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Management of Financial Services

Mutual Funds & AMCs

Introduction

Mutual funds are investment companies that use the funds from investors to invest in other companies or investment alternatives. They have the advantage of professional management, diversification, convenience and special services such as cheque writing and telephone account service. It is generally easy to sell mutual fund shares/units although you run the risk of needing to sell and being forced to take the price offered. Mutual funds come in various types, allowing you to choose those funds with objectives, which most closely match your own personal investment objectives.

A mutual fund is a portfolio, or collection, of individual securities (some combination of stocks, bonds, or money market instruments) managed according to a specific objective spelled out in the fund's prospectus. A mutual fund allows investors to pool their money, then the fund invests it on their behalf. Unlike individual stocks, whose value fluctuates minute by minute, mutual funds are priced at the end of each day the market is open, based on what the securities in the portfolio are worth. The price per share, or net asset value (NAV).

The fee is a percentage of the initial investment. mutual funds sold through brokers are load funds while funds sold directly to the public are no-load or low-load. . Generally. All funds have annual management fees attached. As an investor. you need to decide whether you want to take the time to research prospective mutual funds yourself or pay the commission and have a broker who will do that for you.    A load mutual fund is one that has sales charge or commission attached.

Mutual Fund Operation .

transfer agents. . and custodians (depository participants). registrars.Organisation of Mutual Fund  Three key players namely    sponsor. and asset management company (AMC) are involved in setting up a mutual fund.  They are assisted by other independent administrative entities like banks. mutual fund trust.

Organisation of Mutual Fund .

. The net worth of the immediately preceding year should be more than the capital contribution of the sponsor in AMC and the sponsor should show profits after providing depreciation. with positive net worth in all the immediately preceding five years. This means that the sponsor should have been doing business in financial services for not less than five years. SEBI will register the mutual fund if the sponsor fulfills the following criteria:    The sponsor should have a sound track record and general reputation of fairness and integrity in all his business transactions. interest. and tax for three out of the immediately preceding five years.Sponsor   Sponsor means any person who acting alone or with another body corporate establishes a mutual fund. The sponsor of a fund is akin to the promoter of a company as he gets the fund registered with SEBI.

 The sponsor and any of the directors or principal officers to be employed by the mutual fund. The sponsor is required to contribute at least 40% of the minimum net worth of the asset management company. either directly or acting through the Trustees. He also appoints an Asset Management Company as fund managers. The sponsor forms a trust and appoints a Board of Trustees. The sponsor. also appoints a custodian to hold the fund assets.  . should not have been found guilty of fraud or convicted of an offence involving moral turpitude or guilty of economic offences.

who are the beneficiaries of the Trust. contributing to its initial capital and appoints a trustee to hold the assets of the Trust for the benefit of the unit. The sponsor forms the Trust and registers it with SEBI. .Mutual Funds as Trusts    A mutual fund in India is constituted in the form of a public Trust created under the Indian Trusts Act. The fund then invites investors to contribute their money in the common pool. The fund sponsor acts as the settler of the Trust.holders. by subscribing to ‘units’ issued by various schemes established by the Trust as evidence of their beneficial interest in the fund. 1882.

50% of the trustees shall be independent trustees (who are not associated with an associate. a mutual fund is just a ‘pass through’ vehicle. The trustees shall be accountable for and be the custodian of funds/property of respective scheme.  Thus. which is an independent body and acts as protector of the unit -holders’ interests. Most of the funds in India are managed by the Board of Trustees. . At least. or sponsor in any manner). subsidiary.

It charges a fee for the services it renders to the mutual fund trust. floats and then manages the different investment schemes as per SEBI regulations and the Trust Deed. The AMC. in the name of the Trust. The AMC of a mutual fund must have a net worth of at least Rs 10 crore at all times and this net worth should be in the form of cash. It acts as the investment manager to the Trust under the supervision and direction of the trustees. The AMC should be registered with SEBI. .Asset Management Company        The trustees appoint the Asset Management Company (AMC) with the prior approval of SEBI. to manage the affairs of the mutual fund and operate the schemes of such mutual funds. The AMC is a company formed and registered under the Companies Act. 1956.

It must submit quarterly reports to the mutual fund. At least 50% of the directors of the board of directors of AMC should not be associated with the sponsor or its subsidiaries or the trustees. . It can undertake specific activities such as advisory services and financial consultancy.     It cannot act as a trustee of any other mutual fund. It is required to disclose the scheme particulars and base of calculation of NAV. The trustees are empowered to terminate the appointment of the AMC and may appoint a new AMC with the prior approval of the SEBI and unit-holders.

An AMC shall submit to the trustee’s quarterly reports. . The AMC shall exercise due diligence and care in all its investment decisions. The trustees at the request of an AMC can terminate the assignments of the AMC.Obligations of AMCs     The AMC shall take all the reasonable steps and exercise due diligence to ensure that any scheme is not contrary to the Trust deed and provisions of investment of funds pertaining to any scheme is not contrary to the provisions of the regulations and Trust deed. The AMC shall be responsible for the acts of commission or commissions by its employees or the persons whose services have been procured.

or their relatives for the purpose of any securities transaction and distribution and sale of brokerage/commission paid is disclosed in half-yearly accounts of the mutual fund. No person. The AMC shall abide by the code of conduct specified in the fifth schedule. who has been found guilty of any economic offence or involved in violation of securities law. The registrars and share transfer agents to be appointed by AMC are to be registered with SEBI. .   An AMC shall not deal in securities through any broker associated with a sponsor or a firm which is an associate of sponsor beyond 5% of the daily gross business of the mutual fund. should be appointed as key personnel. No AMC shall utilize services of the sponsor or any of its associates. employees.

Advantages of Mutual Funds            Professional Management Diversification Convenient Administration Return Potential Low Costs Liquidity Transparency Flexibility Choice of schemes Tax benefits Well regulated .

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Types of MF Schemes By Structure .

Usually closed mutual funds trade at discounts to their underlying asset value. Also like a publicly traded company. only a fixed number of shares are available. The fund is open for subscription only during a specified period. Investors can invest in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stock exchanges where they are listed. These funds have a stipulated maturity period generally ranging from 3 to 15 years. you buy or sell shares in the fund through a broker just like a stock (including paying a commission). the price fluctuates in response to the fund's performance and (very important) what people are willing to pay for it.Closed –End Fund    A closed-end fund looks much like a stock of a publicly traded company: it's traded on some stock exchange. The market price of closed-end funds is determined by supply and demand and not by net-asset value (NAV). . as is the case in open-end funds.

but the fund company values the shares on its own. investor sentiment about the fund is not considered. not with any exchange. . The price fluctuates in response to the value of the investments made by the fund. A large portion of most open mutual funds is invested in highly liquid securities. Open-end funds keep some portion of their assets in short-term and money market securities to provide available funds for redemptions.Open-end Fund   An open-end fund is the most common variety of mutual fund. which enables the fund to raise money by selling securities at prices very close to those used for valuations. Investors buy and sell shares usually by dealing directly with the fund company. In other words. Both existing and new investors may add any amount of money they want to the fund. there is no limit to the number of shares in the fund.

.Interval Funds    Interval funds combine the features of openended and close-ended schemes. Let us now classify Mutual Fund Schemes on the Basis of its Investment Objective. They are open for sale or redemption during predetermined intervals at NAV related prices.

Types of MF Schemes By Investment Objective .

Such schemes normally invest a majority of their corpus in equities. .Growth Funds    The aim of growth funds is to provide capital appreciation over the medium to long term. Growth schemes are ideal for investors who have a long-term outlook and are seeking growth over a period of time.

though risks are typically lower than that in a growth fund. Such schemes generally invest in fixed income securities such as bonds.Income Fund     The aim of Income Funds is to provide regular and steady income to investors. Capital appreciation in such funds may be limited. Income Funds are ideal for capital stability and regular income. . corporate debentures and Government securities.

Balanced funds with equal allocation to equities and fixed income securities are ideal for investors looking for a combination of income and moderate growth. investors would be exposed to risks similar to that of the equity market. Such schemes periodically distribute a part of their earning and invest both in equities and fixed income securities in the proportion indicated in their offer documents.Balanced Fund     The aim of Balanced Funds is to provide both growth and regular income. . This proportion affects the risks and the returns associated with the balanced fund .in case equities are allocated a higher proportion.

. Commercial Paper and Inter-Bank Call Money.Money Market Fund     The aim of Money Market Funds is to provide easy liquidity. These schemes generally invest in safer short-term instruments such as Treasury Bills. Certificates of Deposit. These are ideal for corporate and individual investors as a means to park their surplus funds for short periods. preservation of capital and moderate income. Returns on these schemes may fluctuate depending upon the interest rates prevailing in the market.

Types of MF Schemes Other Schemes .

Investments made in Equity Linked Savings Schemes (ELSS) and Pension Schemes are allowed as deduction under Section 88 of the Indian Income Tax Act. as the Government offers tax incentives for investment in specified avenues.Tax Savings Schemes   These schemes offer tax rebates to the investors under specific provisions of the Indian Income Tax laws. . 1961.

.Index Funds  Index Funds attempt to replicate the performance of a particular index such as the BSE Sensex or the NSE S&P CNX 50.

.e. Pharmaceuticals. restricted to specific sector(s) / industry (ies). i. These schemes carry higher risk as compared to general equity schemes as the portfolio is less diversified. Information Technology.Sectoral Funds  Sectoral Funds are those which invest exclusively in specified sector(s) such as FMCG. etc.

The fund company will sell you units at that price (don't forget about any sales charge) or will buy back your units at that price (possibly less some fee). subtract some amount for liabilities. Net Asset Value (NAV) = (Value Of All Securities Held By The Fund .Net Asset Value      Net Asset Value is the market value of the assets of the scheme minus its liabilities. this is the investment company's best assessment of the value of a portfolio holdings in their fund. divide the result by the number of outstanding units in the fund and you have the NAV.  The per unit NAV is the net asset value of the scheme divided by the number of units outstanding on the Valuation Date. Basically. They use the daily closing price of all securities held by the fund. and is what you see listed in the paper.Expenses And Liabilites Of The Fund)/ Number Of Outstanding Units In The Fund .

 Transaction fees paid when you buy or sell shares in a fund   . and they are the main reason why the majority of funds end up with sub-par performance.Costs in Mutual Funds  Costs are the biggest problem with mutual funds. Some critics of the industry say that mutual fund companies get away with the fees they charge only because the average investor does not understand what he/she is paying for. Fees can be broken down into two categories:  Ongoing yearly fees to keep you invested in the fund. These costs eat into your return. What's even more disturbing is the way the fund industry hides costs through a layer of financial complexity and jargon.

Administrative costs . this fee ensures that mutual fund managers remain in the country's top echelon of earners.5% and 1% of assets on average. This is sometimes also referred to as the Management Expense Ratio (MER).  While it sounds small. Some funds are excellent at minimizing these costs while others (the ones with the cappuccino machines in the office) are not. . customer service. this cost is between 0. record keeping. agent commission.Also known as the management fee. registrar fees and the selling and promotion expenses.These include necessities such as postage. The Expense Ratio is also known as Annual Recurring Expenses. etc. This basket of charges comprises the fund management fee.Expense ratio      The ongoing expenses of a mutual fund is represented by the expense ratio. cappuccino machines. The expense ratio is composed of the following: The cost of hiring the fund manager(s) .

 . Funds state their buying and selling price after taking the transaction cost into account. The limit stands at 2. the Securities & Exchange Board of India (SEBI) has stipulated an upper limit that a fund can charge.50 per cent for equity funds and 2.   There are marketing and distribution expenses and all those involved in the operations of a fund like the custodian and auditors also get a share of the pie. Interestingly.25 per cent for debt funds. However to keep things in check. brokerage paid by a fund on the purchase and sale of securities is not reflected in the expense ratio.

Find out      Growth option Dividend payout option SIP SWP State of MF Industry in India .

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