better investment management skills which ensure higher returns to the investor than what he can manage on his own. 3) Less Risk Investors acquire a diversified portfolio of securities even with a small investment in a Mutual Fund. The risk in a diversified portfolio is lesser than investing in merely 2 or 3 securities. 4) Low Transaction Costs Due to the economies of scale (benefits of larger volumes), mutual funds pay lesser transaction costs. These benefits are passed on to the investors. 5) Liquidity An investor may not be able to sell some of the shares held by him very easily and quickly, whereas units of a mutual fund are far more liquid. 6) Choice of Schemes
19 Mutual funds provide investors with various schemes with different investment objectives. Investors have the option of investing in a scheme having a correlation between its investment objectives and their own financial goals. These schemes further have different plans/options. 1) Transparency Funds provide investors with updated information pertaining to the markets and the schemes. All material facts are disclosed to investors as required by the regulator. 2) Flexibility Investors also benefit from the convenience and flexibility offered by Mutual Funds. Investors can switch their holdings from a debt scheme to an equity scheme and vice-versa. Option of systematic (at regular intervals) investment and withdrawal is also offered to the investors in most open-end schemes. 3) Safety Mutual Fund industry is part of a well-regulated investment environment where the interests of the investors are protected by the regulator. All funds are registered with SEBI and complete transparency is forced.
DISADVANTAGES OF MUTUAL FUND
1) Costs Control Not in the Hands of an Investor Investor has to pay investment management fees and fund distribution costs as a percentage of the value of his investments (as long as he holds the units), irrespective of the performance of the fund. 2) No Customized Portfolios The portfolio of securities in which a fund invests is a decision taken by the fund manager. Investors have no right to interfere in the decision making process of a fund manager, which some investors find as a constraint in achieving their financial objectives. 3) Difficulty in Selecting a Suitable Fund Scheme: Many investors find it difficult to select one option from the plethora of funds/schemes/plans available. For this, they may have to take advice from financial planners in order to invest in the right fund to achieve their objectives.
IMPORTANCE OF MUTUAL FUND
1) Offering Tax Benefits: Certain funds offer tax benefits to its customers. Thus, apart from dividend, interest and capital appreciation, investors also stands to get tax benefits concessions. For instance sum of Rs 10000 received as dividend from a mutual fund is deductible from the gross total income. 2) Supporting Capital Market: Mutual funds play a vital role in supporting the development capital markets. The mutual funds make the capital markets active by means of providing a sustainable domestic source of demand for capital market instruments. The savings of people are directed towards investments in capital markets through these mutual funds. 3) Providing Better Yields: The pooling of funds from a large number of customers enables the funds to have funds at its disposal. Due to these large funds, mutual funds are able to buy cheaper and sell dearer than the small and medium investors. Thus they are able to command better market rates and lower rates of brokerage. So they provide better yields to their customers. 4) Rendering Expertised Investment Service at Low Cost: The management of the fund is generally assigned to professionals who are well trained and have adequate experience in the field of investment.
22 5) Introducing Flexible Investment Schedule: Some mutual funds have permitted the investors to exchange their units from one scheme to another and this flexibility is of great boon to investors. Income units can be changed for growth units depending upon the performance of the funds. 6) Simplified Record Keeping: An investor with just an investment in 500 shares or so in 3 – 4 companies has to keep proper records of dividend payments, bonus issues, price movements, purchase or sale instructions, brokerage and other related items. It is very tedious and consumes a lot of time. One may even forget to record the right issues and may forfeit the same. Thus, record keeping is the biggest problem for small and medium investors. 7) Acting As Substitutes For Initial Public Offering ( IPO) : In most cases investors are not able to get the allotment of IPOs of companies because they are often oversubscribed many times. Moreover, they have to apply for a minimum of 500 shares which is very difficult particularly for small investors. But, in mutual funds, allotment is more or less guaranteed.
NET ASSET VALUE (NAV)
The net asset value of the fund is the cumulative market value of the assets fund net of its liabilities. In other words, if the fund is dissolved or liquidated, by selling off all the assets in the fund, this is the amount that the shareholders would collectively own. This gives rise to the concept of net asset value per unit, which is the value, represented by the ownership of one unit in the fund. It is calculated simply by dividing the net asset value of the fund by the number of units. However, most people refer loosely to the NAV per unit as NAV, ignoring the "per unit". We also abide by the same convention Calculation of NAV The most important part of the calculation is the valuation of the assets owned by the fund. Once it is calculated, the NAV is simply the net value of assets divided by the number of units outstanding. The detailed methodology for the calculation of the asset value is given below. Asset value is equal to Sum of market value of shares/debentures + Liquid assets/cash held, if any + Dividends/interest accrued Amount due on unpaid assets Expenses accrued but not paid
24 For liquid shares/debentures, valuation is done on the basis of the last or closing market price on the principal exchange where the security is traded For illiquid and unlisted and/or thinly traded shares/debentures, the value has to be estimated. For shares, this could be the book value per share or an estimated market price if suitable benchmarks are available. For debentures and bonds, value is estimated on the basis of yields of comparable liquid securities after adjusting for illiquidity. The value of fixed interest bearing securities moves in a direction opposite to interest rate changes Valuation of debentures and bonds is a big problem since most of them are unlisted and thinly traded. This gives considerable leeway to the AMCs on valuation and some of the AMCs are believed to take advantage of this and adopt flexible valuation policies depending on the situation. Interest is payable on debentures/bonds on a periodic basis say every 6 months. But, with every passing day, interest is said to be accrued, at the daily interest rate, which is calculated by dividing the periodic interest payment with the number of days in each period. Thus, accrued interest on a particular day is equal to the daily interest rate multiplied by the number of days since the last interest payment date. Usually, dividends are proposed at the time of the Annual General meeting and become due on the record date. There is a gap between the dates on which it becomes due and the actual payment date. In the intermediate period, it is deemed to be "accrued". Expenses including management fees, custody charges etc. are calculated on a daily basis.
MUTUAL FUND CLASSES
When checking for different quotes on mutual funds, you might see different prices for classes of mutual fund shares that seem to be holding similar or identical products. These different classes - 'A', 'B' and 'C' - all are characterized by their different load structures. 'A' shares generally denote a front-load charge. This load is generally fixed for the duration of the fund and will vary depending on the different types of mutual funds. Fund companies recognize that the front load is a deterrent to investors, so to sweeten the attractiveness of the fund, they may reduce the management expense ratios (MER). Thus, some funds claim that, even though you are paying a large fee up front, you will end up saving money if you decide to hold this fund for a long duration. The 'B' shares normally are deferred-load funds. In many instances this deferred load will dissipate along a schedule so that the longer you hold the fund, the smaller the deferred load becomes. When the deferred fund no longer has back-end charges, it will normally be reclassified as an 'A' share. It may seem advantageous to purchase and hold the 'B' class until the load structure completely dissolves, but this is not necessarily the case. Fund companies may circumvent lost profits by charging a higher MER. The 'C' shares are constant-load funds. Regardless of the number of years the fund is held, the load charge is present. Since this fund's load is lower than both the 'A' and 'B' classes, it generally also has a higher expense ratio to offset the fund company's lost revenue; furthermore, 'C' shares typically do not reclassify into 'A' shares, which means
26 that the purchaser of these shares will be stuck paying the full load when he or she sells the fund. Keep in mind that fund companies will denote their multi-class mutual funds differently, but the letters we refer to above are the most common classifications. When you are looking to purchase a new fund, it's definitely important that you understand the load structure and availability of different classes. Also, remember that loads don't automatically get you a higher return. In fact, most evidence suggests that no-load funds are almost always a better choice.
HOW MUTUAL FUND WORKS
Every mutual fund has a goal - either growing its assets (capital gains) and/or generating income (dividends) for its investors. Distributions in the form of capital gains (shortterm and long-term) and dividends may be passed on (paid) to shareholders as income or reinvested to purchase more shares. For tax purposes, keep track of your distributions and cost basis of purchased/reinvested shares. Like any business, mutual funds have risks and costs associated with returns. As a shareholder, the risks of a fund and the expenses associated with fund's operation directly impact your return. Returns As an investor, you want to know the fund's return-its track record over a specified period of time. So what exactly is "return?" A mutual fund's return is the rate of increase or decrease in its value over a specific period of time usually expressed in the following increments: one, three, five, and ten year, year to date, and since the inception of the fund. Since return is a common measure of performance, you can use it to evaluate and compare mutual funds within the same fund category. Generally expressed as an annualized percentage rate, return is calculated assuming that all distributions from the fund are reinvested. Since average returns can sometimes "hide" short-term highs and lows, you should evaluate returns for a time period of several years-not just one year or less. A fund that has a high return in one year may have experienced losses in other years-these
28 fluctuations may not be apparent in its average return. While a fund's return shows its track record, keep in mind that past performance is no guarantee of future results. When using returns to compare funds, always use net returns. Net returns are the true returns of both load and no-load funds after deducting all costs and expenses.
INVESTORS RIGHTS AND FACILITIES
1) Mutual funds are required to give name of the contact person in the offer, to whom investors can approach in case of any query, complaints or grievances. Trustees of the mutual funds monitor the activities of mutual fund. The names of the directors of the asset Management Company and trustees should be given in the offer documents. Investors should approach the concerned mutual fund / investor service centre of the mutual fund with their complaints. If their complaints remain unresolved, the investors can approach SEBI for resolving their complaints. 2) All mutual funds are required to put their NAVs on the website of association of mutual funds in India (AMFI). The mutual funds are also required to publish their performance in the form of half yearly results. These results should include their returns/ yields over a period of last six months, 1 year, 3 years, 5 years and since inception of schemes. Other details like percentage of expenses of total assets are also required to be disclosed. The mutual funds are required to send annual report or abridged annual report to the unit holders at the end of the year. 3) The mutual funds are required to disclose full portfolios of all their schemes on half - yearly basis. These may be sent to unit – holders or published in newspapers. Scheme portfolios show investment in made in each security i.e.
29 equity, debentures, money market instruments, government securities, etc. and their quantity, market value and % to NAV. 4) Transfer of units of closed ended schemes, after purchasing from stock markets, is required to be done within 30 days from the date of lodgment of certificates within the mutual fund. 5) A mutual fund is required to dispatch dividend warrants to the unit – holders within 30 days of the declaration of the dividend and the redemption or repurchase proceeds within 10 working days from the date of receipt of redemption or repurchase request from the unit – holder. In case the mutual fund fails to dispatch the redemption / repurchase proceeds within stipulated time period, asset Management Company is liable to pay interest as specified by SEBI from time to time (15% at present).
Morgan Stanley raised large corpus (more than Rs.10bn) in around early 1994. The entire exercise in fund raising was centered on the hype of the fund being was the first fund promoted by an internationally acclaimed asset management company. It was marketed like any other public issue and fund investors rushed to invest in the scheme hoping to get superior returns. No one bothered to explain to them that Morgan Stanley AMC was a service provider - providing them the service of investment advice and management. No one explained to them that they were not investing in a share of a company – in fact the artificial gray market premium served to perpetrate this feeling. The IPO was a great success. It ensured that the name "Morgan Stanley" was now a part of the dreams of more than 1 million Indians. The fund raising exercise, unfortunately, coincided with the peak of stock market boom. Indian stock markets lack depth and are quite illiquid. The fund managers were compelled to invest in equities in a big hurry as a number of Foreign Institutional Investors were investing huge sums of money in the country resulting in a mad rush for equity stocks. The fund’s managers invested a considerable amount of money in smaller companies with low floating stock and low market capitalization, either through the secondary market or through private placements. These companies had experienced the highest appreciation in prices in the immediate past. The market position started changing from late 1994. The boom in the market made it possible for many companies to raise equity capital and literally hundreds of public/rights issues opened for subscriptions every week, many of them at high issue prices. There
31 were also massive private placements of equity shares and GDR issues at huge premiums. There were very few companies which did not wash their hands in this great gravy train. This deluge of paper soaked up money and reduced the amount available for fresh investment both from resident Indians, domestic mutual funds and from foreign institutional investors. At this time, the RBI commenced on its tight money policy in a bid to control inflation from raising its head. Money supply tightened and bond yields started increasing dramatically. High industrial growth and tight money created a shortage for credit and rates started going sky high. Many corporates and banks started redeeming their holdings in the Unit Trust of India and other mutual funds. This put major pressure on the market, which was already showing signs of weakness. What followed was the great crash. And in this crash, the biggest losers were the smaller capitalization stocks. Many of these stocks lost more than 90% of their peak prices. Morgan Stanley AMC restructured the funds portfolio at big losses. As the NAV went below par, investors’ confidence was shattered. Being a closed-ended scheme the Morgan Stanley’s mutual fund unit is also listed on the stock markets. Crisis of confidence led to its price on the stock exchange crashing and it started quoting at a steep discount to its NAV. The fund started buying back units in order to reduce the discount and also to boost the NAV (buying back units at prices below the NAV results in a profit, which will reduce the NAV). Given its large corpus size no amount of buy back or otherwise support could help boost the investor confidence. Since then the equity markets have gone nowhere with the index still below the level at which the fund was invested. Most of the stocks in the Sensex have performed poorly with markets punishing commodity companies and companies with non-transparent Indian managements. To top it, many erstwhile bluechips have reported disastrous financial performances.
32 Consequently, the NAV of MSGF mirrors this gory saga of the Indian markets. In fact, the fund invested considerable amount of money in FMCG, pharmaceutical and software companies at the right time which improved the NAV from 1998 onwards. How important is an AMC (Asset Management Company) behind a mutual fund? AMC controls the operations and functioning of a mutual fund. It is very critical to the performance of a mutual fund as it decides on the style of functioning, people who are going to manage the funds, the commitment to service quality and overall supervision. The financial strength and the commitment of the AMC sponsors to the business are very key issues. This is because most AMCs lose money in the first few years of operations. In most cases, these losses are much more than the capital requirements stipulated by SEBI. Hence, a sponsor which is financially weak or which cannot capital to the business either because of its inability or unwillingness will result in an unhealthy operation. There will be a tendency to cut corners and unwillingness to spend money to expand operations. This is the last place where high quality persons would want to remain and work. The AMC then remains stunted and the sponsors lose interest. The worst affected are the investors. This is exactly what has happened with some AMCs promoted by Indian business houses. This is also a problem that has afflicted some of the AMCs floated by nationalized banks. In these organizations, the traditional thinking is prevalent which can be summarized as "money is power". Since mutual fund business did not have access to too much money, a posting in the AMC became punishment postings for some personnel who were not doing well in the parent organization or who lost out in the organizational politics. The management of the banks also did not allow these AMCs to become independent viable businesses. The CEO’s of the AMCs did not have any clue of the mutual fund business and neither were they interested in it – the entire effort was spent in getting a posting back in the parent. The fund managers had no experience in the activity making a mockery of "professional management". The sad results are there to see. Some of the parents had to provide funds to bridge the gap in "assured return schemes". It looks extremely likely that some of these AMCs will no longer exist in a few years.
33 How and against what should you benchmark the performance of a mutual fund ? All mutual funds have different objectives and therefore their performance would vary. A mutual funds performance should be benchmarked against mutual funds of similar type or India Infoline mutual fund index for a particular type. e.g. equity fund index, income fund index or balanced fund index or liquid fund index. One can also benchmark the fund against the Sensex or any other broad based index for the particular asset class. One has to be very careful about choosing the comparison period. Ideally, one should compare the performance of equity or an index fund over a 1-2 year horizon. Any comparison over a shorter period would be distorted by short term, volatile price movements. Comparisons over a longer period need to be interpreted carefully by looking at other factors such as change in individuals managing the fund, one time investment successes etc. Similarly, the ideal comparison period for a debt fund would be 6-12 months while that for a liquid/money market fund would be 1-3 months. Apart from the entire period, one should also compare the performance in smaller intervals within the same period say intervals of one month duration. To make comparison meaningful, one has to compare the average annual compounded rate of return. This adjusts for comparisons of differing period and also facilitates comparison across different classes. The return also incorporates dividend payouts. Thus, for example, one can say that ABC income fund has given a compounded annual growth rate (CAGR) of 13% p.a. including dividends in the last 2 years while XYZ income fund has given a CAGR of 13.2% p.a. over the last 3 years.
Sites referred : www.moneycontrol.com
Books referred : I. Financial Service Management by Dipak Abhyankar II. Financial Markets & Services by Gordon & Natrajan