Mutual

Funds
What are Mutual Funds?
A mutual fund is a company that pools money from many investors and invests it in
securities such as stocks, bonds, and short-term debt. The combined holdings of the
mutual fund are known as its portfolio. Investors buy shares in mutual funds. Each share
represents an investor’s part ownership in the fund and the income it generates.
Why do people buy mutual funds?

•Professional Management. 

•Higher returns

•Diversification or “Don’t put all your eggs in one basket.”

•Affordability

•Liquidity

•Transparency

•Highly regulated
Types of Mutual Funds
Drawbacks of Mutual Funds
•No guarantee of returns

•Unpredictable

•Higher cost of management

•No control
 Factors influencing selection of
mutual funds
Past Performance

Timings

Size of Fund

Age of fund

Largest holding

Fund manager

Expense Ration

PE Ratio

Portfolio Turnover
 Evaluating Performance of Mutual
Funds
 Performance can be evaluated by comparing NAV and cost of mutual funds.

Net Asset Value: Net asset value (NAV) is defined as the value of a fund’s assets minus the value of its
liabilities. It is the amount which a unit holder would receive if mutual fund were wound up.
NAV= Market value of investments + receivables + Other accrued income + Other assets – Accrued Expenses
– Other payables – Other Liabilities
NAV= Net Assts of Scheme/No of Units

Cost of Mutual Funds: Broadly cost of mutual funds carries two components:

Initial Expenses

Ongoing Recurring Expenses

Computation of Returns
Mainly investors derive three types of returns on mutual funds:

Cash Dividends - D1

Capital gain disbursements CG1

Changes in the funds NAV- NAV1 – NAV0

 Annual Return= D1+CG1+(NAV1 – NAV0) *100

NAV0
Criteria for Evaluating the
Performance
Following three ratios are used to evaluate the performance of mutual funds:

Sharpe Ratio

Treynor Ratio

Jensen’s Alpha
Sharpe Ratio
The Sharpe ratio was developed by Nobel laureate William F. Sharpe and is used to
help investors understand the return of an investment compared to its risk.

Sharpe Ratio= Return Portfolio – Return on Risk free investment

Standard Deviation of the Portfolio

*Subtract the risk-free rate from the return of the portfolio. The risk free rate could be a U.S. Treasury
rate or yield, such as the one-year or two-year Treasury yield.

*Divide the result by the standard deviation of the portfolio’s excess return. The standard
deviation helps to show how much the portfolio's return deviates from the expected return. The
standard deviation also sheds light on the portfolio's volatility.
Treynor Ratio
Treynor ratio is a measure of the returns earned more than the risk-free return at a given level
of market risk. It highlights the risk-adjusted profits generated by a mutual fund scheme. This ratio
was given by Jack Treynor, thereby expanding the contribution of William Sharpe towards modern
portfolio theory.

Treynor Ratio= Return Portfolio – Return on Risk free investment

Beta of the Portfolio

(Sensitivity of the portfolio towards movement of the underlying benchmark)

Jensen’s Alpha
The ratio is the performance ratio which evaluates the returns of the fund over its index. This helps
investors examine the risk adjusted performance of the portfolio and determine risk reward profile
of mutual fund. 

Alpha= Return on Portfolio – Expected Return

TOP 5 MEASURES TO EVALUATE A MUTUAL FUND’S PERFORMANCE
Alpha

Beta

Expense Ratio

Allocations in the Fund’s Portfolio

Rolling Returns
Exchange Traded Funds
An exchange-traded fund (ETF) is a type of pooled investment security that operates much like a
mutual fund.

Typically, ETFs will track a particular index, sector, commodity, or other assets, but unlike mutual
funds, ETFs can be purchased or sold on a stock exchange the same way that a regular stock can.

An ETF can be structured to track anything from the price of an individual commodity to a large and
diverse collection of securities. ETFs can even be structured to track specific investment strategies.
Difference between ETFs and
Mutual Funds
Mutual Funds
Mutual Funds are traded at the
closing net asset value.
Mutual Funds have varying
operating expenses.
Most Mutual Funds have a
minimum expense specified.
Mutual Funds have more tax
liabilities than ETFs.
Mutual Fund shares can only be
purchased directly from the funds
at the NAV price that is fixed
during the trading day.
Exchange Traded Fund (ETF)
Exchange Traded Funds are traded
during the course of a trading day
and its value varies during this
time.
ETF has lower operating
expenses.
There is no minimum investment
specified for Exchange Traded
Funds.
ETFs offer tax benefits to the
investors due to the manner of its
creation and redemption.
ETF can be bought and sold
anytime on the stock exchange, at
the prevailing market price.
ETFs Vs Mutual Funds
Generally, compared to ETFs, the transaction costs are There is an additional cost involved while trading ETFs,
zero when mutual fund shares are bought or sold. which is called the "bid-ask spread".

ETF has higher liquidity since it is not connected to its

Mutual Funds have lower liquidity compared to
daily trading volume. ETF liquidity is related to the
Exchange Traded Funds.
liquidity of the stocks included in the index.

ETF do not have a time limit on selling an asset. The

Some mutual funds levy a penalty on selling the share
investor can buy or sell at any point of the trading day at
early. Usually, the time limit imposed on selling a share is
the price available during the time. Therefore, there is no
90 days from the date of purchase.
minimum holding period specified for the same.

Exchange Traded Funds track an index, i.e., it tries to

Mutual Funds are index-tracking but is actively managed
match the price movements and returns indicated in an
by professionals. Assets are picked in such a way that it
index by assembling a portfolio which is similar to the
beats the index and achieves higher performance.
index constituents.
Types of ETFs
Diversified passive equity ETFs are designed to mirror the performance of widely followed stock
market benchmarks such as the S&P 500, the Dow Jones Industrial Average, and the MSCI Europe
Australasia Far East (EAFE) indices. Major index-based ETFs have tended to follow their performance
benchmarks closely.

Niche passive equity ETFs such as those that mirror the sector subsets of the bigger index

Active equity ETFs allow their managers to use their own judgment in selecting investments, rather
than rigidly pegging to a benchmark index. 

Fixed-income ETFs focus on bonds rather than stocks. Major fixed-income ETFs tend to be actively
managed, but have relatively low turnover and generally stable portfolios.
 ETFs
Advantages
•Potential tax efficiency
•Low expense ratios
•Trades throughout the day on an exchange
•No minimum investment dollar amount (may not buy fractional shares)
•Can be sold short and bought on margin

Disadvantages
•Brokerage commissions incurred
•Capital gains occasionally distributed
•Flexibility may encourage frequent trading, potentially negating the tax-efficient edge
Asset Management Company
An asset management company (AMC) is a firm that invests a pooled fund of capital on behalf of its
clients. The capital is used to fund different investments in various asset classes. Asset
management companies are commonly referred to as money managers or money management
firms as well.

V
10 Biggest AMCs in India 2022

•1. SBI Mutual Fund

•2. ICICI Prudential Asset Management Company
•3. HDFC Asset Management Company 
•4. Birla Sun Life Mutual Fund (BSLMF)
•5. Kotak Mahindra Asset Management Company 
•6. Nippon India Asset Management Company 
•7. Axis Asset Management Company
•8. UTI Mutual Fund 
•9. IDFC Asset Management Company
•10. DSP Mutual Fund
Structure of Mutual Funds
Regulation of Mutual Funds
Market regulator SEBI oversees all mutual fund schemes in India. It issues strict guidelines that AMCs
must follow while managing funds. The guidelines call for complete transparency related to a mutual
fund scheme which include full disclosure of:

•fund value

•expenses

•fund utilisation as per the scheme’s objectives

 Regulation of MFI
•Every mutual fund must be registered with SEBI.

•A mutual fund is always set up as a trust, with sponsors, trustees, an asset management company (“AMC”) and a custodian.

•An AMC of a mutual fund should have at least 50% independent directors, a separate board of trustees which includes 50%
independent trustees and independent custodians so as to manage any conflict of interest among fund managers, custodians,
and trustees.
•A single mutual fund can float different schemes but they have to be individually approved by the trustees and all offer
documents have to be filed with the SEBI.

•SEBI lays down certain restrictions on the fees that AMCs can charge for mutual funds and there is also a cap on the expenses
that can be added to the fund.
•Mutual funds can advertise, but advertisements cannot have statements that are misleading. For instance, no mutual fund can
guarantee a return since returns depend on market performance.
Regulation of MFI
•SEBI stipulates the following for open-ended and close-ended funds:
• An open-ended scheme needs a minimum corpus of 50 crores
• A closed-ended scheme needs at least 20 crores corpus
• SEBI checks mutual funds every year in order to make it in compliance with the regulations and
guidelines.

Mutual fund regulation guidelines are hosted on the SEBI website. Click on this link to find out more.
Hedge Funds
A hedge fund is a privately pooled investment fund that uses various strategies to optimise
returns. As the name suggests, a hedge fund “hedges” i.e. attempts to reduce the market risk.
The main aim of the hedge fund is to maximise returns. The hedge fund value is based on the
fund’s NAV (Net Asset Value).
Hedge Funds
A hedge fund falls under Category III of the Alternative Investment Fund (AIF) in India. AIFs
were introduced in India in 2012 by Securities and Exchange Board of India (SEBI) in 2012
under the SEBI (Alternative Investment Funds) Regulations, 2012.

It was introduced in order to have more transparency in the functioning of AIFs.

To be classified as a hedge fund, a fund needs to have a minimum corpus of INR 20 crore and a
minimum investment of INR 1 crore by each investor.

An alternative investment is an investment product apart from traditional investments like

cash, stocks or and Bonds. AIFs include venture Capital, private equity, option, futures, etc.
basically, anything that doesn’t fall under the traditional categories of property, equity or fixed
Income.
Hedge funds Vs Mutual Funds
1.A hedge fund is described as a portfolio investment whereby, only a few accredited investors are
allowed to pool their money together to buy assets. Mutual funds refer to a professionally managed
investment vehicle, where the funds are collected from several investors are pooled together to
purchase securities.

2.Hedge funds seek absolute returns. Conversely, mutual funds seek relative returns on the investment
made in securities.

3.Hedge funds are aggressively managed, where advanced investment and risk management techniques
are used to reap good returns, which is not in the case of mutual funds.
Hedge funds Vs Mutual Funds
4. The owners of a mutual fund are large in number, i.e. there can be thousands of owners of a mutual
fund. However, a hedge fund owners are limited in number.

5. If we talk about the type of investors, hedge fund investors are high net worth investors. On the other
hand, a mutual fund has small and retail investors.

6. Hedge funds are lightly regulated whereas mutual funds are strictly regulated by the Securities
Exchange Board of India (SEBI).
Hedge funds Vs Mutual Funds
7. The management fees depend on the percentage of assets managed in mutual funds. As opposed to
hedge funds, where the management fees are based on the performance of assets.

8. In hedge funds, the fund manager also holds a substantial part of ownership. Unlike mutual funds
where the fund manager does not hold substantial interest.

9. In mutual funds, the reports are published yearly, and disclosure of the performance of assets is made
half yearly. As opposed to hedge funds, where the information is provided to investors only, and there is
no disclosure of operations publicly.
Top Hedge Funds in India
 Munoth Hedge Fund,

Forefront Alternative Investment Trust,

Quant First Alternative Investment Trust and IIFL Opportunities Fund.

There are others such as Singlar India Opportunities Trust, Motilal Oswal's offshore hedge
fund and India Zen Fund.