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Chapter 1

Conceptual Framework
1.1 Introduction Over the past two decades, mutual funds have been among the fastest growing institutions in the world. At the end of 1980, they managed less than $150 billion, but this figure had grown to over $4 trillion by the end of 1997-a number that exceeds aggregate bank deposits (Robert C. Pozen, 1998). Indeed, almost 50 percent of households today invest in mutual funds (Investment Company Institute, 2000). The most important and fastest-growing part of this industry is funds that invest in stocks, particularly actively managed ones. The explosion of newsletters, magazines, and such rating services as Morningstar attest to the fact that investors spend significant resources in identifying managers with stock-picking ability. More important, actively managed funds control a sizeable stake of corporate equity and play a pivotal role in the determination of stock prices. A better understanding of this issue would naturally be useful for investors, especially in light of the massive inflows that have increased the mean size of funds in the recent past. At the same time, the issue of the persistence of fund performance depends crucially on the scale-ability of fund investments. With progressive liberalization of economic policies, there has been a rapid growth of capital market, money market and financial services industry including merchant banking, leasing and venture capital. The main objective of this research is to examine the importance and growth of mutual funds and evaluate the financial and operating performance of mutual fund industry in India and suggest some measures to make it a successful scheme in India. 1.1.1 Origin of Mutual Funds The history of mutual funds dates back to 19th century when it was introduced in Europe, in particular, Great Britain. Robert Fleming set up in 1868 the first investment trust called

Chapter 1 Conceptual Framework


Foreign and Colonial Investment Trust which promised to manage the finances of the moneyed classes of Scotland by spreading the investment over a number of different stocks. This investment trust and other investment trusts which were subsequently set up in Britain and the US, resembled today's close-ended mutual funds. 1.1.2 Mutual Fund History The end of millennium marks 36 years of existence of mutual funds in this country. The ride through these 36 years is not been smooth. Investor opinion is still divided. While some are for mutual funds others are against it. UTI commenced its operations from July 1964 .The impetus for establishing a formal institution came from the desire to increase the propensity of the middle and lower groups to save and to invest. UTI came into existence during a period marked by great political and economic uncertainty in India. With war on the borders and economic turmoil that depressed the financial market, entrepreneurs were hesitant to enter capital market. The Finance Minister, T.T.Krishnamachari set up the idea of a unit trust that would be "open to any person or institution to purchase the units offered by the trust. However, this institution as we see it, is intended to cater to the need of individual investors, and even among them as far as possible, to those whose means are small." His ideas took the form of the Unit Trust of India, an intermediary that would help fulfill the twin objectives of mobilizing retail savings and investing those savings in the capital market and passing on the benefits so accrued to the small investors. UTI commenced its operations from July 1964 with a view to encouraging savings and investment and participation in the income, profits and gains accruing to the Corporation from the acquisition, holding, management and disposal of securities."

1.2 Concept of mutual fund 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. Investments

Chapter 1 Conceptual Framework


in securities are spread across a wide cross-section of industries and sectors and thus the risk is reduced. Diversification reduces the risk because all stocks may not move in the same direction in the same proportion at the same time. Mutual fund issues units to the investors in accordance with quantum of money invested by them. Investors of mutual funds are known as unit holders. The investors in proportion to their investments share the profits or losses. The mutual funds normally come out with a number of schemes with different investment objectives, which are launched from time to time. A mutual fund is required to be registered with Securities and Exchange Board of India (SEBI), which regulates securities markets before it, can collect funds from the public. 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: A mutual fund is an investment company or trust that pools the resources from thousands of its shareholders or unit holders who share common investment goal and then diversifies its investments into different types of securities in order to provide potential returns and reasonable safety. In the period of globalization rapid price fluctuations are occurring for the assets like equity shares, bonds, real estate, derivatives etc., Secondly, an individual also finds it difficult to keep track of ownership of his assets, investments, brokerage dues and banks transactions, etc. In this context, a mutual fund is the solution to all these situations. Mutual funds help the small and medium size investors to participate in today's complex and modern financial scenario. Investors can participate in the mutual fund by buying the units of the fund. The income earned through these investments and capital appreciation realized by the schemes is shared by its unit holders in proportion to the number of units owned by them. In India, the Mutual Fund industry started with the setting up of Unit Trust of India in 1964, as a single State Monopoly. Twenty-three years later Public Sector banks and financial institutions were permitted to establish Mutual Funds in 1987. The Industry was brought under the control of SEBI and opened for private sector participation in 1993.

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1.3 Types of Mutual Fund Scheme Mutual Funds have specific investment objectives such as growth of capital; safety of principal or tax exemption, an investor can select one fund or any number of different funds to meet the specific goals. In general mutual fund fall under 3 general categories 1.3.1 Schemes according to Maturity Period Open ended Scheme - An open-ended fund or scheme is one that is available for subscription and repurchase on a continuous basis. These schemes do not have a fixed maturity period. The key feature of open-end schemes is liquidity. Close ended Scheme -The fund is open for subscription only during a specified period at the time of launch of the scheme. A close-ended fund or scheme has a stipulated maturity period e.g. 5-7 years.

1.3.2 Schemes according to Investment Objective Growth / Equity Oriented Scheme - 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 . 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. 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

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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 Gilt Fund - These funds invest exclusively in government securities. Index Funds - Index Funds replicate the portfolio of a particular index such as the BSE Sensitive index, S&P NSE 50 index (Nifty).

1.3.3 Others Scheme Sector Specific 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 Tax Saving Schemes - These schemes offer tax rebates to the investors under specific provisions of the Income Tax Act, 1961 . E.g. Equity Linked Saving Schemes (ELSS). Fund of Funds (FoF) scheme - A scheme that invests primarily in other schemes of the same mutual fund or other mutual funds is known as a FoF scheme Load or no-load Fund - A Load Fund is one that charges a percentage of NAV for entry or exit.

1.4 Drawbacks of Investing Through Mutual Funds While the benefits of investing through Mutual Funds far outweigh the disadvantages ,an investor and his advisor should be aware of a few shortcomings of using the the Mutual Fund as an investment vehicle :No Guarantees - No investment is risk free. If the entire stock market declines in value, the value of mutual funds shares will go down as well, no matter how balanced the portfolio. Investors encounter fewer risks when they invest in mutual funds than when they buy and sell stocks on their own. However, anyone who invests through a mutual fund runs the risk of losing money.

Chapter 1 Conceptual Framework


Fees and commissions - All funds charge administrative fees to cover their day-to-day expenses. Some funds also charge sales commissions or "loads" to compensate brokers, financial consultants, or financial planners. Even if you don't use a broker or other financial adviser, you will pay a sales commission if you buy shares in a Load Fund. 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. No Control Over Costs - Since investors do not directly monitor the funds operations they cannot control the costs effectively. Regulators therefore usually limit the expenses of mutual fund. Managing a Portfolio of funds - As the number of mutual funds increases, in order to tailor a portfolio for himself, an investor may b holding a portfolio of funds, with the costs of monitoring them and using them, incurred by him.

1.5 Regulatory Aspect

1.5.1 Schemes of mutual funds The Asset management company shall launch no schemes unless the trustees approve such scheme and a copy of the offer has been filed with the Board.

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Every mutual fund shall along with the offer documents of each scheme pay filing fees. The offer document shall contain disclosures, which are adequate in order to enable the investors to make informed investment decision including the disclosure non maximum investments proposed to be made by the scheme in the listed securities of the group companies of the sponsor. A close-ended scheme shall be fully redeemed at the end of the maturity period. Unless a majority of the unit holders otherwise decide for its rollover by passing a resolution. The mutual fund and asset management company shall be liable to refund the application money to the applicants: If the mutual fund fails to receive the minimum subscription amount referred to in clause (i) of sub- regulation. If the moneys received from the applicants for units are in excess of subscription as referred to in clause (ii) of sub-regulation.

1.5.2 Procedure for Action In Case Of Default On and from the date of the suspension of the certificate or the approval, as the case may be, the mutual fund, trustees or asset management company, during the period of suspension and shall be subject to the direction of the Board with regard to any records, documents, or securities that may be in its custody or control relating to its activities as mutual funds, trustees or the asset management company. 1.5.3 Restrictions on Investments

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A mutual fund scheme shall not invest more than 15% of its NAV in debt instrument issued by a single issuer, which are rated not below investment grade by a credit rating agency authorize to carry out such activity under the act. Such investment limit may be extended to 20% of the NAV of the scheme with the prior approval of the Board of Trustees and the Board of Asset Management Company. A mutual fund Scheme shall not invest more than 10% of its NAV in unrated debt instrument issued by a single issuer and the total investment in such instruments shall not exceed 25% of the NAV of the Board of Trustees and the Board of Asset management.

No mutual funds under all its schemes should own more than 10% of any companys paid up capital carrying voting rights.

Such transfers are done at the prevailing market price for quoted instrument on spot basis. The securities so transferred shall be in conformity with the investment objectives of the scheme to which such transfer has been made. An scheme may invest in another scheme under the same asset management company or any other mutual fund without charging any fees, provided that aggregated intercourse inter scheme investment made by all schemes under the same management or in schemes under the management of any other asset management company shall not exceed 5% of the net asset value of the mutual fund. The initial issue expenses in respect of any scheme may not exceed 6% of the funds raised under that scheme. Every mutual fund shall buy and sell securities on the basis of deliveries and shall in all cases of purchases, take delivery of relative securities and in all cases of sale,

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deliver the securities and shall in no case put itself in a position whereby it has to make short sale or carry forward transaction or engage in Badla finance. Every mutual fund shall get the securities purchased or transferred in the name of the mutual fund on account of the concerned scheme, wherever investments are intended to be of long-term nature. Pending deployment of funds of a scheme a mutual fund can invest the funds of the scheme in short term deposits of scheduled commercial banks.

No mutual fund scheme shall make any investment in ; o Any unlisted security of an associate or group company of the sponsor or o Any security issued by way of private placement by an associate or group company of the sponsor. A Mutual fund scheme shall not invest more than 5% of its NAV in the equity shares or equity related investments in case of open-ended schemes and 10 % of its NAV in case of close ended schemes.

Chapter 1 Conceptual Framework 1.6 Major Mutual Fund Companies


Franklin Templeton India Mutual Fund - The group, Franklin Templeton Investments is a California (USA) based company with a global AUM of US$ 409.2 bn. (as of April 30, 2005). It is one of the largest financial services groups in the world. Investors can buy or sell the Mutual Fund through their financial advisor or through mail or through their website. They have Open-end Diversified Equity schemes, Open-end Sector Equity schemes, Open-end Hybrid schemes, Open-end Tax Saving schemes, Open end Income and Liquid schemes, closed end Income schemes and Open end Fund of Funds schemes to offer. HDFC Mutual Fund - HDFC Mutual Fund was setup on June 30, 2000 with two sponsors namely Housing Development Finance Corporation Limited and Standard Life.

Reliance Mutual Fund - Reliance Mutual Fund (RMF) was established as trust under Indian Trusts Act, 1882. The sponsor of RMF is Reliance Capital Limited and Reliance Capital Trustee Co. Limited is the Trustee. It was registered on June 30, 1995 as Reliance Capital Mutual Fund, which was changed on March 11, 2004. Reliance Mutual Fund was formed for launching of various schemes under which units are issued to the Public with a view to contribute to the capital market and to provide investors the opportunities to make investments in diversified securities. State Bank of India Mutual Fund - State Bank of India Mutual Fund is the first Bank sponsored Mutual Fund to launch offshore fund, the India Magnum Fund with a corpus of Rs. 225 cr. approximately. Today it is the largest Bank sponsored Mutual Fund in India. They have already launched 35 Schemes out of which 15 have already yielded handsome returns to investors. State Bank of India Mutual Fund has more than Rs. 5,500 Corers as AUM. Now it has an investor base of over 8 Lakhs spread over 18 schemes.

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Tata Mutual Fund - Tata Mutual Fund (TMF) is a Trust under the Indian Trust Act, 1882. The sponsors for Tata Mutual Fund are Tata Sons Ltd., and Tata Investment Corporation Ltd. The investment manager is Tata Asset Management Limited and its Tata Trustee Company Pvt. Limited. Tata Asset Management Limited is one of the fastest in the country with more than Rs. 7,703 corers (as on April 30, 2005) of AUM.

Unit Trust of India Mutual Fund - UTI Asset Management Company Private Limited, established in Jan 14, 2003, manages the UTI Mutual Fund with the support of UTI Trustee Company Private Limited. UTI Asset Management Company presently manages a corpus of over Rs.20000 Corer. The sponsors of UTI Mutual Fund are Bank of Baroda (BOB), Punjab National Bank (PNB), State Bank of India (SBI), and Life Insurance Corporation of India (LIC). The schemes of UTI Mutual Fund are Liquid Funds, Income Funds, Asset Management Funds, Index Funds, Equity Funds and Balance Funds. Bank of Baroda Mutual Fund (BOB Mutual Fund) - Bank of Baroda Mutual Fund or BOB Mutual Fund was setup on October 30, 1992 under the sponsorship of Bank of Baroda. BOB Asset Management Company Limited is the AMC of BOB Mutual Fund and was incorporated on November 5, 1992. Deutsche Bank AG is the custodian. HSBC Mutual Fund - HSBC Mutual Fund was setup on May 27, 2002 with HSBC Securities and Capital Markets (India) Private Limited as the sponsor. Board of Trustees, HSBC Mutual Fund acts as the Trustee Company of HSBC Mutual Fund.

ABN AMRO Mutual Fund - ABN AMRO Mutual Fund was setup on April 15, 2004 with ABN AMRO Trustee (India) Pvt. Ltd. as the Trustee Company. The AMC, ABN AMRO Asset Management (India) Ltd. was incorporated on November 4, 2003. Deutsche Bank A G is the custodian of ABN AMRO Mutual Fund.

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Birla Sun Life Mutual Fund - Birla Sun Life Mutual Fund is the joint venture of Aditya Birla Group and Sun Life Financial. Sun Life Financial is a global organization evolved in 1871 and is being represented in Canada, the US, the Philippines, Japan, Indonesia and Bermuda apart from India. Birla Sun Life Mutual Fund follows a conservative long-term approach to investment. Recently it crossed AUM of Rs. 10,000 corers. ING Vysya Mutual Fund - ING Vysya Mutual Fund was setup on February 11, 1999 with the same named Trustee Company. It is a joint venture of Vysya and ING. The AMC, ING Investment Management (India) Pvt. Ltd. was incorporated on April 6, 1998.

Prudential ICICI Mutual Fund - The mutual fund of ICICI is a joint venture with Prudential Plc. of America; one of the largest life insurance companies in the US of A. Prudential ICICI Mutual Fund was setup on 13th of October 1993 with two sponsors, Prudential Plc. and ICICI Ltd. The Trustee Company formed is Prudential ICICI Trust Ltd. Sahara Mutual Fund - Sahara Mutual Fund was set up on July 18, 1996 with Sahara India Financial Corporation Ltd. as the sponsor. Sahara Asset Management Company Private Limited incorporated on August 31, 1995 works as the AMC of Sahara Mutual Fund. The paid-up capital of the AMC stands at Rs 25.8 crore. Kotak Mahindra Mutual Fund - Kotak Mahindra Asset Management Company (KMAMC) is a subsidiary of KMBL. It is presently having more than 1,99,818 investors in its various schemes. KMAMC started its operations in December 1998. Kotak Mahindra Mutual Fund offers schemes catering to investors with varying risk - return profiles. It was the first company to launch dedicated gilt scheme investing only in government securities.

Chapter 1 Conceptual Framework


Standard Chartered Mutual Fund - Standard Chartered Mutual Fund was set up on March 13, 2000 sponsored by Standard Chartered Bank. The Trustee is Standard Chartered Trustee Company Pvt. Ltd. Standard Chartered Asset Management Company Pvt. Ltd. is the AMC which was incorporated with SEBI on December 20,1999.

Morgan Stanley Mutual Fund India - Morgan Stanley is a worldwide financial services company and its leading in the market in securities, investment management and credit services. Morgan Stanley Investment Management (MISM) was established in the year 1975. It provides customized asset management services and products to governments, corporations, pension funds and non-profit organizations. Its services are also extended to high net worth individuals and retail investors. In India it is known as Morgan Stanley Investment Management Private Limited (MSIM India) and its AMC is Morgan Stanley Mutual Fund (MSMF). This is the first close end diversified equity scheme serving the needs of Indian retail investors focusing on a long-term capital appreciation.

Escorts Mutual Fund - Escorts Mutual Fund was setup on April 15, 1996 with Escorts Finance Limited as its sponsor. The Trustee Company is Escorts Investment Trust Limited. Its AMC was incorporated on December 1, 1995 with the name Escorts Asset Management limited. Alliance Capital Mutual Fund - Alliance Capital Mutual Fund was setup on December 30, 1994 with Alliance Capital Management Corp. of Delaware (USA) as sponsor. The Trustee is ACAM Trust Company Pvt. Ltd. and AMC, the Alliance Capital Asset Management India (Pvt) Ltd. with the corporate office in Mumbai. Benchmark Mutual Fund - Benchmark Mutual Fund was setup on June 12, 2001 with Niche Financial Services Pvt. Ltd. as the sponsor and Benchmark Trustee Company Pvt. Ltd. as the Trustee Company. Incorporated on October 16, 2000 and headquartered in Mumbai, Benchmark Asset Management Company Pvt. Ltd. is the AMC.

Can bank Mutual Fund - Can bank Mutual Fund was setup on December 19, 1987 with Canara Bank acting as the sponsor. Can bank Investment Management Services Ltd.

Chapter 1 Conceptual Framework


incorporated on March 2, 1993 is the AMC. The Corporate Office of the AMC is in Mumbai. Chola Mutual Fund - Chola Mutual Fund under the sponsorship of Cholamandalam Investment & Finance Company Ltd. was setup on January 3, 1997. Cholamandalam Trustee Co. Ltd. is the Trustee Company and AMC is Cholamandalam AMC Limited.

LIC Mutual Fund - Life Insurance Corporation of India set up LIC Mutual Fund on 19th June 1989. It contributed Rs. 2 Corers towards the corpus of the Fund. LIC Mutual Fund was constituted as a Trust in accordance with the provisions of the Indian Trust Act, 1882. . The Company started its business on 29th April 1994. The Trustees of LIC Mutual Fund have appointed Jeevan Bima Sahayog Asset Management Company Ltd as the Investment Managers for LIC Mutual Fund.

1.7 Some facts for the growth of Mutual Funds in India

100% growth in the last 6 years. Number of foreign AMC's are in the queue to enter the Indian markets like Fidelity Investments, US based, with over US$1trillion assets under management worldwide. Our saving rate is over 23%, highest in the world. Only channelizing these savings in mutual funds sector is required. We have approximately 29 mutual funds which is much less than having more than 800. There is a big scope for expansion. 'B' and 'C' class cities are growing rapidly. Today most of the mutual funds are concentrating on the 'A' class cities. Soon they will find scope in the growing cities.

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Mutual fund can penetrate rural like the Indian insurance industry with simple and limited products. SEBI allowing the MF's to launch commodity mutual funds. Emphasis on better corporate governance. Trying to curb the late trading practices. Introduction of Financial Planners who can provide need based advice.