Mutual Funds Industry in India

The origin of mutual fund industry in India is with the introduction of the concept of mutual fund by UTI in the year
1963. Though the growth was slow, but it accelerated from the year 1987 when non-UTI players entered the industry.

In the past decade, Indian mutual fund industry had seen a dramatic imporvements, both qualitywise as well as
quantitywise. Before, the monopoly of the market had seen an ending phase, the Assets Under Management (AUM)
was Rs. 67bn. The private sector entry to the fund family rose the AUM to Rs. 470 bn in March 1993 and till April
2004,it reached the height of 1,540 bn.

Putting the AUM of the Indian Mutual Funds Industry into comparison, the total of it is less than the deposits of SBI
alone, constitute less than 11% of the total deposits held by the Indian banking industry.

The main reason of its poor growth is that the mutual fund industry in India is new in the country. Large sections of
Indian investors are yet to be intellectuated with the concept. Hence, it is the prime responsibility of all mutual fund
companies, to market the product correctly abreast of selling.

The mutual fund industry can be broadly put into four phases according to the development of the sector. Each phase
is briefly described as under.

First Phase - 1964-87

Unit Trust of India (UTI) was established on 1963 by an Act of Parliament. It was set up by the Reserve Bank of India
and functioned under the Regulatory and administrative control of the Reserve Bank of India. In 1978 UTI was de-
linked from the RBI and the Industrial Development Bank of India (IDBI) took over the regulatory and administrative
control in place of RBI. The first scheme launched by UTI was Unit Scheme 1964. At the end of 1988 UTI had
Rs.6,700 crores of assets under management.

Second Phase - 1987-1993 (Entry of Public Sector Funds)

Entry of non-UTI mutual funds. SBI Mutual Fund was the first followed by Canbank Mutual Fund (Dec 87), Punjab
National Bank Mutual Fund (Aug 89), Indian Bank Mutual Fund (Nov 89), Bank of India (Jun 90), Bank of Baroda
Mutual Fund (Oct 92). LIC in 1989 and GIC in 1990. The end of 1993 marked Rs.47,004 as assets under
management.

Third Phase - 1993-2003 (Entry of Private Sector Funds)

With the entry of private sector funds in 1993, a new era started in the Indian mutual fund industry, giving the Indian
investors a wider choice of fund families. Also, 1993 was the year in which the first Mutual Fund Regulations came
into being, under which all mutual funds, except UTI were to be registered and governed. The erstwhile Kothari
Pioneer (now merged with Franklin Templeton) was the first private sector mutual fund registered in July 1993.

The 1993 SEBI (Mutual Fund) Regulations were substituted by a more comprehensive and revised Mutual Fund
Regulations in 1996. The industry now functions under the SEBI (Mutual Fund) Regulations 1996.

The number of mutual fund houses went on increasing, with many foreign mutual funds setting up funds in India and
also the industry has witnessed several mergers and acquisitions. As at the end of January 2003, there were 33
mutual funds with total assets of Rs. 1,21,805 crores. The Unit Trust of India with Rs.44,541 crores of assets under
management was way ahead of other mutual funds.

Fourth Phase - since February 2003

This phase had bitter experience for UTI. It was bifurcated into two separate entities. One is the Specified
Undertaking of the Unit Trust of India with AUM of Rs.29,835 crores (as on January 2003). The Specified Undertaking
of Unit Trust of India, functioning under an administrator and under the rules framed by Government of India and
does not come under the purview of the Mutual Fund Regulations.

The second is the UTI Mutual Fund Ltd, sponsored by SBI, PNB, BOB and LIC. It is registered with SEBI and
functions under the Mutual Fund Regulations. With the bifurcation of the erstwhile UTI which had in March 2000 more
than Rs.76,000 crores of AUM and with the setting up of a UTI Mutual Fund, conforming to the SEBI Mutual Fund
Regulations, and with recent mergers taking place among different private sector funds, the mutual fund industry has
entered its current phase of consolidation and growth. As at the end of September, 2004, there were 29 funds, which
manage assets of Rs.153108 crores under 421 schemes.

INTRODUCTION
Concept of Mutual Funds
A Mutual Fund is a trust that pools the savings of a number of investors who share a common
financial goal. The money thus collected is then invested in capital market instruments such as
shares, debentures and other securities. The income earned through these investments and the
capital appreciation realised are shared by its unit holders in proportion to the number of units
owned by them. Thus a Mutual Fund is the most suitable investment for the common man as it
offers an opportunity to invest in a diversified, professionally managed basket of securities at a
relatively low cost. The flow chart below describes broadly the working of a mutual fund:

MUTUAL FUND OPERATION FLOW CHART

 How mutual funds earn money
A mutual fund is a means of investing that enables individuals to share the risks of
investing with other investors. All contributors to the fund experience an equal share of
gains and losses for each dollar invested. A mutual fund owns the securities of several
corporations. A mutual fund pools money from hundreds and thousands of investors to
construct a portfolio of stocks, bonds, real estate, or other securities, according to the
kind of investments the mutual fund trades. Investors purchase shares in the mutual
fund as if it was an individual security. Fund managers hired by the mutual fund
company are paid to invest the money that the investors have placed in the fund.
Heeding the adage "Don't put all your eggs in one basket" the holders of mutual fund
shares are able to gain the advantage of diversification which might be beyond their
financial means individually

Performance of Mutual Funds in India

Let us start the discussion of the performance of mutual funds in India from the day the concept of mutual
fund took birth in India. The year was 1963. Unit Trust of India invited investors or rather to those who
believed in savings, to park their money in UTI Mutual Fund.

For 30 years it goaled without a single second player. Though the 1988 year saw some new mutual fund
companies, but UTI remained in a monopoly position.

The performance of mutual funds in India in the initial phase was not even closer to satisfactory level.
People rarely understood, and of course investing was out of question. But yes, some 24 million
shareholders was accustomed with guaranteed high returns by the begining of liberalization of the
industry in 1992. This good record of UTI became marketing tool for new entrants. The expectations of
investors touched the sky in profitability factor. However, people were miles away from the praparedness
of risks factor after the liberalization.

The Assets Under Management of UTI was Rs. 67bn. by the end of 1987. Let me concentrate about the
performance of mutual funds in India through figures. From Rs. 67bn. the Assets Under Management
rose to Rs. 470 bn. in March 1993 and the figure had a three times higher performance by April 2004. It
rose as high as Rs. 1,540bn.

The net asset value (NAV) of mutual funds in India declined when stock prices started falling in the year
1992. Those days, the market regulations did not allow portfolio shifts into alternative investments. There
were rather no choice apart from holding the cash or to further continue investing in shares. One more
thing to be noted, since only closed-end funds were floated in the market, the investors disinvested by
selling at a loss in the secondary market.

The performance of mutual funds in India suffered qualitatively. The 1992 stock market scandal, the
losses by disinvestments and of course the lack of transparent rules in the whereabout rocked confidence
among the investors. Partly owing to a relatively weak stock market performance, mutual funds have not
yet recovered, with funds trading at an average discount of 1020 percent of their net asset value.

The supervisory authority adopted a set of measures to create a transparent and competitve
environment in mutual funds. Some of them were like relaxing investment restrictions into the
market, introduction of open-ended funds, and paving the gateway for mutual funds to launch
pension schemes.

The measure was taken to make mutual funds the key instrument for long-term saving. The
more the variety offered, the quantitative will be investors.

At last to mention, as long as mutual fund companies are performing with lower risks and higher
profitability within a short span of time, more and more people will be inclined to invest until and
unless they are fully educated with the dos and donts of mutual funds.

1. Mutual Fund Industry in India

1.1 History of Mutual Funds in India

The mutual fund industry in India has been in existence since 1964 when the Government of India
established the United Trust of India (UTI) under a special Act of Parliament. For almost twenty years,
the various schemes offered by the UTI were the only options available to the investors to invest in
mutual funds. The monolithic structure of the mutual funds in India was, however broken when
Government of India permitted the public sector banks and public sector insurance corporations such as
Life Insurance Corporation of India and general Insurance Corporation of India to launch their own
funds. Later in 1993, during the period of the emergence of liberalization and globalization, the
Government also permitted private sector to enter the mutual fund business.

1.2 Elements of Mutual Fund

A mutual fund is set up by a sponsor. However, the sponsor cannot run the fund directly. He has to set
up two arms: a trust and Asset Management Company. The trust is expected to assure fair business
practice, while the AMC manages the money. All mutual funds functions under Sebi (Mutual Fund)
regulations 1996 except UTI.

The mutual fund collects money directly or through brokers from investors. The money is invested in
various instruments depending on the objective of the scheme. The income generated by selling
securities or capital appreciation of these securities is passed on to the investors in proportion to their
investment in the scheme. The investments are divided

into units and the value of the units will be reflected in Net Asset Value or NAV of the unit. NAV is the
market value of the assets of the scheme minus its liabilities. NAV is the net asset value of the scheme
divided by the number of units outstanding on the valuation date. Mutual fund companies provide daily
net asset value of their schemes to their investors. NAV is important, as it will determine the price at
which you buy or redeem the units of a scheme depending on the load structure of the scheme.

Classification of mutual funds in India-

1. Open-ended funds: Investors can buy and sell units of open-ended funds at NAV-
related price every day. Open-end funds do not have a fixed maturity and it is available for subscription
every day of the year. Open-end funds also offer liquidity to investments, as one can sell units whenever
there is a need for money.

2. Close-ended funds: These funds have a stipulated maturity period, which may vary
from three to 15 years. They are open for subscription only during a specified period. Investors have the
option of investing in the scheme during initial public offer period or buy or sell units of the scheme on
the stock exchanges. Some close-ended funds repurchase the units at NAV-related prices periodically to
provide an exit route to the investors.

Mutual Funds are divided into two types which are as under:

1. Equity Funds: These are the types of funds where the capital of investor is invested in
the stock market. Equity funds are termed as high risk high return funds. Equity funds can be open
ended as well as closed ended. Equity funds also have a marginal exposure to debt assets depending on
the investment objective of the fund manager. Safety of capital is not assured in equity funds.

2. Debt Funds: These are funds where the safety of capital is assured. The capital of an
investor will be invested in the government bonds, securities and current assets. A debt fund gives an
assured return to its investor. It’s a low risk low return fund. Debt funds can be open ended as well as
closed ended. Debt funds can have a marginal exposure in equity.

There are two options in equity and debt funds which are as follows:

A. Dividend: An investor will be awarded dividends whenever the fund declares it. Broadly it’s the
income generated by the mutual fund scheme on its investment is distributed to the investor. Dividend
is not assured by an Asset Management Company and it is linked closely to the stock/debt market. The
investor can choose either to encash or re invest it in the same mutual fund scheme.

B. Growth: In growth option the investor does not receive an income. The growth option

reflects the growth in investments registered by the mutual fund scheme. The investor can

either redeem the entire money or can do partial withdrawal.

There are different types of mutual fund schemes in both equity and debt which are as

follows:

1. Interval Funds: These funds combine the features of both open and close-ended

funds. They are open for sale and repurchase at a predetermined period.

2. Growth funds: They normally invest most of their corpus in equities, as their

objective is to provide capital appreciation over the medium-to-long term. Growth

schemes are ideal for investors with risk appetite.

3. Income funds: As the name suggests, the aim of these funds is to provide regular and

steady income to investors. They generally invest their corpus in fixed income securities

like bonds, corporate debentures, and government securities. Income funds are ideal for

those looking for capital stability and regular income.

4. Balanced funds: The objective of balanced funds is to provide growth along with

regular income. They invest their corpus in both equities and fixed income securities as indicated in the
offer documents. Balanced funds are ideal for those looking for income and moderate growth.

5. Money market funds: These funds strive to provide easy liquidity, preservation of

capital and modest income. MMFs generally invest the corpus in safer short-term instruments like
treasury bills, certificates of deposit, commercial paper and inter-bank call money. Returns on these
schemes hinges on the interest rates prevailing in the market. MMFs are ideal for corporate and
individual investors looking to park funds for short period.

6. Tax saving schemes: Tax saving schemes or equity-linked savings schemes offer tax

rebates to investors under section 88 of the Income Tax Act. They generally have a lock- in period of
three years. They are ideal for investors looking to exploit tax rebates as well as growth in investments.

7. Special schemes: These schemes invest only in the industries specified in the offer

document. Examples are InfoTech funds, FMCG funds, pharma funds, etc. These

schemes are meant for aggressive and well-informed investors.

8. Index funds: Index Funds invest their corpus on the specified index such as BSE

Sensex, NSE index, etc. as mentioned in the offer document. They try to mimic the composition of the
index in their portfolio. Not only are the shares, even their weight age replicated. Index funds are a
passive investment strategy and the fund manager has a limited role to play here. The NAV’s of these
funds move along with the index they are trying to mimic save for a few points here and there. This
difference is called tracking error.

9. Sector specific schemes: These funds invest only specified sectors like an industry or

a group of industries or various segments like ‘A' Group shares or initial public offerings.

Features of mutual funds in India:-

Affordability: Mutual funds allow you to start with small investments. For example, if

you want to buy a portfolio of blue chips of modest size, you should at least have a few lacs of rupees. A
mutual fund gives you the same portfolio for meager investment of Rs 1,000-5,000. A mutual fund can
do that because it collects money from many people and it has a large corpus.

Professional management: The major advantage of investing in a mutual fund is that

you get a professional money manager for a small fee. You can leave the investment decisions to him
and only have to monitor the performance of the fund at regular intervals.

Diversification: Considered the essential tool in risk management, mutual funds makes it

possible for even small investors to diversify their portfolio. A mutual fund can effectively diversify its
portfolio because of the large corpus. However, a small investor cannot have a well-diversified portfolio
because it calls for large investment. For example, a modest portfolio of 10 blue-chip stocks calls for a
few a few thousands.

Convenience: Mutual funds offer tailor-made solutions like systematic investment plans and systematic
withdrawal plans to investors, which is very convenient to investors. Investors also do not have to worry
about the investment decisions or they do not have todeal with their brokerage or depository, etc. for
buying or selling of securities. Mutual funds also offer specialized schemes like retirement plan,
children's plan, industry specific schemes, etc. to suit personal preference of investors. These schemes
also help small investors with asset allocation of their corpus. It also saves a lot of paper work.

Cost effectiveness: A small investor will find that a mutual fund route is a cost effective method. AMC
fee is normally 2.5% and they also save a lot of transaction costs as they get concession from
brokerages. Also, they get the service of a financial professional for a very small fee. If they were to seek
a financial advisor's help directly, they may end up pay more. Also, the size of the corpus should be large
to get the service of investment experts, who offer portfolio management.

Liquidity: You can liquidate your investments anytime you want. Most mutual funds dispatch checks for
redemption proceeds within two or three working days. You also do not have to pay any penal interest
in most cases. However, some schemes charge an exit load.
Tax breaks: You do not have to pay any taxes on dividends issued by mutual funds. You also have the
advantage of capital gains taxation. Tax-saving schemes and pension schemes give you the added
advantage of benefits under Section 88. Investments up to Rs 10,000 in them qualify for tax rebate.

Transparency: Mutual funds offer daily NAVs of schemes, which help you to monitor your investments
on a regular basis. They also send quarterly newsletters, which give details of the portfolio, performance
of schemes against various benchmarks, etc. They are also well regulated and Sebi monitors their
actions closely.

The mutual fund pool money from investors and invest in shares and income earn from
the shares distributed between the account holders according to their share of holdings. Indian mutual
fund industry is sound and effective in case of investor's point of view.

In the recent years Indian mutual fund industry is witnessing a rapid growth as a result of infrastructure
development, increase in personal financial assets, and rise in foreign participation. With the growing
risk appetite, rising income and increasing awareness mutual funds in India are becoming a preferred
investment option compared to other investment options such as fixed deposits and postal savings
which are considered safe but give comparatively low return destinations.