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MUTUAL FUNDS

NAME: KOMAL.D.RANAWAT. STD: T.Y.BCOM DIV: B ROLL NOS: 299

INDEX 1. 2. 3. 4. 5. 6. 7. 8. 9. INTRODUCTION. HISTORY OF MUTUAL FUNDS. CONCEPT OF MUTUAL FUNDS. FLOW CHART. ADVANTAGES OF MUTUAL FUNDS. DISADVANTAGES OF MUTUAL FUNDS. TYPES OF MUTUAL FUNDS SCHEME. ORGANISATION OF MUTUAL FUNDS. FUTURE OF MUTUAL FUNDS IN INDIA.

Introduction
Investment in a portfolio can take different forms. An investor can either invest directly in securities, or can through an investment company, also referred to as mutual funds. An investment company is a financial intermediary that collects money from investors and invest in various securities on their behalf. The returns from these investments are passed on to the investors, either periodically, or at the end of a specified time period. The investment company charges fees for its services, referred to as management fees. Investment companies are of 2 kinds- closed-end and open-end. Closed end investment companies have a limited investment horizon. The investors invest in the investment company for a specified time period, and the investment company manages the investment for the said duration. At the end of the duration the investments are liquidated and the investors receive the funds along with the returns. In the USA, the closed ended investment companies are referred to as closed-end mutual funds. In UK they are called investment trusts.Internationally, the regulations allow the closed-end mutual funds to raise funds only through share capital, ie , they are not allowed to raise funds through debt. The share capital of such companies and hence their invisible funds, remain constant throughout their life. They neither sell their shares after the initial funds raising, nor buyback their shares during their specified investment horizon. Liquidity is provided to the investors by trading the companys share in the secondary market. The shares are freely transferable. Open-ended investments companies have a unlimited investment horizon. They sell and buyback their shares at regular intervals throughout their existence. Hence their invisible funds or portfolio size keeps on changing. In addition, these companies can take debt on their books. ( in India however neither type of investment companies are allowed to borrow money except for certain specified uses and for a specified maximum period). These openend investment companies are called as mutual fund in the US and unit trusts in UK. Since liquidity is provided by the funds themselves, the shares are not traded on secondary market. The returns generated on the funds are regularly paid out to the investors. In India both close ended and open ended investment companies are called as mutual funds. Except the unit trust of

India, all mutual funds in India are organized and setup under the Indian trusts as trusts. Their role is to accept savings from the investors and invest the same as per the objectives incorporated in the text of the trust deed to manage diversified portfolio for the investors.Hence a mutual fund can be defined as a trust that pools the savings of a number of investors who share a common financial goal. The money thus collected is then invested by the fund manager on behalf of the investors in different types of securities. The income earned through the investment and the capital appreciated realized by the scheme are shared by its unit holders in proportion to the number of units owned by them. What exactly is a mutual fund? Very simply, a mutual fund is an investment vehicle that pools in the monies of several investors, and collectively invests this amount in either the equity market or the debt market, or both, depending upon the funds objective. This means you can access either the equity or the debt market, or both, without investing directly in equity or debt.

History of mutual funds


In the second half of the 19th century, investors in UK considered the stock market as an attractive investment opportunity. Yet, the small investors did not have the funds required to operate I the market effectively. This led to the establishment of investment companies which provided an opportunity to small investors to invest in equity market. The first investment company was the Scottish American investment company, setup in London in 1860.most of the investment company established at that time were closed ended, and invested primarily in stock market. Due to this the performance of these company was closely linked to stock market booms and clashes. Initially, these investments trusts became very popular and their number increased to over 50. but most of them were wiped out in the 1890 stock market crisis. During this period a few investment companies came up in the US too, though they did not grow like the UK counterparts due to lack of investors interest in stock market. However when investment companies were revived in the 1920s with the boom phase in the stock market, their growth was more in US than in the UK. In this phase open ended investment companies were more in vogue as they were allowed to borrow money for investing in securities. This facility allowed them to increase their shareholders return in a booming market. It was during this period that the first mutual fund , the Massachusetts investors truss was formed in boston in 1924. however mutual fund went overboard in borrowing fund and recklessly invested the surplus fund in stock market. When market clashed in 1929, the value of these over-leveraged was totally eroded As these funds invested predominantly in the equities even in the late 1960, stock market decline of 1970 resulted in the returns on mutual funds becoming unattractive for the investors. This again turned away the investors from mutual funds. There were not many alternatives to investors.

1963 1964 1987 1993 1996 2003

Establishment of Unit Trust of India Unit Scheme 1964 launched Entry of non-UTI, Public Sector mutual funds Entry of private sector funds First Mutual Fund regulations came into being Substitution of prevalent rules by SEBI (Mutual Funds) Regulations 1996 UTI bifurcated into two separate entities - Specified Undertaking of Unit Trust of India - UTI Mutual Fund Existence of 421 schemes, managing assets worth Rs. 153108

2004

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 realized 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:-

FLOW CHART

Savings form an important part of the economy of any nation. With savings invested in various options available to the people, the money acts as the driver for growth of the country. Indian financial scene too presents multiple avenues to the investors. Though certainly not the best or deepest of markets in the world, it has ignited the growth rate in mutual fund industry to provide reasonable options for an ordinary man to invest his savings. Investment goals vary from person to person. While somebody wants security, others might give more weightage to returns alone. Somebody else might want to plan for his childs education while somebody might be saving for the proverbial rainy day or even life after retirement. With objectives defying any range, it is obvious that the products required will vary as well.

Advantages of Mutual Funds

1. Professional Management
Mutual Funds provide the services of experienced and skilled professionals, backed by a dedicated investment research team that analyses the performance and prospects of companies and selects suitable investments to achieve the objectives of the scheme. This risk of default by any company that one has chosen to invest in, can be minimized by investing in mutual funds as the fund managers analyze the companies financials more minutely than an individual can do as they have the expertise to do so. They can manage the maturity of their portfolio by investing in instruments of varied maturity profiles. 2. Diversification Mutual Funds invest in a number of companies across a broad cross-section of industries and sectors. This diversification reduces the risk because seldom do all stocks decline at the same time and in the same proportion. You achieve this diversification through a Mutual Fund with far less money than you can do on your own.
3. Convenient Administration

Investing in a Mutual Fund reduces paperwork and helps you avoid many problems such as bad deliveries, delayed payments and follow up with brokers and companies. Mutual Funds save your time and make investing easy and convenient.

4. Return Potential

Over a medium to long-term, Mutual Funds have the potential to provide a higher return as they invest in a diversified basket of selected securities. Apart from liquidity, these funds have also provided very good post-tax returns on year to year basis. Even historically, we find that some of the debt funds have generated superior returns at relatively low level of risks. On an average debt funds have posted returns over 10 percent over one-year horizon. The best performing funds have given returns of around 14 percent in the last one-year period. In nutshell we can say that these funds have delivered more than what one expects of debt avenues such as post office schemes or bank fixed deposits. Though they are charged with a dividend distribution tax on dividend payout at 12.5 percent (plus a surcharge of 10 percent), the net income received is still tax free in the hands of investor and is generally much more than all other avenues, on a post tax basis.
5. Low Costs

Mutual Funds are a relatively less expensive way to invest compared to directly investing in the capital markets because the benefits of scale in brokerage, custodial and other fees translate into lower costs for investors. 6. Liquidity In open-end schemes, the investor gets the money back promptly at net asset value related prices from the Mutual Fund. In closed-end schemes, the units can be sold on a stock exchange at the prevailing market price or the investor can avail of the facility of direct repurchase at NAV related prices by the Mutual Fund. Since there is no penalty on pre-mature withdrawal, as in the cases of fixed deposits, debt funds provide enough liquidity. Moreover, mutual funds are better placed to absorb the fluctuations in the

prices of the securities as a result of interest rate variation and one can benefits from any such price movement. 7. Transparency Investors get regular information on the value of your investment in addition to disclosure on the specific investments made by your scheme, the proportion invested in each class of assets and the fund manager's investment strategy and outlook.
8. Flexibility

Through features such as regular investment plans, regular withdrawal plans and dividend reinvestment plans; you can systematically invest or withdraw funds according to your needs and convenience. 9. Affordability A single person cannot invest in multiple high-priced stocks for the sole reason that his pockets are not likely to be deep enough. This limits him from diversifying his portfolio as well as benefiting from multiple investments. Here again, investing through MF route enables an investor to invest in many good stocks and reap benefits even through a small investment. Investors individually may lack sufficient funds to invest in high-grade stocks. A mutual fund because of its large corpus allows even a small investor to take the benefit of its investment strategy.
10. Choice of Schemes

Mutual Funds offer a family of schemes to suit your varying needs over a lifetime.

11. Well Regulated

All Mutual Funds are registered with SEBI and they function within the provisions of strict regulations designed to protect the interests of investors. The operations of Mutual Funds are regularly monitored by SEBI. 12. Tax Benefits Last but not the least, mutual funds offer significant tax advantages. Dividends distributed by them are tax-free in the hands of the investor. They also give you the advantages of capital gains taxation. If you hold units beyond one year, you get the benefits of indexation. Simply put, indexation benefits increase your purchase cost by a certain portion, depending upon the yearly cost-inflation index (which is calculated to account for rising inflation), thereby reducing the gap between your actual purchase cost and selling price. This reduces your tax liability. Whats more, tax-saving schemes and pension schemes give you the added advantage of benefits under Section 88. You can avail of a 20 per cent tax exemption on an investment of up to Rs 10,000 in the scheme in a year

Disadvantages of mutual funds


Mutual funds are good investment vehicles to navigate the complex and unpredictable world of investments. However, even mutual funds have some inherent drawbacks. Understand these before you commit your money to a mutual fund. 1. No assured returns and no protection of capital If you are planning to go with a mutual fund, this must be your mantra: mutual funds do not offer assured returns and carry risk. For instance, unlike bank deposits, your investment in a mutual fund can fall in value. In

addition, mutual funds are not insured or guaranteed by any government body (unlike a bank deposit, where up to Rs 1 lakh per bank is insured by the Deposit and Credit Insurance Corporation, a subsidiary of the Reserve Bank of India). Restrictive gains Taxes During a typical year, most actively managed mutual funds sell anywhere from 20 to 70 percent of the securities in their portfolios. If your fund makes a profit on its sales, you will pay taxes on the income you receive, even if you reinvest the money you made. Management risk When you invest in a mutual fund, you depend on the fund's manager to make the right decisions regarding the fund's portfolio. If the manager does not perform as well as you had hoped, you might not make as much money on your investment as you expected. Of course, if you invest in Index Funds, you forego management risk, because these funds do not employ managers.

Types of mutual fund schemes


A wide variety of Mutual Fund Schemes exist to cater to the needs such as financial position, risk tolerance and return expectations etc. The table below gives an overview into the existing types of schemes in the Industry. By structure: a) open-ended schemes

b) close-ended schemes c) interval schemes By investment objective: a) growth schemes b) income schemes c) Balanced schemes d) money market schemes Other schemes: a) Tax saving schemes b) special schemes c) index schemes d) sector specific schemes

By Structure
a) Open-ended schemesOpen-ended or open mutual funds are much

more common than closed-ended funds and meet the true definition of a mutual fund a financial intermediary that allows a group of investors to pool their money together to meet an investment objective to make money! An individual or team of professional money managers manage the pooled assets and choose investments, which create the funds portfolio. They are established by a fund sponsor, usually a mutual fund company, and valued by the fund company or an outside agent. This means that the funds portfolio is

valued at "fair market" value, which is the closing market value for listed public securities. An open-ended fund can be freely sold and repurchased by investors. Close-ended schemes Close-ended or closed mutual funds are really financial securities that are traded on the stock market. Similar to a company, a closed-ended fund issues a fixed number of shares in an initial public offering, which trade on an exchange. Share prices are determined not by the total net asset value (NAV), but by investor demand. A sponsor, either a mutual fund company or investment dealer, will raise funds through a process commonly known as underwriting to create a fund with specific investment objectives. The fund retains an investment manager to manage the fund assets in the manner specified. By investment objective: A scheme can also be classified as growth scheme, income scheme, or balanced scheme considering its investment objective. Such schemes may be open-ended or close-ended schemes as described earlier. Such schemes may be classified mainly as follows:
a) Growth / Equity Oriented Schemes

The aim of growth funds is to provide capital appreciation over the medium to long- term. Such schemes normally invest a major part of their corpus in equities. Such funds have comparatively high risks. These schemes provide different options to the investors like dividend option, capital appreciation, etc. and the investors may choose an option depending on their preferences. Income / Debt Oriented Scheme The aim of income funds is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as

bonds, corporate debentures, Government securities and money market instruments. Such funds are less risky compared to equity schemes. These funds are not affected because of fluctuations in equity markets. However, opportunities of capital appreciation are also limited in such funds. Income funds By definition, such funds can invest in the entire gamut of debt instruments. Most income funds park a major part of their corpus in corporate bonds and debentures, as the returns there are the higher than those available on government-backed paper. But there is also the risk of defaulta company could fail to service its debt obligations. b) Balanced Fund The aim of balanced funds is to provide both growth and regular income as such schemes invest both in equities and fixed income securities in the proportion indicated in their offer documents. These are appropriate for investors looking for moderate growth. They generally invest 40-60% in equity and debt instruments. These funds are also affected because of fluctuations in share prices in the stock markets. However, NAVs of such funds are likely to be less volatile compared to pure equity funds.
c) Money Market or Liquid Fund

These funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income. These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds. These funds are appropriate for corporate and individual investors as a means to park their surplus funds for short periods.

Other types of funds Pooled Funds A "pooled fund" is a unit trust in which investors contribute funds that are then invested, or managed, by a third party. A pooled fund operates like a mutual fund, but is not required to have a prospectus under securities law. Pooled funds are offered by trust companies, investment management firms, insurance companies, and other organizations. Pooled funds and mutual funds are substantially the same, but differ in their legal form. Like a mutual fund, a pooled fund is a trust that is set up under a "trust indenture". This specifies how the pooled fund will operate and what the duties of the various parties to the trust indenture will be. The trust indenture specifies an investment policy for the pooled fund and how management fees will be charged. Pooled funds, like mutual funds, are "unit trusts". This means that investors deposit funds into the trust in exchange for "units" of the fund, which reflect a pro-rata share of the fund's investments. The fund trust indenture will specify how units are issued and redeemed, as well as, the frequency and procedures for valuations. Pooled funds can be either "closed" or "open". An "open" pooled fund is the most common type of pooled fund, and allows units to be redeemed at scheduled valuations. A "closed" pooled fund does not allow redemptions, except in specific circumstances or at termination of the trust. Closed pooled funds are usually established to hold illiquid investments such as real estate or very specialized investment programs, such as hedge funds. The major difference between pooled funds and mutual funds is their legal status under securities law. Pooled funds are not "public" investments, which means investment and trading in pooled funds is restricted. Securities legislation define the rules for a "public" security. Publicly issued securities must meet certain

requirements before issue, particularly in information disclosure through their prospectus, or reporting by issuers. Pooled funds are exempt from prospectus requirements under securities law, usually under the "private placement", or "sophisticated investor", clauses in the Securities Act. This means that investments in pooled funds must be over $150,000. Financial institutions such as banks, trust companies or investment counselling firms are allowed to invest their clients in their own pooled funds, by specific exemptions granted under the Securities Act. Each pooled fund investment must be reported to the relevant Securities Commission. Once a client is invested in a pool fund, the result is identical to being in a mutual fund with the same investment mandate
a) Specific Sectoral & Thematic funds /schemes

These are the funds/schemes which invest in the securities of only those sectors or industries as specified in the offer documents. e.g. Pharmaceuticals, Software, Fast Moving Consumer Goods (FMCG), Petroleum stocks, etc. Thematic funds are those fund which invest in a stocks which will benefit from a particular theme like Outsourcing, Infrastructure etc. The returns in these funds are dependent on the performance of the respective sectors/industries. While these funds may give higher returns, they are more risky compared to diversified funds.

Organization of a Mutual

Fund

The structure of mutual funds in India is governed by SEBI (Mutual Fund) Regulations, 1996. In India, is mandatory to have a three tier structure of Sponsor-Trustee-Asset Management Company.

Sponsor Sponsor is the person who acting alone or in combination with another body corporate establishes a mutual fund. The sponsor establishes the mutual fund and registers the same with SEBI. Sponsor appoints the Trustees, custodians and the AMC with prior approval of SEBI and in accordance with SEBI Regulations. Sponsor must have a 5-year track record of business interest in the financial markets. Sponsor must have been profit making in at least 3 of the above 5 years. Sponsor must contribute at least 40% of the net worth of the Investment Managed and meet the eligibility criteria prescribed under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996. Trust

The Mutual Fund is constituted as a trust in accordance with the provisions of the Indian Trusts Act, 1882 by the Sponsor. The trust deed is registered under the Indian Registration Act, 1908. Trustee Trustee is usually a company (corporate body) or a Board of Trustees (body of individuals). The main responsibility of the Trustee is to safeguard the interest of the unit holders and inter alia ensure that the AMC functions in the interest of investors and in accordance with the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, the provisions of the Trust Deed and the Offer Documents of the respective Schemes. At least 2/3rd directors of the Trustee are independent directors who are not associated with the Sponsor in any manner. Asset Management Company (AMC) The AMC is appointed by the Trustee as the Investment Manager of the Mutual Fund. The AMC is required to be approved by the Securities and Exchange Board of India (SEBI) to act as an asset management company of the Mutual Fund. At least 50% of the directors of the AMC are independent directors who are not associated with the Sponsor in any manner. The AMC must have a net worth of at least 10 crore at all times. Registrar and Transfer Agent The AMC if so authorized by the Trust Deed appoints the Registrar and Transfer Agent to the Mutual Fund. The Registrar processes the application form, redemption requests and dispatches account statements to the unit

holders. The Registrar and Transfer agent also handles communications with investors and updates investor records. Custodian A custodian is an agent, bank, trust company, or other organization which holds and safeguards an individual's, mutual fund's, or investment company's assets for them.

Future of Mutual Funds in India


Future of Mutual Funds in India - An Overview Financial experts believe that the future of Mutual Funds in India will be very bright. It has been estimated that by March-end of 2010, the mutual fund industry of India will reach Rs 40,90,000 crore, taking into account the total assets of the Indian commercial banks. The estimation was based on the December 2004 asset value of Rs 1,50,537 crore. In the coming 10 years the annual composite growth rate is expected to go up by 13.4%. Since the last 5 years, the growth rate was recorded as 9% annually. Based on the current rate of growth, it can be forecasted that the mutual fund assets will be double by 2010. Indian Mutual Funds Future - Growth Facts

In the past 6 years, Mutual Funds in India have recorded a growth of 100 %. In India, the rate of saving is 23 %. In the future, there lies a big scope for the Indian Mutual Funds industry to expand. Several asset management companies which are foreign based are now entering the Indian markets. A number of commodity Mutual Funds will be introduced in the future. The SEBI (Securities Exchange Board of India) has granted the permission for the same.

More emphasis is put on the effective Mutual Funds governance.