You are on page 1of 26

managed type of collective investment

scheme that pools money from many

investors to buy stocks, bonds, shortterm money market instruments,
and/or other securities.
Mutual funds are operated by money
managers, who invest the fund's
capital & attempt to produce capital
gains & income for the fund's
investors. A mutual fund's portfolio is
structured and maintained tomatch
the investment objectives stated inits

Mutual funds givesmall investors

access toprofessionally managed,
diversified portfolios of equities, bonds
and other securities, which would be
quite difficult to create with a small
amount of capital. Each shareholder
participates proportionally in the gain
or loss of the fund. Mutual fund units
or shares are issued & can typically be
purchased or redeemed as needed at
the fund's current net asset value
(NAV)per share, whichis sometimes
expressed as NAVPS.

Earning from a mutual fund:

Income is earned from dividends on stocks and
interest on bonds. A fund pays out nearly all of
theincome it receives over the year to fund
owners in the form of a distribution.
If the fund sells securities that have increased in
price, the fund has a capital gain. Most funds
also pass on these gains to investors in a
If fund holdings increase in price but are not
sold by the fund manager, the fund's shares
increase in price. One can then sell mutual fund
shares for a profit.

Funds will also usually give you a choice

either to receive a check for distributions or
to reinvest earnings & get more shares.

Advantages of Mutual Funds

Professional Management One gets professional

management of money. Investors purchase funds as
they do not have time or expertise to manage their
own portfolios. A mutual fund is relatively inexpensive
way for a small investor to get a full-time manager to
make & monitor investments.
Diversification - Investing in mutual fund instead of
owning individual stocks or bonds, risk is spread out.
Diversification is for investing in large number of
assets so that loss in any particular investment is
minimized by gains in others. Large mutual funds
typically own hundreds of different stocks in many
different industries. It wouldn't be possible for
individual investor to build this kind of a portfolio

Economies of Scale - As mutual fund

buys & sells large amounts of
securities at a time, its transaction
costs are lower than what an individual
would pay for securities transactions.
Liquidity - Just like an individual
stock, a mutual fund allows to request
that shares be converted into cash at
any time.
Simplicity - Buying a mutual fund is
easy! Pretty well any bank has its own
line of mutual funds & minimum

Professional Management - Many investors
debate whether or not the professionals are any
better than you or I at picking stocks.
Management is by no means infallible, & even if
the fund loses money, the manager still gets
Costs - Creating, distributing & running mutual
fund is expensive. Everything from managers
salary to investors statements cost money.
Those expenses are passed on to the investors.
Since fees vary widely from fund to fund, failing
to pay attention to the fees can have negative
long-term consequences. Remember, every
rupee spent on fees is a rupee that has no
opportunity to grow over time.

Dilution - It's possible to have too much

diversification as funds have small holdings in
so many different companies, high returns from
a few investments often don't make much
difference on the overall return.Dilution is also
the result of a successful fund getting too big.
When money starts pouring into funds having
strong success, fund manager often has trouble
to find good investment for all the new money.
Taxes - When a fund manager sells a security,
capital-gains tax is imposed. Investors need to
keep these facts in mind when investing.Taxes
can be mitigated by investing in tax-sensitive
funds .

Net asset value or NAV

A fund's net asset value or NAV equals
current market value of a fund's
holdings minus fund's liabilities
(sometimes referred to as "net
It is usually expressed as per-share
amount, computed by dividing net
assets by the number of fund shares
outstanding. Valuing the securities held
in a fund's portfolio is often the most
difficult part of calculating net asset

It is a measure of volume of a fund's
securities trading. It is expressed as
percentage of net asset value & is
normally annualized. Turnover equals
the lesser of a fund's purchases or
sales during a given period (of no
more than a year) divided by
average net assets. If the period is
less than a year, the turnover figure
is annualized.

Investing in Mutual Funds : Choosing Mutual

Buying : One can buy some mutual funds by
contacting fund companies directly or through
brokers, banks, financial planners, or insurance
NAV is fund's assets minus liabilities, is the value of
a mutual fund. NAV per share is value of one share
in mutual fund which is quoted in newspapers.
Basically NAV per share may be considered as
price of mutual fund. It fluctuates everyday.
When shares are bought at current NAV per share,
sales front-end load (fees) may be paid. When
shares are sold, the fund will you NAV less any
back-end load (fees).

Identifying Goals & Risk Tolerance Identifying a goal is important to find the
right fund for the task.
Before investing in fund, identify
why you are investing?
What is your goal?
Are long-term capital gains desired, or
current income is preferred?
Will the money be used to pay for current
expenses, or to supplement long term plan?
For short-term goals, money market funds
may be the right choice, For long term goals,
bond funds, stock funds may be appropriate.

Issue of risk tolerance is also important.

Investors taking more risk may prefer
stock funds over bond funds.
Investors taking less risk may prefer
bond funds over stock funds.
Investors trying to outperform funds
benchmark index or more concerned
about cost of investments - cost index
funds may be preferred.
How much money to invest
Whether to invest in a lump sum or a
regularly over the time

Each mutual fund has different risks & rewards. In general, the
higher the potential return, the higher the risk of loss.
Although some funds are less risky than others, all funds have
some level of risk - it's never possible to diversify away all risk.
This is a fact for all investments.
Each fund has a predetermined investment objective that
tailors fund's assets, regions of investments & investment
strategies. At the fundamental level, there are three types of
mutual funds:
1) Equity funds (stocks)
2) Fixed-income funds (bonds)
3) Money market funds
All mutual funds are variations of these three types. For
example, while equity funds that invest in fast-growing
companies are known as growth funds, equity funds that
invest only in companies of the same sector or region are
known as specialty funds.

Money Market Funds

The money market consists of shortterm debt instruments, mostly
Treasury bills. This is a safe place to
park money. One won't get great
returns, but won't have to worry
about losing your principal. A typical
return is twice the amount you would
earn in a regular checking/savings
account & a little less than the
average certificate of deposit (CD).

Bond/Income Funds
Their purpose is to provide current income
on a steady basis. Such mutual funds, the
terms "fixed-income," "bond," and
"income" are used. These MF invest
primarily in government & corporate debt.
While fund holdings may appreciate in
value, primary objective of these funds is
to provide a steady cash-flow to investors.
Generally conservative investors and
retirees. Invest in these funds.

Bond funds are likely to pay higher returns

than certificates of deposit & money market
investments, but bond funds aren't without
risk. Because there are many different types
of bonds, bond funds can vary dramatically
depending on where they invest. For
example, a fund specializing in high-yield
junk bonds is much more risky than a fund
that invests in government securities. Nearly
all bond funds are subject to interest rate
risk, which means that if rates go up the
value of the fund goes down.

Balanced Funds
The objective of these funds is to provide a
balanced mixture of safety, income & capital
appreciation. Strategy of balanced funds is to
invest in a combination of fixed income & equities.
A typical balanced fund might have a weighting of
60% equity & 40% fixed income. The weighting
might also be restricted to a specified maximum or
minimum for each asset class.
Similar type of fund is known as asset allocation
fund. Objectives are similar to those of a balanced
fund, but these kinds of funds typically do not have
to hold a specified percentage of any asset class.
The portfolio manager is therefore given freedom
to switch the ratio of asset classes as the economy
moves through the business cycle.

Equity Funds
These MF invest in stocks, represent
largest category of mutual funds.
Generally, investment objective of this
class of MF is long-term capital growth
with some income.
There are many different types of equity
funds as there are many different types
of equities. A way to understand the
universe of equity funds is to use a style
box. The idea is to classify funds based
on both size of companies invested in
and investment style of the manager.

The term value is style of investing that looks

for high quality companies that are out of
favor with the market. These companies are
characterized by low P/E and & high dividend
yields. The opposite of value is growth, which
is the companies that have had & will have
strong growth in earnings, sales & cash flow. A
compromise between value & growth is
blend, which refers to companies that are
neither value nor growth stocks & are
classified as being somewhere in the middle.
----------- Investment Style -------------l
l Mid
l Small




For example, a mutual fund that

invests in large-cap companies that
are in strong financial shape but
have recently seen their share prices
fall would be placed in the upper left
quadrant of the style box (large and
The opposite of this would be a fund
that invests in startup technology
companies with excellent growth
prospects. Such a mutual fund would
reside in the bottom right quadrant
(small and growth).

What are small cap, mid cap and large cap shares?
Market capitalization (or mkt cap) of any stock traded in
the stock market is the stocks current market price
multiplied with its total shares outstanding.
The classification of stocks into large cap, mid cap & small
cap is quite subjective & would depend on the views of
investors (both big and small) in this regard. For instance,
stocks with a market capitalization of 5,000 crores & above
may be classified as large caps; stocks with a market
capitalization between 1,000 crores & 4,999 crores may be
classified as mid caps; & stocks with market capitalization
of less than 1,000 crores may be classified as small caps.
The above is only an example; you may choose to abide by
the classification available with your investment advisor; or
you may decide to create your own classification at your
convenience, as you may consider the latter classification
more suitable for the efficiency of your investment decision
making process.

Mid cap funds are those mutual funds,

which invest in small / medium sized
companies. As there is no standard
definition classifying companies as small
or medium, each mutual fund has its own
classification for small and medium sized
companies. Generally, companies with a
market capitalization of up to Rs 500 crore
are classified as small. Those companies
that have a market capitalization between
Rs 500 crore and Rs 1,000 crore are
classified as medium sized. Companies
having market capitalization above Rs
1000 crore are large sized.

Global/International Funds
An international fund (or foreign fund) invests
only outside home country. Global funds
invest anywhere around the world, including
home country.
It's tough to classify these funds as either
riskier or safer than domestic investments.
They do tend to be more volatile & have
unique country and/or political risks. But, on
the flip side, they can, as part of a wellbalanced portfolio, actually reduce risk by
increasing diversification. Although the world's
economies are becoming more inter-related, it
is likely that another economy somewhere is
outperforming the economy of home country.

Specialty Funds
These MF are all-encompassing category
consisting of funds that have proved to be
popular but don't necessarily belong to
specific categories. This type of MF
forgoes broad diversification to
concentrate on a certain segment of the

Sector funds are targeted at specific

sectors of the economy such as financial,
technology, health, etc. Sector funds are
extremely volatile. There is a greater
possibility of big gains, but one has to
accept that your sector may be a tank.

Regional funds make it easier to focus on a specific

area of the world. This may mean focusing on a
region (say Latin America) or an individual country
(for example, only Brazil). An advantage of these
funds is that they make it easier to buy stock in
foreign countries, which is otherwise difficult and
expensive. Just like for sector funds, one has to
accept high risk of loss, which occurs if the region
goes into a bad recession.
Socially-responsible funds (or ethical funds) invest
only in companies that meet criteria of certain
guidelines or beliefs. Most socially responsible
funds don't invest in industries such as tobacco,
alcoholic beverages, weapons or nuclear power.
The idea is to get a competitive performance while
still maintaining a healthy conscience.

Index Funds
This type of mutual fund replicates
the performance of a broad market
index such as the S&P 500 or Dow
Jones Industrial Average (DJIA). An
investor in an index fund figures that
most managers can't beat the
market. An index fund merely
replicates the market return &
benefits investors in the form of low